Commission vs. fee-based vs. fee-only
Which advisory model is best?
There is a slow but steady trend among financial advisors whereby they are
transitioning from a pure commission-based model, to one where they charge fees
based on portfolio value. Advisors resident in each camp continue to debate
strongly the relative merits of each model. Which model is best? It depends.
Since there are no universally accepted definitions, here are my definitions
of commission, fee-based, and fee-only advisors.
The dominant model used by Canadian financial advisors is to sell products
(i.e. load mutual funds & life insurance) of companies that will pay a
commission to selling advisors. Clients need not write a cheque for the
advisor's services and receive no invoice.
Fee-based advisors come in different forms and may use different terminology.
Many fee-based advisors simply operate on a front-end load basis - charging no
front-end sales charge but doing so to secure the higher trailers paid on
front-end funds. These advisors may also use mutual fund wrap programs like
Harmony, Quotential, Sovereign, or Viscount. Advisor compensation remains
embedded in the products used and advisors earn commission income (i.e. load
Fee-only is the term given to those advisors whose only compensation source
is the client; with no fees or commissions accepted from any other party. These
advisors may use low-fee mutual funds (i.e. F-class or no load), exchange traded
funds, and individual securities. Such advisors, if they serve high net worth
individuals, may use separately managed accounts or simply position themselves
as a manager of managers. Since fee-only advisors use products that pay no
commission, they invoice clients separately for their services.
Annual cost of commission advisor: about 2.50%
Clients of advisors working on commission would pay an average of about 2.5%,
including GST. That's the median of all mutual funds in Morningstar Canada's
PALTrak software program so it's representative of what the typical client is
paying. Roughly half of these clients buy mutual funds on a deferred sales
charge (DSC) or back end load basis.
Annual cost of fee-based advisor: 1.50% to 3.00%+
Clients of fee-based advisors could be paying anywhere from 1.5% to well over
3% per year. I suspect the broad range of fees here is due to the embedded
nature of advisor compensation. For instance, an advisor could use pooled funds
from Acuity or Standard Life (Legend series) and receive up to 0.5% per year in
trailers and the client would pay no more than about 1.5% per year in fees.
However, these products also allow advisors and clients to agree to add
additional fees on these products taking the cost up to an additional 1% or so
per annum. Also, many wrap programs, often used by so-called fee-based advisors,
carry annual fees in the 3% to 3.5% range since many build in 1.5% per year for
While the total cost to the client is comparable to the commission model,
it's unusual to find any DSC or back-end loads with fee-based advisors.
(However, this is not unheard of as some wrap programs have DSC sales options.)
Annual cost of fee-only advisor: 1.25% to 2.50%+
Clients of fee-only advisors can also face a wide range in fees but the
important distinction here is that all of the advisor's compensation comes only
from the client. The range in fees, again, results from the choice of product.
Advisors using ETFs and individual securities should be able to structure a
balanced portfolio for a client for about 1.25% per year - assuming a 1% annual
fee for the advisor. However, many advisors have fee schedules that start at
about 1.5%, which drives the total portfolio cost into the 1.9% range for a
passive investment portfolio.
If, instead, the fee-only advisor is making at least partial use of F-class
mutual funds (i.e. actively managed funds with advisor compensation stripped
out), the cost will likely approach that of the commission model. Fees for
F-class mutual funds range from about 60 basis points for some bond funds up to
1.75% or more for some global or specialty equity funds. So, clearly, the bottom
line fee here is highly dependent on the product choice and could even exceed
that of the commission option.
In all of these models, the client is (directly or indirectly) paying the
advisor not only for providing the advice but also for implementing all of the
recommendations agreed to by the client and for ongoing service (i.e. regular
reporting, fielding calls, annual reviews, etc.).
While the total cost of each model may be quite similar, each differs
significantly in the level of transparency and resulting accountability.
The highest level of transparency is achieved by the fee-only advisory model
since there is no doubt about who is paying what to whom and why. All the cards
are laid out on the table in an invoice to the client. The only downside here is
the consumer psyche.
Remember the uproar that ensued when the embedded manufacturer's tax was
replaced with the more transparent GST? Yes, people pay more attention to what
they pay when it's in their faces, rather than when it's 'out of sight, out of
mind'. And switching from the latter to the former is painful, indeed, despite
any associated benefits.
The fee-based model comes in a distant second since the compensation is still
embedded in the product cost. So, transparency may depend on the choice of
product and the diligence of the advisor. For example, wrap programs will
usually show the quarterly fee details, even if fees are simply paid by selling
units of the wrap pools. This disclosure gets a thumbs-up, but what it doesn't
include are those fees charged directly at the fund level.
It is common practice for operating expenses and, in some cases, base fees
for the wrap manufacturer to be deducted at source - i.e. at the fund level.
Fund-level expenses are not shown on quarterly statements as fees paid since
they are already factored in daily (in the calculation of each fund's net asset
value per unit). An advisor may go out of her way to summarize these all-in fee
figures for clients but it is not required.
While mutual fund disclosure is quite good today (despite the odd beef), only
'keener' clients of commission advisors - a small minority - have any clarity
when it comes to their total portfolio costs and the portion that is paid to
their advisor (and his dealer). So, transparency depends entirely on how keen
the advisor is to fully inform clients about such details.
For instance, when I was the in-house analyst for a MFDA firm, I designed
investment policies (and drafted investment policy statements) for clients of
some of our advisors when my help was requested. The first page was a cover
page. Pages two and three explained the various forms of fees and commissions
and quantified these items for each client - in percentage and dollar terms. The
result was a level of transparency exceeding that of fee-based advisors and
equal that of fee-only advisors. But, again, this depends entirely on the
advisor. (Incidentally, my experience has been that advisors looking to woo
wealthy clients would do themselves a favour by opting for full disclosure. See
this October 2004 article on this topic.)
Generally, the more transparent the advisory model, the more a client is
likely to hold an advisor accountable not only for the quality of his advice,
but also the quantity. In short, a client is less likely to question the value
received for his commission dollars when the commissions are somewhat
out-of-sight. On the other hand, when the compensation is more in-your-face - as
with receiving an invoice and having to write a cheque - clients are more likely
to shrewdly compare fees with services received.
Having been on both sides of the fence (I started as a commission advisor and
have been providing fee-only advice for several years) I can say that this
accurately describes my experiences.
The superior model
No one advisory model is categorically superior to the other. With minimum
fee levels the norm for fee-only advisors, clients will less than $250k to
invest are likely best served by qualified fee-based or commission advisors.
Indeed, it is this variety of choice that allows most people to gain access to
financial advice that might not otherwise be available in a fee-only model.
Then again, regulators continue to grapple with the fact that most
individuals calling themselves "financial advisors" actually carry a
sales license. Accordingly, these salespeople or advisors only get paid once
they sell a product. With so many of these folks conducting themselves as truly
professional advisors, there is a mismatch between the value of the services
actually provided and the value of the service that actually triggers
In theory, fee-only may be a superior model based on costs, transparency, and
accountability. However, if all advisors choose this model, many people would
simply refrain from getting any advice - a choice that is arguably the most
costly for the majority of investors. Plus, a model doesn't make a superior
advisor. Only superior individuals make superior advisors.
And of the question that graces this article's by-line (which model is best?)
one might ask: best for whom - advisor or client? My response is that,
longer-term, what is best for the client is also best for the advisor. After
all, what is better for an advisory business than taking good care of clients?
Dan Hallett, CFA, CFP is the President of
Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as
Investment Counsel in Ontario and provides independent investment research to
financial advisors. He can be reached at