“Fiduciary” and “Fee-Only” Matter Less Than You Think | White Coat Investor

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Today’s guest post was submitted by James Sweeney CFA, CFP®, MBA. James is the Founder and Wealth Advisor of SwitchPoint Financial Planning, a flat-fee financial planning firm, and one of our WCI Recommended Advisors. This is not a sponsored post.]

A few months ago, the CFP® Board decided to remove compensation method from its “Find Your CFP® Professional” search tool on letsmakeaplan.org. The move was supposedly an effort to emphasize the fiduciary duty of CFP® professionals, rather than their method of compensation.

They also said that consumers rarely use compensation method as a primary search tool.

I believe the CFP® Board got this one wrong. And apparently, most consumers are getting it wrong as well. 

In this article, I will argue that compensation structure is a primary driver of services provided and advice given, and that it should be a primary selection criterion for consumers in search of a financial advisor.

Incentives Beat Adjectives: Why “Fiduciary”, “Fee-Only”, and, “Independent” Matter Less Than You Think

Everyone Wants to Say They Are A Fiduciary

A few years ago, a physician called my office to ask for a second opinion. He had been in discussions with a financial advisor at a prominent insurance company who was proposing whole life insurance for a significant portion of this investor’s portfolio. 

We discussed the pros and cons of whole life insurance and in the end, I recommended against it. This difference in opinion was confusing to my new client. Why would two expert “advisors” recommend such different strategies? 

I explained to him that, as a fiduciary, I had a legal obligation to act in his best interest, while the other advisor was financially motivated to sell him life insurance.

He quickly replied, “Oh, well my other advisor is a fiduciary as well.”

For a moment I was floored. How could this be? Every client of this particular firm that I had ever met had been sold whole life insurance – and a lot of it. How could this advisor recommend the same high-commission product to every single client, and yet be a fiduciary?

But it was true – sort of. This advisor was a Certified Financial Planner®. And since 2007, CFP® practitioners have committed to a fiduciary standard for financial planning (recently updated to apply to all aspects of financial advice). I am sure this advisor considered himself a fiduciary. 

Did he care to explain to his clients the fine details of when he is obligated to act as a fiduciary, and when he is not? No. Perhaps it was disclosed in some fine print somewhere. But it is easier to just say “Yes, I’m a fiduciary.”

A few years ago, when the Department of Labor first proposed the “Fiduciary Rule”, the term fiduciary exploded in popularity and has turned into more of a marketing tactic than a standard of care.

[In case it isn’t clear, a fee-based advisor like many insurance agents and mutual fund salesmen can wear two hats. When wearing one, he has a fiduciary duty. When wearing the other, he does not. Good luck figuring out when he takes one off and puts the other on.-ed]

More Adjectives That Sell

“Fiduciary” certainly isn’t the only buzzword advisors like to throw around. I’ve seen many advisor websites that discuss, at length, what “fee-only” means and why you should hire a fee-only advisor. This type of content helps their websites rank well on Google for a commonly searched keyword. And yet, on closer inspection, you find that they also sell insurance or other commissioned products. These “hybrid” advisors seem to have convinced themselves that they are “fee-only” because they charge fees on the investments they manage. They consider the commission work as almost a totally separate business. 

Maybe they need a lesson on what the word “only” means. Or maybe the marketing benefit of being lumped into the fee-only crowd is just too tempting to leave alone.

Likewise, I’ve seen many advisors describe themselves as “independent” and tout the merits of working with an independent advisor. But what does “independent” mean? Does it simply mean you don’t work for one of the big brokerage firms? Many independent firms are still members of regional broker-dealers and have conflicts of interest that come with that relationship. Even some fee-only advisors are not truly independent because of referral relationships and the like. At the end of the day, being independent means different things to different people. But it sounds good, so it is flaunted on websites to try to establish credibility.

So, what are investors to do?

Simple.

Ignore the adjectives. 

Incentives Matter More Than Adjectives

As consumers, we prefer simple clues to indicate a product or service is trustworthy. It’s what makes brands so valuable. It’s what makes the term “doctor” so valuable. These indicators of quality or expertise are valuable to both those who own them and to the consumers that do business with them. 

In financial services, consumers are desperate for a similarly simple and clear way to identify the “good” advisors. 

And advisors know this and are happy to use it for their own benefit.

Unfortunately for consumers, many of the titles and adjectives in the financial world are unregulated. And if they are regulated, it’s often very loosely.

