Fee-only or fee-based financial advisor. How are they different?

All financial advisors are not the same. Some call themselves fee-only advisors and others as fee-based. They might sound similar, but are they interchangeable?

While both of them facilitate wealth management for you, they differ in their workings.

Fee-only advisors

Fee-only advisors, as the name suggests, earn their remuneration only in the form of fees from the client (that is you). So, if you hire them, you pay a flat fee or on an hourly or project basis. And that’s the only compensation they get. They don’t distribute financial products that could otherwise earn them more.

One of the advantages of dealing with fee-only advisors is that we can expect uniformity when it comes to servicing their clients regardless of the size of their assets.

Fee-based advisors

Fee-based advisors, in turn, might not charge you at all. However, they are compensated by way of commissions when you invest through them. They hold licenses that allow them to distribute investment and insurance products for a commission. Some advisors might additionally charge you for their advisory services.

Who is better?

There is a certain measure of conflict of interest in the dealings of fee-based advisors. Supposing they earn one per cent of investment as commission for recommending product ‘A’ instead of ‘B’ which earns them even more (1.5%), it’s likely that some advisors unless they have a fiduciary responsibility, might recommend the latter.

However, if their compensation is not affected by the commission structures – like in the case of fee-only advisors – they are more likely to be neutral and act in the best interest of the client.

Fee-only advisors also come in various packages. They can be classified according to the way they charge.

1. Flat fees

Flat-fee advisors charge anywhere from Rs 5,000-50,000 (or even more) in the first year. It is usually higher for NRIs. You might approach them during the year for any investment-related advice. Once the financial plan is made, the follow-up fees for the subsequent years are usually lower.

2. Asset-based fees

Here, the advisor charges on the basis of a certain percentage (say 1%-2%) of your assets. For instance, you have an existing portfolio of Rs 10 lakh, then you might be charged Rs 10,000 every year (at 1%) for managing it.

Fees charged as a percentage of your assets are only a replacement for commissions. These advisors may dedicate more time and attention to clients with large assets.

3. Performance-based advisors

These types of advisors usually have a two-tiered fee structure. One, where they charge a base fee that will be linked to your assets. For instance, there will be an annual base fee of 1% of your assets and a 20% share in profits over and above that if the portfolio returns are more than 10%.

While it seems to be a lucrative proposition for investors, it has the risk of the advisor taking a disproportionate risk on your portfolio in order to earn more returns (and fees).

Out of the lot, most investors may be better off choosing flat-fee charging advisors. This will also work out well if you have a reasonable portfolio size.

How to choose one

First of all, check for a list of financial advisors in the country. It is important to look for a certified financial professional (NISM, CFP amongst others) or a Sebi-registered investment advisor (RIA).

Check credentials and relevant track record. Ask for references from the former clients and take their feedback.

Ensure the fee structure is clear and transparent. Also, understand what’s in the deal –frequency of engagements etc.

Shortlist three of them. Interact and be prepared with a list of questions that could be asked and your financial priorities.

Hire them only when you are comfortable and clear about what you are paying for.