“Fee-only advisors derive no compensation from selling commission-based products; any compensation they receive comes from clients. That compensation structure helps ensure that the advisor is working strictly on the client’s behalf and isn’t inclined to favor products that may not be in the client’s best interest,” according to Esther Pak, of Morningstar, in a post on Yahoo Finance.
Pak goes on to explain that “fee-based advisors use a compensation structure that’s a hybrid of what commission-based planners and fee-only advisors employ. They accept compensation from clients as well as commissions from third parties, such as mutual funds or insurance companies, every time they sell their products. Therein lies the potential conflict of interest. While you may pay a fee-based planner less outright compensation than what you’d pay for a fee-only advisor, fee-based advisors can earn commissions by putting you in certain products, and the commissions they earn on some investments may be higher than others. Thus, the advisor may have a financial incentive to favor one product over another.”
She points out that “most fee-based planners work under a suitability standard rather than a fiduciary duty. Whereas advisors who have a fiduciary duty should be able to demonstrate they’ve chosen the best products for their clients, advisors operating under the suitability standard should make recommendations that are suitable (though maybe not the best) for their clients based their time horizons and risk tolerance.”
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