Anyone can say they “put your interests first”. Anyone can say they are “holistic” or “fee-only” or act as a “fiduciary”. Anyone can say they will just “do the right thing.”

In short, anyone can talk the talk. The sad reality is that our industry has more expert salesman in it than expert advisors.

But what really matters are the incentives. 

What matters is walking the walk.

There is a reason my client’s former advisor recommended life insurance to all of his clients. It’s how he earns a living. And it’s how the company he works for generates a profit.

A common analogy used is the case of a dietician and a butcher. Who should you go to for holistic advice on your diet? It seems painfully obvious, right? Your butcher doesn’t know what you should be eating, he just wants to sell you some steak. He’s not a bad person. He’s not dishonest. He’s just a butcher. He makes his living selling meat. That’s what he knows. 

Likewise, commission-based advisors may be good, honest people. They may even consider that they are acting in your best interest. But at the end of the day, they are in the business of selling whatever makes their company the most money. 

Whether they are being deliberately dishonest, or they are simply doing the job they have been trained to do, is irrelevant.  

Most Fee-Only Advisors Still Face Significant Conflicts

Another common fee model for financial advice is charging a percentage of assets (often referred to as an AUM or assets under management fee) – typically around 1% per year. Some advisors who manage investments focus only on the investments they manage, while others also offer comprehensive financial advice. While the fee-only AUM model is a vast improvement over commissions when it comes to giving less-conflicted advice, it still falls far short as a model for delivering holistic financial planning. 

Why? Consider that nearly all decisions related to your financial plan impact the size of the portfolio your advisor manages, and therefore are in direct conflict with your advisor’s revenue stream. For example:

• How much to spend in retirement
• When to retire
• Whether you should pay off debt using your investment portfolio
• Whether you should take a lump sum or monthly pension

The list goes on and on.

Not only does an AUM fee influence planning advice, but it can also influence an advisor’s investment strategy.

I once had a conversation with a financial advisor who believed he had the ability to pick mutual funds that would outperform the market. I told him the research indicated that this was highly unlikely. So we decided to put it to the test. We reviewed his top ten clients’ performance over the previous ten years and compared it to equivalent index fund portfolios. In every case, the index portfolios had higher returns than his clients. 

When I asked him if he was ready to switch to a passive investment strategy he said, “James, I can’t do that. Some of my clients pay me over $30,000 a year to manage their portfolios. I can’t just put them in a buy-and-hold portfolio of a handful of index funds.”

I believe a strong force holding back a lot of good advisors from embracing a truly buy-and-hold investment approach is the feeling that they have to actively manage portfolios in order to justify their AUM fees.

If you seek holistic, unbiased financial advice, it makes no sense to hire a financial professional whose business model drives them to a specific set of knowledge and to make particular recommendations.

Myth #1 AUM Fees Align Interests

One argument I’ve heard many, many times is that AUM fees incentivize advisors to grow client accounts, and therefore align the advisor’s incentives with their clients’.

Do they? 

What if your advisor has an established practice and is nearing retirement? Let’s say she manages $100 million in assets and charges an average of 1%, putting her annual revenue at $1 million. Is this advisor more worried about growth or capital preservation? If your investment plan calls for a high risk/high return approach, this advisor has a conflict with you because she prefers to keep her revenue steady and not take a lot of risk.

The flip side could also be true. Maybe your plan calls for low risk, but your advisor is looking to grow his practice. Now his incentive is to take more risk than is appropriate for your situation.

Unless you believe your advisor has a secret formula for getting higher returns without more risk (if you do, I’d invite you to read one of the many articles on this site that argue the contrary), then having your advisor’s revenue tied to your portfolio strategy is not beneficial to you and is likely a detriment.

Once again, what you want is not an advisor whose compensation varies depending on her advice. You want an impartial opinion that only considers your situation and needs.

Myth #2 – Conflicts Are Okay If “Managed”

Another common argument made by those who are clinging to the highly lucrative status quo is that all fee models face conflicts. Rather than eliminate conflicts, it is sufficient to simply “manage” them. 

The concept of “manageable” versus “unmanageable” conflicts was recently discussed on a podcast hosted by two prominent industry leaders, Michael Kitces and Carl Richards. 

According to Michael, very high commissions are unmanageable. He cites a 20% upfront commission product with a 20-year surrender. On the other hand, a 3% commission seems manageable.

