Fee vs. Commission-Based Financial Advisors: What’s the Difference?

Just as there are endless types of food, clothing, and travel destinations, there are also different types of financial advisors. And just like you would never pick a restaurant, a pair of jeans, or a vacation spot without checking things out first, choosing the right advisor also deserves a bit of research.

Now, research is not just for scholars in lab coats. It is one of the most useful skills you can have. It helps you make sense of things, compare your options, and figure out what is right for you. You can make a quick pro-and-con list or scroll through reviews before deciding. Either way, you need to get in and do the work.

That said, doing the digging yourself can be a bit of a hassle. Wouldn’t it be nice if all the information you needed were in one place? Well, that is exactly what this article is here for. Let’s break down fee-based vs commission-based pros and cons so you can decide, with confidence, who is the right fit to handle your financial affairs.

Understanding the key characteristics of a fee-based financial advisor

A fee-based financial advisor’s charges can vary depending on a few things, such as the type of services you need, the advisor’s experience, and the size of your portfolio. But what is more important to understand is how they earn their money. Fee-based financial advisors get paid in two ways. The first is through fees, and the second via commissions.

The fee part is charged at a flat rate for their services. It can also be billed by the hour. So, the more hours they devote to you, the more money they will charge, and vice versa. There are also those who charge a percentage of your total assets under management (AUM). For example, they may charge 1% of your portfolio every year. So, you would pay depending on how big your portfolio is now or how much it grows. Then there are financial advisors who charge you for specific services, such as retirement planning, tax strategy, debt management, investment reviews, and more.

The second part, which is the commission, is charged on products. In addition to the fees you pay them, you may also pay them a commission on financial products they sell or recommend to you. This could include insurance policies, annuities, mutual funds, stocks, or other investment products. So, if you choose to invest in something they suggest, they may earn a commission from that sale.

You might be wondering if that creates a conflict of interest. After all, the advisor could simply recommend a product just because they would earn a commission from it. This is a major reason why you need to be careful.

Some fee-based financial advisors have a fiduciary duty, which means they are legally required to act in your best interest. But many of them are fiduciaries only when they are providing advice under the fee part. It does not apply when they are selling products. When they switch to a sales role, that legal obligation may no longer apply. So, before you start working with one, you need to check a few things.

Check if they are registered with the Securities and Exchange Commission (SEC). Advisors registered with the SEC are usually bound by fiduciary duty when acting as advisors. But when they sell products, they often operate under different rules. In the past, broker-dealers only had to meet a suitability standard, which meant their recommendations had to be suitable, not necessarily the best for you. However, the SEC’s Regulation Best Interest has raised the bar, requiring brokers to make recommendations that truly serve clients’ best interests. Still, it is always better to double-check what standards your advisor follows.

Another thing to note is that many people easily confuse a fee-based advisor with a fee-only advisor. A fee-only advisor earns only through fees. So, you hire them for specific services, pay them directly, and that is it. They do not make any money from commissions or product sales. Fee-based advisors, on the other hand, earn from both fees and commissions.

Understanding the key characteristics of a commission-based financial advisor

When you hear the term commission-based financial advisor, the name almost gives it away. These financial advisors earn their income primarily through commissions on the financial products they sell. You do not have to pay a fee or a percentage of your total assets. All of their earnings come directly from the products they recommend, and you choose to buy.

Whenever you invest in a product they suggest, such as a mutual fund, insurance policy, annuity, or even certain stock investments, they receive a commission from the product provider. The amount they earn usually depends on the product type and the amount you invest. You may pay anywhere between 1% and 6% in commission on your investment. The exact cost can differ from investment to investment.

Insurance products, especially annuities, usually carry higher commissions. These can be as high as 5% to 6% of your premium. Mutual funds, on the other hand, may not charge a commission, but you could pay a load. This is charged when you buy or sell the fund. These loads typically range from 1% to 5%, depending on the type of fund you select.

The commission-based compensation model can work well in some cases, especially if you only need help buying a particular product, such as an insurance policy, mutual fund, or stock. You do not have to pay an additional fee for the financial advisor’s services. However, because commission-based advisors earn money through the products they sell, there can be an inherent problem of personal bias, and you may not be able to trust their recommendations fully. A financial advisor might recommend a product that pays them a higher commission, even if it neglects your interests.

