Fee-Only vs. Commission Advisors

What is a fee-only investment advisor?

A fee-only investment advisor is a Registered Investment Advisor (RIA) who is registered with either the Securities Exchange Commission (SEC) or the State Securities Board of the state you reside in, or both. A fee advisor can charge a fee of up to 2% a year, usually paid quarterly, to help you select, manage, and monitor your retirement plan or brokerage investment account using both domestic and international mutual funds and individual stock and bond portfolios. If you hire a fee-only investment advisor, you are entitled under Federal and State laws to require full disclosure for all fees and expenses paid to the investment advisor.

The dedicated fee-only investment advisor will not take commission compensation by selling "load" mutual funds or insurance annuities. A true fee-only advisor should only recommend "no-load" (no commissions) mutual funds from firms like Fidelity Investments, Schwab or TD Waterhouse for your  personal and business retirement and individual brokerage accounts, or Fidelity Investments for your ORP/403(b) investment portfolios

Lack of Disclosure:

A commission-compensated insurance company or brokerage house salesperson is not required to disclose the commission or "load" percentage or the dollar amount of the commissions they are paid when they sell you a retirement plan investment.

For your edification, here is a breakdown of how "load" products are structured. "Load" mutual fund generally come in three varieties:

  • front-load (A shares) - commission comes off the original investment
  • back-load (B shares) - commission paid up front with 5-7 years surrender penalty on each dollar invested
  • level-load (C shares) - commission paid with each contribution / often with a 1 year surrender penalty

Most commission-based brokerage advisors rarely recommend C share mutual funds. Yet C shares mutual fund shares are the most cost-effective of the commission generating mutual funds. Why? Because the salesperson would only get 1/2% to 3/4% a year commission when they "sell" a C share mutual fund to their clients.

A or B share mutual funds pay gross commissions of up to 6%, which gets split by the investment firm and the sales representative. Only buy C shares mutual funds if you cannot invest in no-load mutual funds.

Can a fee-based investment advisor make commission income?

An investment advisor committed to a fee-only clientele will not charge both fees and commissions when working with a client. Some investment advisors hype themselves as "fee-based," simply because they have the Registered Investment Advisor (RIA) designation. Bordering on the unethical, a RIA that sells "load" mutual funds or insurance annuities is trying to look "objective," but is really just another salesperson trying to make the quickest money possible at his/her clients' expense.

Moreover, insurance annuities, unlike front-load mutual funds, do not give a volume commission discount when an investor puts in $25,000 or more. Insurance annuities pay the salesperson a flat commission of 3% to 7% on each deposit - no matter how much money an investor deposits to the insurance annuity. 

What is a reasonable fee to pay an investment advisor?

For a fee-only investment advisor only managing a portfolio of mutual funds, it is not as difficult or time consuming as managing a portfolio of individual stocks. It seems only reasonable that at most a 1% annual fee, usually paid quarterly, is adequate compensation for an investment advisor to manage your retirement plan or brokerage account mutual fund portfolio.

Professional management of individual stock portfolios require more research, time, risk, and expertise, thereby justifying a higher annual management fee. Federal and State laws limit an investment advisor's fee to 2% a year, although anything over 1.5% a year is of questionable value.

Treat your investment portfolio as if you are running a business.

If you were a business owner who needed to hire an employee to do a job for you, would you pay an employee's annual salary as far as four years in advance? If you answered no, then you should not be using a commission compensated insurance or brokerage firm representative to manage your retirement plan portfolio. With a commission-compensated investment advisor, you would pay a 3% to 5% commission up front on each deposit that you make to your retirement plan or brokerage portfolio. If you hire a fee-only investment advisor, you are only paying 1/4% every three months. As long as the fee-only investment advisor is doing a good job, you pay as you go, so to speak. No loads, no restrictive surrender penalties, and hopefully low expense investments.

Seriously consider the way your investment advisor is compensated to manage your retirement plan or investment portfolio. Commission compensation rewards the advisor years in advance, while the fee-only advisor is compensated as long as he/she is doing a good job managing your money. Hence, a fee-only investment advisor makes much more sense for the investor/consumer.

Finally, a fee-only investment advisor is a partner in both the potential growth and possible loss in your mutual fund portfolio each and every day. In other words, if the value your retirement plan grows, the investment advisor's fee income grows as well. If your retirement plan value shrinks, the investment advisor's fee income shrinks as well.

When all is said and done, the commission-based advisor/salesperson of mutual funds, stock portfolios, or variable annuities has no real incentive to "manage" your retirement plan or investment portfolio on a day-to-day basis, since you have already paid for his/her services in advance.

The choice is yours to make.