WHY A "FEE-ONLY" PRACTICE?
WHY A "FEE-ONLY" PRACTICE?
Oconee FPS is a fee-only practice because we believe that such a practice is the best means by which our clients can receive unbiased, independent, and cost-effective advice to reach their financial goals. Let us explain.
First, let's be blunt: Nobody works for nothing (unless this is pro bono or volunteer work). The key questions a potential client must ask a financial planner are:
These questions may be summarized by asking:
"Start with the general practitioner a Financial Planner (whose) compensation should be from fees alone." (Money Magazine)
How Financial Planners' Methods of Compensation Differ
People who are financial planners are compensated in different ways.
No-fee Planners: Some planners are insurance agents who sell insurance products to clients and are compensated by the commissions they receive. There are also stock brokers or mutual fund salespersons who are compensated similarly. These persons generally work for insurance agencies, brokerage houses, banks, mutual fund companies, and similar businesses. They charge no fees to their clients because they receive commissions on the products they sell. That is their compensation.
Fee-based planners: Some planners who sell financial products to their clients develop a financial plan for them for a specified fee. Then, they sell financial products to these clients and the commissions received from these sales offset the specified fee, sometime reducing it substantially. They distinguish themselves from No-Fee Planners by the specified fee they charge for the plan although the actual fee paid by clients may be much less than the original fee. Thus, their compensation is a mixture of commissions and client fees.
Fee-only Planners: Some planners charge a fee for their services, an hourly rate and/or a flat fee, and do not sell any financial products. Oconee FPS is such a company. We work for and are accountable only to our clients, and we receive our fees for services directly from them. We do not sell any financial products. We receive no commissions, no kickbacks, and no referral fees. We are independent of any brokerage house, bank, insurance company, or legal or accounting firm. Thus, we serve purely in an advisory capacity and not as a sales mechanism. When the purchase of financial products is recommended to meet client needs, we recommend the most effective and cost-efficient provider of those products.
Some financial planners manage their clients' assets as well as provide planning services. They are usually compensated by a percentage of the assets under their management
"The most important matter is how the planner is compensated. Hire the planner
who has no financial stake in (your) investments." (Forbes )
"The most important matter is how the planner is compensated. Hire the planner who has no financial stake in (your) investments." (Forbes )
Why is the Method of Compensation Important?"
The answer is simple and can be expressed succinctly: potential conflict of interest
Simply put, for a planner to give financial advice and then to have his or her compensation based upon commission received from the sale of financial products is an invitation to mischief.
We choose out words carefully here. We say "a potential conflict of interest" and "an invitation to mischief" and we say this deliberately. The fact is that many financial planners who are no-fee and fee-based are decent, integral people who have their clients' interests at heart. They have a wealth of information and experience to share with their clients and are happy to do so. But they need to be compensated as we all do. They have to put bread on their tables and take care of their families as we all do. The conflict of interest arises when the compensation to be received from the sale of a financial product influences the advice that is given. And that could happen very easily. It's caused by human nature.
Cash Value Insurance.
At midlife, at the time when many clients have dependents who count on their earning power to sustain themselves, these clients need protection of this earning power. They need life insurance. For the majority of people, the most cost efficient method of supplying such protection is though term life insurance. Term life insurance is pure protection. Based upon mortality rates and actuary tables a person pays a given premium to an insurance company in return for which the company promises to pay a certain amount (the face value) to the beneficiaries should the person die.
Insurance agents sell such term insurance (although it can be bought through other means as well). The problem is that the commissions received by the sale of term insurance are quite modest. Other insurance products which give protection but have investment properties as well (this includes all cash value insurance products) pay much larger commissions to the selling agent. So while a client may need the pure protection of term insurance, the insurance agent might be inclined to recommend a cash value policy since it would yield a higher commission. This is the potential conflict of interest. This is the invitation to mischief.
Most of us seek a reduction in the income taxes we pay. There are a variety of means by which income taxes can be deferred, reduced, or avoided entirely. One of the ways of deferring taxes is through the purchase of annuities sold by insurance agents and stock brokers. Annuity contracts allow a "tax-free cash buildup" which in essence defers taxation of compounded investment earnings until the earnings are withdrawn. This is a good deal. However, there are two questions to consider: 1) What is the cost to the purchaser of an annuity contract? and 2) Are there other ways of deferring, reducing, or avoiding taxes?
In fact, when purchased from insurance agents or stock brokers the costs of annuities can be substantial. The initial amounts invested in an annuity contract are reduced by these costs. And this reduces the overall earning power of the investments which underlie the annuity contract On the other hand, there are several other ways, more cost-efficient ways, of accomplishing the same result as annuity contracts. Yet annuities are sold by insurance agents and stock brokers. This is the potential conflict of interest. This is the invitation to mischief.
There are more than 6,000 mutual funds available for purchase. For many people, investments in mutual funds are highly desirable. Which to choose depends on a client's financial goals, risk tolerance, and time horizon among other factors. Some funds are sold by stock brokers or mutual fund salespersons who receive a commission on the sale. These are "load funds," the load being the commission paid. Other funds are purchased by the person directly from the fund itself without the use of a broker. These are "no-load" funds, the absence of a commission constitutes the absence of a load. As was the case for annuities, money paid by the client which goes to pay a planner's commission is money that doesn't get invested for the client.
As a group, no-load funds do as well as load funds with much variation in each category. Which fund might a person expect a stockbroker or a mutual fund salesperson to recommend to a client? The load fund or the no-load fund? This is the potential conflict of interest. This is the invitation to mischief.
"Financial Planners who take commissions have a built-in conflict of interest
even with disclosure, my choice would be a Fee-Only planner."
(Jane Bryant Quinn in Newsweek.)
"Financial Planners who take commissions have a built-in conflict of interest even with disclosure, my choice would be a Fee-Only planner." (Jane Bryant Quinn in Newsweek.)
When a planner's livelihood depends on the commissions received by clients, it is natural to expect that advice be given to purchase financial products that yield commissions. That's why full disclosure on the part of the financial planner regarding compensation is essential. Forbes magazine once reported that a tax CPA (who was not necessarily representing himself as a financial planner) sold a client an immediate annuity for $1,000,000 and pocketed a $60,000 commission for himself. That's a nice piece of change for one transaction. Who was that CPA working for? His client or himself?
Whether or not a no-fee or a fee-only financial planner will give sound, unbiased advice to a client is a function of the planner's integrity. Honesty, integrity, character and other human attributes will vary from planner to planner (including fee-only planners as well as the others) and nothing written in this discussion should necessarily be taken as a slam against no-fee or fee-based planners. We merely seek to point out the various problems inherent in the non fee-only compensation models.
There are of course additional factors involved in selecting a financial planner other than the method of the planner's compensation. Click on Choosing a Financial Planner on this website and read our thoughts on this.
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