But this should not deter you from hiring a commission-based advisor. They are professionals and good at their job. They also genuinely care about their clients and work hard to suggest suitable products. But you can still be cautious on your part. So, you can ask how much commission they will earn from a recommendation. You can also ask them if they have a fiduciary duty. For instance, Registered Investment Advisors (RIAs) are required to follow a fiduciary standard. So, they will put your interests first. They also have to file a document called Form ADV, which clearly outlines their fee structure and potential conflicts of interest.

You can hire RIAs to ensure your interests are not neglected or overruled. Also, understand that advisors, like broker-dealers, are more likely to operate on a commission basis and to follow suitability standards. So, if you end up hiring one of these, their recommendations would only be suitable for you, not necessarily the best.

Solving the fee-based vs commission-based financial advisor quandary

1. Consider your needs, budget, and preference for fiduciary duty

Choosing between a fee-based and a commission-based financial advisor is about what you need from your advisor. Your decision should depend on your goals, the kind of advice you are looking for, and also your budget.

If you are looking for comprehensive guidance on financial planning, tax planning, retirement strategies, or investment management, a fee-based advisor might be the better choice. They usually take a more holistic view of your finances. You can pay them by the hour, a flat fee, or a percentage of your AUM, depending on what works best for you. Because their compensation includes both fees and commissions, you get a mix of personalized advice and recommendations on suitable investment products.

Another point to consider is fiduciary duty. If it is important to you that your advisor acts in your best interest at all times, a fee-based advisor is more likely to operate under that fiduciary standard, at least when they are providing advice in their fee-based capacity. On the other hand, if you only need help with specific products, such as buying an insurance policy, a commission-based financial advisor may be a more practical option. You will only pay commissions on the products you purchase, with no ongoing fees.

And of course, budget plays a big role. Fee-based advisors can be more expensive overall since you are paying for their time, expertise, and sometimes a percentage of your portfolio. Commission-based advisors might seem cheaper upfront, but keep in mind that the costs are built into the products you purchase.

2. Consider potential conflicts of interest

Conflicts of interest can show up on both sides, no matter which type of financial advisor you choose. After all, both fee-based and commission-based advisors can earn money through commissions at some level. Hence, there may always be a small chance their recommendations could be influenced by what benefits them more than it benefits you.

That is why it is so important to check whether your financial advisor follows a fiduciary duty. Someone who is legally bound to act in your best interest is generally more trustworthy. Still, you should take time to research your financial advisor’s background, understand how they are compensated, and make sure their approach aligns with your long-term goals. It also helps to know a bit about investing yourself. The more informed you are, the harder it is for anyone to take advantage of you.

Fee-based advisors often work with clients over the long term. This can help build a relationship based on trust. Commission-based advisors, on the other hand, tend to work more on a product-by-product basis. This may be a short-term association, where you may not have a strong rapport with the financial advisor. In this case, you may not be able to trust them completely.

Quick fee-based and commission-based financial advisor pros and cons list

Pros of fee-based financial advisors

• They are usually fiduciaries and are legally required to act in your best interest.
• They may offer comprehensive financial guidance across multiple areas, including tax planning, investments, and retirement.
• They provide both services and product recommendations. This helps you align your financial strategy with suitable investment choices.

Cons of fee-based financial advisors

• They can be more expensive due to ongoing fees or percentage-based charges.
• They are not complete fiduciaries, and some may still earn commissions on certain products, which can blur the line between impartial advice and personal interests.
• Conflicts of interest can still exist, especially if they receive mixed compensation.

Pros of commission-based financial advisors

• They are generally more budget-friendly since you pay only when you buy a product.
• Their service tends to be quick and straightforward. This is ideal if you prefer a short-term relationship instead of ongoing management.
• They often have access to a wide range of financial products through their industry connections.

Cons of commission-based financial advisors

• They are usually not fiduciaries, so they are not legally required to put your interests first.
• They may not offer holistic or ongoing financial advice.
• They may focus more on selling products.
• Conflicts of interest can arise since their income depends on what they sell and how much you buy.

Fee vs commission – Which advisor to choose?

Now that you have a clear picture of the differences and a handy list of pros and cons, you can figure out which type of financial advisor fits you best. You must consider your financial needs and goals, both short- and long-term. It can also help to meet both types before deciding. Set up a consultation or two and see who feels like the right fit. Pay attention to how transparent they are about fees. And remember, there is no rush.

The goal is to find one you are comfortable with and can trust. A good starting point could be using our advisor directory, which helps you connect with professionals based on your preferences.