Today we’re going to look at the differences between a fee-only advisor and a fee-based advisor.
I am writing this article for all of you who are working with someone who tells you they’re fee-based and they’re probably ripping you off, hiding their commissions, selling you products, and you don’t know it. I am going to show you how to determine if someone is not being transparent with you.
I am going to review some fee illustrations to demonstrate to you just how significant the conflict of interest can be when you’re working with someone who says they are fee-based. In this article I will review five fee illustrations covering annuities, private REITS, structured products, private equity, and hedge funds.
About 90% of financial advisors are dual registrant advisors who often say that they are fee-based and they often misrepresent their fiduciary obligation to you, the consumer.
Unfortunately, there are a lot of people who are working with someone that they trust and are being taken advantage of, and they just don’t know it. A fee-based advisor is nothing more than a realtor in disguise; capable of receiving all sorts of hidden commissions. A fee-based dual registrant financial advisor typically has a series 65 investment adviser license, a series 7 stockbroker license, and often has an insurance license too.
Let’s look at some fee calculations so that you can see what a fee-based advisor can hide from you.
Fee-Based Financial Advisor Selling Annuities
In this example, we are giving $1,000,000 to each advisor and comparing the potential fees. Let’s start with the fee-only RIA. We give them $1,000,000 and they charge 1%. The fee calculation is simple. The fee will be $10,000 in the first year. The entire fee will be visible. Nothing will be hidden.
Let’s compare the fee-only scenario to a fee-based dual registrant who’s telling the client that they are a fiduciary. First, is the fee-based advisor a fiduciary, true or false?
Well, the advisor is a fiduciary on the $500,000 fee-based account, but not a fiduciary on the $500,000 where they’re using their insurance license to sell a variable annuity with hidden commission. This advisor is a dual registrant. The advisor is getting paid fees and commission. The problem is that you won’t see the commission on the variable annuity.
You are going to see the 1% fee on $500,000, but you won’t see the typical variable annuity commission which is going to be 7% on the other $500,000 which is a $40,000 commission.
Your fees in the first year will be $40,000. But wait, you’re only going to see $5,000!
This set up is very common with fee-based advisors who confuse you by telling you they are fiduciaries and then jam an annuity down your throat and rip you off using their insurance license.
Always remember, advisors who sell variable annuities are among the most selfish salespeople that exist.
Fee-Based Financial Advisor Selling REITS
Our second fee calculation example is for a dual registrant who likes to sell private REIT limited partnerships. Same setup. The advisor is leading with a fee-based account telling the consumer, the client, that they are a fiduciary, but they are hiding significant commission in limited partnerships.
The hidden fees are substantial. The fee-based dual registrant advisor is receiving an 8% hidden commission on $700,000.
In the first year your fees are $59,000, but $56,000 in fees will be hidden from you.
It’s like magic. You are only going to see $3,000 in fees.
Meanwhile, advisers like this are telling you, oh, I’m your fiduciary, but what they are not telling you is that in your brokerage account where they are selling you these products, they are not fiduciaries and will be receiving huge commissions, none of which you get to see.
Fee-Based Financial Advisor Selling Structured Products
In this example our fee-based advisor is churning $400,000 of your money in structured products. The fee-based advisor confuses you by telling you they are a fiduciary, but the catch is that he is only a fiduciary on the $600,000 fee-based account. In the $400,000 account the advisor is taking you down for hidden commissions.
You are going to see a 1% fee on the $600,000. This account is where the advisor is acting as a fiduciary and saying that he is fee-based. But the advisor is going to hide the 3 1/2 percent commission on $400,000 of structured products.
Your total fees in the first year are going to be $20,000, but only $6000 is going to be visible.
Fee-Based Financial Advisor Selling Private Equity
What if you have one of those sophisticated fee-based advisors that sells you some private equity? Wow, that sounds great doesn’t it? But guess what, they’re hiding the private equity commissions too. Yep, you don’t get to see it.
Same situation, first year fees are $19,000, but you only see $7,000. To top it all off, they probably told you they’re a fiduciary!
Once again, the advisor is a fiduciary on $700,000 but not on the $300,000 where they’re hiding their fees and using their brokerage license to sell you a product.
You can be a cardiologist, tech entrepreneur, attorney, engineer, etc., i.e. a very smart person and still fall victim to this sales game.
I can’t count the number of times I’ve seen this shakedown with fee-based advisors.
Fee-Based Financial Advisor Selling Hedge Funds
We wouldn’t be thorough if we left out hedge funds. You know those fancy investments that Warren Buffett thinks are worthless for good reason.
Here we have a fee-based dual registrant who once again is leading with a $600,000 fee-based account and telling you that they are your fiduciary. But simultaneously the advisor opens a brokerage account and uses their brokerage license to sell you $400,000 of hedge fund products.
The advisor is going to get paid under the table 3% commission that you don’t see and so your first-year fees are going to be $18,000 but you’ll only see $6,000.
Fiduciary on One Account and Broker on Another
Here’s an example that shows how fee based dual registrants play these games and get away with it legally. Often fee-based advisors will open multiple accounts for a client. Sometimes this is done to trick you. They tell you they are a fiduciary but then neglect to tell you that they are only a fiduciary on certain accounts. Then they churn your brokerage account with products for hidden commissions. The entire time you think you are working with a fiduciary and you are completely ignorant to the fact that you are being taken advantage of. This scam is by design. The advisor sells you on the fact that they are a fiduciary. But they don’t tell you that they are going to be a part time fiduciary and acting as your broker on other accounts. Sophisticated shell game that happens every day to lots of savvy investors. I’ve seen this so many times it’s ridiculous.
In stark contrast, if you’re working with a fee only RIA, it’s real simple. The fee-only RIA is going to be a fiduciary on every single account one hundred percent of the time.
Here is is a summary table that shows the differences between a fee-only registered investment advisor and a fee-based dual registering financial advisor.
Fee-Only Fiduciary vs Fee-Based Financial Advisor
The differences are profound. Fee-based dual registrant financial advisors, have conflicts of interest, can hide their compensation, and can sell you products that are not in your best interest. With a fee-based advisor, they may be following the lower legal standard of suitability versus acting as a fiduciary.
I encourage you to familiarize yourself with these differences and learn why you don’t want to work with a fee based financial advisor.
No one wants to be taken advantage of. But the reality is that most fee-based advisors are nothing more than a wolf in sheep’s clothing.
They can take advantage of you in the blink of an eye and unless you are super sophisticated, you’re not going to know it.
The problem is that often the client is friends with the the fee-based advisor. They trust them. So they don’t want to hear that they’re getting taken advantage of. I’ve seen it so many times where a person is being taken advantage of and they just don’t want to believe it. Also, there is nothing illegal about a fee-based financial advisor taking advantage of a client.
Someone who is registered as an investment advisor or stockbroker and an insurance agent can do what’s in their best interest and not yours. They can legally do this to you and you don’t really have any recourse.
If they have established suitability and they are selling you products, keyword products that are suitable, you don’t really have a leg to stand on.
They can rip you off and can hide the commissions. There’s nothing you can do about it.
You want to get away from this nonsense?
Find a fee only registered investment advisor who’s a fiduciary 100% of the time.
Always transparent and required by law to always act in your best interest.
Problem solved.
Ethan S. Braid, CFA
President
HighPass Asset Management