There are a variety of ways clients consume financial advice. However, the delivery of financial advice may be conflicted, meaning a financial solution may be provided which may benefit the provider but may not be in the best interest of the client. The structure of advisor compensation is arguably the greatest cause of conflicted advice.
Generally speaking, compensation in the industry is either through fees or through commissions. Traditional “brokers” typically are compensated via commissions, which is payment for executing a transaction or for selling a specific investment product.
Unfortunately, commission based compensation can vary between similar products. For example, a front-loaded mutual fund may pay a commission of 4-5%, while a similar front-loaded mutual fund from a different distributor may pay a commission of 3-4%. This compensation differential potentially can conflict a broker who is selling mutual funds as they may be influenced to provide the first fund due to the higher level of associated compensation and not necessarily because it is a better fund for the client’s financial situation.
Similarly, brokers who sell individual stocks on a commission basis typically are paid for each transaction executed. This may influence brokers to increase turnover to increase the number of transactions to drive up the resulting compensation.
In short, differential compensation and compensation based on volume of transactions create a question regarding the objectivity of advice.
By contrast, a fee-only structure attempts to remove the conflict of interest inherent in a typical commission based arrangement. Under a fee-only agreement, a client agrees up front to a specific fee for the services provided. Fees generally are structured as a percentage of assets under management, or an hourly or flat fee for financial advice.
Under a fee-only structure, an advisor cannot accept any additional compensation associated with the recommendation of a specific product and does not receive any incremental compensation based on the volume of transactions. This leaves the advisor in a position to objectively evaluate products and transactions. A decision between product A and product B comes down to the merits of the product as a decision either way will not affect the advisor compensation. For individual security transactions, advisor compensation under a fee-only arrangement is not dependent on the volume of transactions, leaving the advisor free to focus on the investment merits, tax and other client focused implications to each transaction.
Furthermore, under a fee-only structure, the advisor is generally incented to develop a long-term client relationship, and making objective decisions which always have the client’s best interest in mind is core to such a relationship.
Sanitas Wealth Management is structured as a fee-only advisor in order to provide transparency to the client relationship and to remove the conflict of interest presented by commission based compensation.