The Fee-Only vs. Fee-Based Financial Planner Dustup: Much Todo About Something?

Tuesday, May 6, 2014 at 5pm
By John Friedman

Quick: what’s the difference between a “fee-only” financial planner and a “fee-based” financial planner?

You haven’t a clue, right?

Well, that means that the financial planning community hasn’t done a great job educating the public at large about what these labels mean, which is too bad because helping the public be smart about choosing a financial planner is what this fee-only vs fee-based distinction is supposed to be all about.

So the public doesn’t get any content out of these labels. Zilch. Nada. But, my oh my and gosh a’mighty, do financial planners ever get a lot out of ’em! Why, within the industry these “-only” vs. “-based” labels are fightin’ words, and are often the talk of the inside-baseball town, resulting in lawsuits and abrupt, something’s-not-right-here departures of head honchos and the like.

So it’s all Montagues and Capulets, with the “-only” camp viewing the “-based” camp as impure and overly commercial and the “-based” camp viewing the “-only” camp as smug and overly self-righteous.

*  *  *

So what are these labels and the distinction between the two all about? In a word: money. This fee-only vs fee-based distinction is all about the avenues through which a given financial planner has money coming into his or her coffers.

Does the FP’er get paid commissions and/or is the FP’er even remotely involved with a business in which commissions happen? If so, then, that FP’er is de-based (sorry for the pun). If not, then the FP’er is (to follow through on the pun) de-only. Or something like that because, quite honestly, there’s been a lot of confusion and debate within the industry about these terms lately.

*  *  *

Financial services businesses are not like most businesses. Most businesses are purchase-based: you buy a pair of shoes for one hundred bucks. Others are fee-for-service based: you pay your plumber two hundred dollars for fixing your sink.

By contrast, most financial businesses are “vig” based. Vig is a business slang word meaning something akin to a “slice,” as in “our vig is a very reasonable half a percent of the money involved.”

Vigs are often stated in terms of small percentages, and that’s where the idea of basis points come in. So in total bizspeak, that sentence above would be, “we take a 50 basis point vig of assets under management.”

Vigs are everywhere in financial services; they permeate, they overlap, they stack, they lay low, they auto-ding, they surprise, they combine, they this, they that, they squirrel and they burrow.

You know your 401k? There are likely several layers of firms/people getting their vigs in on that plan, many of which fly under the radar entirely, and a lot of which, in practical terms, still fly quite low because very few people are actually aware that these vigs are being taken.

And so on and so on. When it comes to anything having to do with financial services, if you assume that lots of people are taking lots of tastes along the way, often in a-intuitive complex ways that you would never dream of, then you will often be assuming correctly.

*  *  *

Financial planning is mostly vig based. Most financial planners do some financial planning, and some even charge separately, in a fee-for-service (plumber-like . . . ) way, for doing that planning, but, by and large, most of them get paid most of their money for managing other people’s money, and the way they get paid that money is by taking an auto-dinged vig against the money they manage, typically in the neighborhood of 100 basis points per year (that’s 1% in normal peoplespeak). Because these payments happen automatically — never an invoice or bill doth pass! — and tend to only appear as a single line item (perhaps purposefully buried) deep within their monthly statement for their account, many clients never even notice the payments they are making to their planners, and many planners appear to like it that way just fine, thankyouverymuch.

And that’s why, to many people’s initial surprise, financial planners really care about how many investible dollars you have that they can manage and against which they can charge their auto-pay vig. It’s nice to get paid automatically, and it’s nice to apply your vig against a big number.

*  *  *

And now we come to the main point of entry for the fee-based vs. fee-only distinction. If a financial planner takes a 1% annual vig against assets and generates no revenues from any other source whatsoever, period the end, no provisos and no yes-buts, then you can for-sure think of that planner as a “fee-only” planner.

But many financial planners generate revenues from other sources. Many, for instance, get paid commissions, either with or without also taking something like that 1% Assets Under Management vig described above. The most straightforward example of this is when the financial planner is also an insurance agent and sells insurance. There are lots of planners who sell insurance, such as life insurance, disability insurance, and long-term care insurance, as well as annuities (which are like upside down life insurance policies, in the sense that both life insurance policies and annuity contracts are sold by life insurance companies, but when a life insurance company sells you an annuity, there most assuredly will come a day thereafter when that life insurance company hopes you’ll die right away, as in tomorrow, while when a life insurance company sells you life insurance, then every day thereafter that life insurance company will be hoping that you never die, ever).

