Are your financial advisor’s fees eroding your savings?

Expert financial advice boosts your savings and reduces your outgoings – it’s a weighty investment well made. How then do we validate our choice of expert? Which choice is the “right” one?

A telling distinction is how your advisor is compensated for their work.

Some advisors earn commission for selling you certain investment products, whilst others are paid a simple fee for their services. The difference between fee-based and commission-based advisors isn’t just technical – the way in which they’re compensated can have a huge impact on their motivations, advice and decisions regarding your money.

Today I want to look at the differences between these, and explore the positive aspects of working with a fee-based advisor. This will empower you to better decide who is worthy of your trust and investment. 

Have I hired the right advisor?

Employing a financial advisor can be highly beneficial, especially if you do so early in life – studies show us that workers who delegated their investments from aged 20 onwards saw a 20% increase in their average wealth compared to people who didn’t.

But effective financial advice isn’t always easy to find. Despite the existence of brilliant, trustworthy advisors on the market, many people unknowingly employ the opposite: advisors who invest their money for personal gain or charge excessive fees which actually erode their savings over time.

So how can you ensure your money is in capable hands?

To find an advisor you can trust, you need to understand their motivations. And to understand their motivations, you need to look at how they’re getting paid.

To find an advisor you can trust, you need to understand their motivations. And to understand their motivations, you need to look at how they’re getting paid.

What’s the difference between fee-only and commission-based advisors? 

Fee-only advisors charge in one of two ways: either a specific amount for a service or an annual fee based on the value of the assets they’ve been assigned to manage – usually between 1% and 2% of the total.

Commission-based advisors, on the other hand, gain compensation from investment transactions. Essentially, their pay is affected by how much stock they buy or sell. This introduces a motivational element that is not wholly grounded in your success alone. 

Choosing a fee-only advisor over a commission-based one

There’s considerable debate – and doubt – surrounding commission-based advisors. Studies on behavioural finance show us that most individuals prefer to pay their advisors on a fee-only basis. The reasons for this vary but mainly relate to the quality of service and a conflict of interest in the client-advisor relationship.

Here are some of the benefits to be expected by choosing a fee-only advisor over one that’s receiving a commission.

1. Wiser investments: Whilst great returns are never guaranteed in any investment strategy, fee-only advisors care about the enduring success of your investments. They are therefore more likely to opt for low-cost, low-risk solutions and long-term gains over investment products that provide quick fixes.

2. Increased portfolio diversification: With a focus on long-term success, fee-only advisors have a greater incentive to grow your portfolio. As they aren’t tied to a particular bank’s products or services, they are able to deliver a more diversified portfolio. This makes them more likely to achieve better results with less risk.

3. Better image, better results: Whereas commission-based advisors push sales to obtain clients, the fee-based advisor relies more on reputation to pull in business. That reputation rests on knowledge. Peer-reviewed research specifically concerning UAE investor and advisor behaviour has concluded that building self-image and the reputation of their firm is a key driver of all activity – and their success as a result.

4. Non-sales approach: Fee-only advisors are almost always fiduciaries, which means they have a legal obligation to give trusted advice in the best interest of their client. Unlike commission-based advisors – who are influenced predominantly by transactions and sales – their main job is to help you succeed in areas relevant to you: managing your investment portfolio, building a financial strategy and answering your financial questions.

5. Greater trust: Trust is vital in your client-advisor relationship. Studies show that the premise of a fee-based relationship fosters a greater level of trust between firms and their financial advisors. Compared to a commission-based relationship, the firms’ decision-makers were much more likely to take direction from the advisors and were also more likely to involve them in their decision-making process. 

What dangers do commission-based advisors pose for my savings? 

Not long ago, commission-based advisors were the norm, but this pricing structure has now fallen out of favour. A behavioural finance case study published by The Healthcare Research Foundation revealed that only 20% of people were satisfied or comfortable paying advisors on a commission-only basis.

A behavioural finance case study published by The Healthcare Research Foundation revealed that only 20% of people were satisfied or comfortable paying advisors on a commission-only basis.

Why? Let’s look at some reasons.

Hidden clauses and fees: Commission-based advisors receive a commission on certain investments and products. This means they may encourage you to make purchases that aren’t the best choice for you – there’s money in it for them. This is supported by peer-reviewed research – a 2015 study published in the Economics Letters journal found that changing the amount of commission received by financial advisors had a significant influence on the purchase of insurance products.

Losses and lower returns: To improve their bottom line, commission-based advisors will often opt for investments with higher commission, overlooking lower commission options that may bring better returns for you. Whilst initial results might look very promising, short-term gains may hide long-term losses.

Potential for dishonesty: There is often a conflict of interest within commission-based relationships, which can give rise to dishonest practices among advisors. Investments can be deceptive, and some clients find that they’ve purchased products with hidden fees or clauses the nature of which they’re unaware. These commonly include being unable to touch the money for a certain number of years.

How do I choose the right advisor?

Investing involves high stakes, and you’ll encounter important and difficult decisions when evaluating sources of financial advice. Even with fee-only advisors, you must do careful research before placing your funds, assets, and trust in their hands. It’s also worth asking them how they are personally remunerated, for example, are they self-employed and therefore potentially going to recommend fee or commission based investments to suit them, or are they employed with a salary from their firm so they’re more interested in the client than the sale?

Check credibility: First, validate their knowledge. Only opt for reputable companies and make sure advisors have the right accreditations, such as Certified Financial Planner (CFP), Certified Public Accountant (CPA), Chartered Financial Analyst (CFA), Chartered Financial Consultant (ChFC) or Chartered Institute for Securities and Investment (CISI).

Do a background check: Don’t enter the relationship blindly. Make sure the advisor is registered with the local financial services authority, and carry out some targeted research into them and their company. Check third-party sources like newspapers and websites for reviews, past successes and links to any fraudulent activity.

Interview: Once you’ve narrowed your search, request an interview-style meeting. You also want to make sure they are the right fit for your situation: appropriate to your level of funds and able to provide the relevant type of financial help. Like any reputable doctor or lawyer, they should take the time to understand your personal circumstances and be willing to build a tailored financial strategy.

Agree a service level: Be clear about the level of communication and control you need during the process. Do you want to be in contact once a week, or once a quarter? Are you happy to delegate all investment decisions to them, or do you want to be consulted at key stages? Establish a service level early on and challenge them if it’s not maintained.

Check their fees: Don’t be misled by confusing pricing structures, and if you’re unsure, ask your advisor to clarify. They should be able to tell you how much of their payment comes from the fees you pay them and how much from the commission, and be able to put it into writing. Lack of transparency and an inability to justify their fees are serious warning signs.

Don’t be misled by confusing pricing structures, and if you’re unsure, ask your advisor to clarify.

Your future, prioritised

It’s clear that commission-based advisors – who take a cut from the products you purchase – can present both material and moral hazards to your money. Fee-only advisors who charge for nothing except their skills and counsel are more incentivised to act in your best interests.

And whilst not all fee-based advisors are trustworthy – and not all advisors on commission are untrustworthy – it’s less risky to pay someone simply for their advice alone. They will always have the advantage of more transparency, more considered investment decisions, and freedom from conflicts of interest.

Essentially, they have no other agenda than to help you succeed, which is why a fee-based relationship also creates an environment more conducive to trust.

Beyond payment, any financial advisor should have certain qualities that are self-evident. They should be willing to engage at the level of service you need, be invested in your long-term goals, and be able to build a tailored financial strategy around your specific circumstances.

This advice will help secure the services of a trusted expert who will work to deliver optimal, lasting solutions that are entirely in the interests of one person: you.