Michael also believes it is a manageable conflict to ask your AUM-based advisor if you should withdraw from your investment account to pay off your mortgage – potentially costing your advisor tens, if not hundreds, of thousands of dollars in fees over the life of the mortgage.

I disagree.

To me, a conflict is a conflict. Trying to label conflicts as manageable or unmanageable is too subjective. What may be manageable to one advisor who has an established practice and personal savings, may be irresistible to an advisor who is struggling. 

The goal should be to eliminate every conflict possible.

Myth #3 – All Fee Models Have Conflicts, So It Doesn’t Matter Which One You Choose

“But wait,” the naysayers shout, “all fee models have conflicts!” 

It is 100% true that when a fee is exchanged for a service a conflict always exists: the customer wants to receive more service and pay less, while the service provider wants to do less and get paid more. 

This is true in every fee model, for every service, in every industry that exists.

Everyone wants to get paid more for doing less.

How this plays out in the advisory world is that hourly advisors may want to drag out your project as long as possible – similar to what we sometimes see with attorneys. Meanwhile flat fee, AUM-based, and commissioned advisors may prefer to spend as little time as possible with each client since their fee doesn’t vary based on time spent.

So, it is true that we cannot remove ALL conflicts of interest. This conflict will always exist. But this conflict is different than most of the conflicts I have been discussing. This conflict is simply one of the consumer and service provider each trying to capture more of the value created by their relationship.

What we can and should get rid of are conflicts between advisor and client that influence the actual advice given.

And Then There Were Two: Hourly and Flat Fee Advice

While commissioned products may be suitable for certain DIY investors and a low AUM fee may work for investment-only advice, I believe there are only two compensation models that are appropriate if you are looking for unbiased, comprehensive financial advice: hourly and flat fee. 

What makes flat fee and hourly unique (not perfect, but unique), is that, unlike the other structures we’ve discussed, the compensation of hourly and flat fee advisors doesn’t vary based on the advice given.

Sure, an hourly advisor may spend more time on a project than necessary. But when the hourly advisor makes her final recommendation, she has no financial incentive to recommend one solution over another. 

Likewise, it doesn’t matter to a flat fee advisor if you buy term insurance or whole life, if you pay off your mortgage or add to your investment account, or if you delay social security or take it early. His compensation doesn’t change.

As the owner of a wealth management firm that charges a flat annual fee, I am certainly not impartial in my view of compensation models. At the same time, I’ve probably given this topic more thought than most. 

Having worked at a hybrid firm, an AUM-based firm, and now as the owner of a flat-fee firm, I can see the difference, clear as day, from product-centric advice, to investment-centric, to holistic.

What drove the difference in focus was not experience or credentials or fiduciary status – all firms had experienced CFP® practitioners who considered themselves fiduciaries. The difference in focus then has everything to do with the business models. 

What Does Matter in Your Advisor Search

The CFP Board got it wrong when they removed compensation from their advisor listings. If anything, they should have gone the other way (as White Coat Investor has with their recommended advisors) and been more specific about how their advisors are compensated. Of course, they most certainly were under immense pressure from segments of the industry who don’t want fees to be part of the discussion. 

But there’s no way to escape the fact that the way someone makes their living drives the way they run their business. It’s that simple. 

Talk is cheap. As you seek guidance for your financial life, ignore all the adjectives.

Instead, focus on three things:

#1 Experience and Expertise

Does the advisor have the experience and expertise to help you solve the problems you are looking to solve? This will require you to research the credentials and designations of the advisor as well as ask careful questions about existing clients and how the advisor has approached situations similar to yours.

#2 Services

Does the advisor offer the services you are looking for? For example, if you are a do-it-yourselfer looking for a second opinion, an hourly advisor may be a great fit, but not if you are looking for investment management. Meanwhile, there is a wide spectrum of services offered by different flat fee advisors – from specific services like one-time retirement plans or student loan planning, to comprehensive services that include ongoing investment management and financial planning for an annual retainer fee. Bottom line: make sure you understand what services you are getting. 

#3 Compensation

How is the advisor compensated? As we’ve been discussing, this will largely drive the types of services offered and the type of advice given. Hopefully, this article has helped you understand how each fee model can influence advisors.

If you focus on these concrete criteria, instead of the marketing fluff pumped out by advisory firms, you will drastically increase your odds of finding the right advisor for you. 

What do you think? What do you think is the best way to pay for financial advice? Comment below!