People who sell insurance get paid sales commissions, which, using the language above, are also vigs. They too, represent a slice of what is involved, though often the slice is big enough to not be very slice-like, with a great example being simple life insurance, as to which the commission is usually 100%-plus of the first year premium paid, followed by some more slice-like vigs for about a couple of handfuls of years after that.

If a financial planner generates revenues via commissions from, e.g., selling life insurance or annuities, then you can for-sure think of that planner as a “fee-based” planner. Yes, you heard that correctly: in its most simple use, “fee-based” means “with commissions” — not at all obvious upon first blush, is it?

*  *  *

But, wouldn’t you know it, there’s a lot of middle ground between those two examples because there are lots of different paths and ways in which vigs wind their ways towards various people in the financial planning food chain. For instance, what if a person owns two entirely separate businesses, one selling insurance and one being a pure-as-the-driven-snow financial planner generating revenues via nothing but assets under management fees? Can the latter call itself fee-only? There are fights going on about this stuff.

*  *  *

I think it’s all silly. Very silly. And very strangely inbred and the sound of one-hand clapping.

I think it’s all silly primarily because very few people in the public at large know about this distinction. I know this because I ask the lead-off question of this piece a lot, and not one person outside the profession has ever told me that s/he has heard about the fee-based vs fee-only distinction, and, in response to my follow-up question, not one has ever said that they can get even a gist from the labels themselves. Not one.

It’s not like these labels are in beta testing or anything; they’ve been around for a long time. They’ve simply never taken purchase with the public at large. That has to mean that the labels are badly formulated. And when you think about it even a little bit, it’s clear that they are. After all, when you want to distinguish between two things, it makes sense to have labels that have zero linguistic overlap, right? If the big distinction is that one is fees and nothing but, and the other one is fees plus something else, perhaps the other label should forego the word “fee” and focus on the “something else”, yes?

Or better yet, how about if we scrap the labels and simply have financial planners list all the avenues through which they, both at the individual level and at the level of the entity within which they work, received or generated money last year from any individual or entity whatsoever? Sure, there’d have to be some no-gos and some carve-outs and some tight definitions, but the baseline starting point should be this: list all manner of money which you received last year, and do so in terms of From, For, How Paid, and Basis of Calculation, i.e., who paid the money, what the money paid for, how the money was paid, and how the amount of money paid was determined.

Here’s my disclosure:

All Manner of Money John Friedman Financial Received Last Year

Item 1.

From: clients

For: in exchange for financial advice.

How Paid: via hand-written check or via bank-generated e-check one-off dialed-in to client’s bank account by client

Basis of Calculation: hourly rate or per-project rate

Item 2.

There is no Item 2. One revenue stream is it!

Item 3.

  . . . . 

Item X.

 

The idea here is that, when prospective clients look at this disclosure, they’ll know what’s up — what’s going on with that FP’er’s business model. No confusing labels!

Indeed, under this sort of disclosure regimen, I would probably advise anyone choosing among financial planners to simply look at how long their lists are — long is bad/short is good — and that, all things being equal, they should pick the one with the fewest items in their list. Because the longer that list, the more likely it is that, when you’re sitting down and getting advice from that person, that person will be working for someone other than you.

*  *  *

I close with a final, inside-baseball comment, which likely would be viewed as fighting words among the fee-only crowd, or at least as a shot across their bow.

I’ve said it before and often, and I’ll say it again right here. Assets under management fees are somewhat appropriate for money managers, though alpha-based performance fees, because they are much better aligned with value delivered, are more appropriate.

But assets under management fees are a huge swing and a miss for financial planners because a good financial planner seeks to provide wise counsel to clients about their entire financial life, while managed assets are only a silo (and a very idiosyncratic silo at that) within that financial life. The fact that you can make a ton of money on AUM fees does not justify their use and, indeed, brings into question the entire fiduciary interaction, as does the passive nature of the payment mechanism itself.

Rather, figuratively and often fairly close to literally, when it’s time to be paid a true fiduciary looks his or her charge in the eye and names numbers, at which time the charge says:

Thanks for being here for me.
I appreciate it. You’ve been a big help.
Here’s your payment. It’s well deserved.

It’s kind of like when you pay a plumber who finishes fixing your sink half an hour before your in-laws are due to arrive for dinner. You’re happy the plumber arrived to save the day, and happy to do the fair exchange of dollars for functioning sink. And it’s not at all like when a quarter-annual payment shows up on your credit card statement for a membership at the gym you stopped using months ago.

I hasten to add this: there are a lot of AUM’ers out there I admire, and who I think are very good for their clients. And there are quite a few I count as friends, too. In the end, then, it’s the person, not the revenue model, that makes the difference.

 

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