A common piece of investment advice is to only seek out fee-only financial planning services. These services don't take commissions from the financial institutions that they sell products from. Instead, they make their money from charging you an annual fee based on the value of your investment portfolio. In theory, this means that they always have your best interests in mind while managing your portfolio.
Fee-based financial planning services, on the other hand, are allowed to take commissions from the financial institutions that they sell investment products from. They typically work as brokers for a single financial institution or a group of them, and they'll be more likely to plan a client's portfolio around products sold by these institutions. Some people feel that this creates a conflict of interest—they will be more likely to only offer products from the institution that gives them commissions.
However, are fee-only financial planning services truly the best choice for everyone? Below, you'll find three downsides of fee-only financial planning and why fee-based may be the best option for you overall.
1. They Have a Financial Interest in Aggressive Investments
A common myth about fee-only financial planning services is that they have no financial incentive in directing your investments. After all, they're not getting commissions from financial institutions for selling their products, so they should always invest your portfolio with your best interest in mind, right?
Unfortunately, this isn't always the case. Since the most common compensation model for fee-only financial planning services is to charge you a percentage of your portfolio as their annual fee, their financial incentive is to make the value of your portfolio grow as quickly as possible. The larger your portfolio, the more money they'll make in fees.
For most investors, this sounds like a great deal—their incentive, overall, is to increase the value of your investments. However, this fails to take into account the realities of the financial markets. As people near retirement age, common financial planning advice is to move a larger portion of investments towards stable, low-yield investments such as bonds. These financial products will protect the value of your portfolio if an economic downturn happens.
For a fee-only financial planning service, this would hurt their bottom line—they want as much of your portfolio in riskier high-yield investments as possible. The percentage-based fee structure encourages fee-only financial planning services to invest aggressively in order to keep your portfolio growing. In some cases, this aggressive approach may leave your portfolio overly exposed to market forces, which increases your risk of losing a significant amount of money if the economy enters a recession.
Fee-based financial planning services, on the other hand, are able to still make money through commissions regardless of how much your portfolio is growing. They're under less incentive to invest aggressively, which helps to reduce the market exposure of your portfolio.
2. They're Unlikely to Recommend Alternative Risk Management Products Such as Insurance
One component of financial planning that's often overlooked is insurance. Whole-life financial planning isn't only about investments—it's about lowering financial risk. Insurance products are one way to protect you and your family's finances from unforeseen events. A fee-only financial planner has no incentive to recommend insurance products, as any money that you pay for insurance is less money that you have to invest into your portfolio.
Disability insurance, for example, can help secure stability for you and your family if you ever become unable to work. Fee-based financial planning services are more likely to guide you towards insurance products that protect your finances from disaster, rather than financial products that are designed to grow your portfolio. It's an important risk management strategy that often goes overlooked by fee-only financial planning services.
3. They Don't Have Access to Institutional Investments
Finally, being a broker for a financial institution comes with benefits other than commission. Fee-based financial planning services are more likely to have access to a wider variety of investments through the institution they partner with. Fee-only financial planning services are nearly always going to have access to the same investments you'd have access to as a private investor. Access to institutional investments opens up new investment opportunities that a fee-based financial planning service can help you take advantage of.
As you can see, there are significant downsides to fee-only financial planning services compared to fee-based ones, despite the financial advice that's commonly given. Fee-based financial planning services typically take a more holistic view of your financial needs, and they're more likely to recommend products like insurance that can reduce your financial risk. Your financial future is important, so it's best to use all of the tools available to protect it. Work with a fee-based financial planning service to find out which products are right for your financial needs.