What Is a Fee-Based Investment?
A fee-based investment is a product that's recommended by a financial planner whose compensation includes a percentage of assets under management (AUM) rather than a commission from clients. This is possibly in addition to an hourly rate and other flat fees or performance-based fees. These planners might also earn brokerage commissions if they're broker-dealers.
A fee-based investment shouldn't be confused with a fee-only investment. This is recommended by a financial planner who is solely compensated in fees paid by the client.
Fee-based investments can be offered by investment companies, banks, or other financial institutions.
Key Takeaways
- A financial planner who recommends a fee-based investment might receive a sales commission from the investment provider as well as fees from the investor.
- A financial planner doesn't receive a commission from the provider for recommending a fee-only investment.
- The client will typically be charged other fees that might include an hourly rate or a flat annual percentage of the account assets.
- An investor should ask how the financial planner will be compensated.
How Fee-Based Investments Work
A wide range of fee-based investments is available to investors. They include annuities, mutual funds, stocks, bonds, and other securities. An advisor whose client buys each type of asset is sometimes paid a commission from the sponsoring company for selling it.
The term "fee-based" is also used to describe a hybrid advisor who charges fees to certain clients and earns commissions by selling products to others.
A "fee-based" advisor typically charges clients a fee but may also receive commissions from sponsoring companies for recommending specific investment products. A "fee-only" advisor charges only fees as the name implies.
About Investment Fees
An investment advisor may charge a fee for each service and/or a fixed annual percentage of the assets under management. Annual fees average 1% to 3% and cover most or all of the services a client receives from the advisor.
The commissions paid to an advisor are often folded into the cost to the investor. The expense ratio of a mutual fund includes commissions paid to the advisors who recommend it to their clients.
The brokerage commission is an annual one and will typically be paid to the advisor for as long as the client owns the investment. It's a source of recurring revenue for the advisor.
Special Considerations
Fee-based investments can represent a conflict of interest. Advisors have a financial incentive to sell the product that offers them the best commission rather than what is best for the client.
Both fee-based and fee-only advisors are constrained by professional regulations. Financial advisors may follow one of two standards, fiduciary or suitability.
- Advisors who follow the fiduciary standard are required to put the interests of their clients before their own when they recommend investments.
- Advisors who follow the suitability standard are required to recommend investments that meet the needs of the client in terms of the client's age, income, retirement goals, and other individual characteristics.
Advisors are required by Securities and Exchange Commission (SEC) rules to disclose their compensation to the client in either case.
Advisors who follow fiduciary standards often describe themselves as "fiduciary financial advisors." They may also be members of the National Association of Personal Financial Advisors (NAPFA), an association of fee-only advisors.
Questions to Ask Your Advisor
Not all advisors volunteer information about the fees or commissions they receive. A prospective client can ask an advisor several questions before committing to a financial product.
- What are your professional qualifications and educational background as they relate to financial advice?
- What is your particular area of expertise?
- Are you paid client fees, commissions, or a combination of both?
- Do you adhere to a fiduciary standard?
- Why are you recommending this product to me? Why is it suitable for me?
Fee-Based Investments vs. Fee-Only Investments
A fee-based advisor might collect a fee from the client and a commission from the investment sponsor for some products or just a fee from clients for others. Some clients may pay lower or no fees for recommendations that earn the advisor a commission.
Some investors may prefer a fee-based investment advisor for this reason. The overall fees paid for the investment advisor's services may be lower.
Fee-only advisors don't accept commissions from investment product companies. They charge only fees. They're seen as being free from potential conflicts of interest. They follow a fiduciary standard rather than a suitability standard.
Example of a Fee-Based Investment
Let's say Client A wants to set up a retirement account and meets with Advisor B, a fee-based financial advisor. Advisor B suggests that Client A set up an investment account.
Advisor B assesses Client A's current financial situation as well as the client's goals for the future. After drawing up a plan, Advisor B suggests that Client A put their money in a series of stocks, bonds, mutual funds, exchange-traded funds (ETFs), and other investment vehicles. Client A pays Advisor B a 1% fee for their advisory services as part of their compensation. Advisor B may also receive a commission on some of the investments they sell.
What Is the Difference Between Fee-Based and Fee-Only?
A fee-based investment product is recommended by a financial advisor who may receive a commission from the provider in exchange for its sale. The commission may be included in the annual fees charged by the company that sponsors it and be paid annually to the advisor as long as the investor holds it.
A fee-only investment doesn't come with a commission paid to the advisor. The advisor is reimbursed only through fees that the client pays.
What Is the Difference Between Fee-Based and Commission-Based?
There's little or no difference between a fee-based investment product and a commission-based product. In both cases, the company that sponsors the product is paying a commission to the advisor who successfully recommends it to a client. The client may or may not pay additional fees for the services of the advisor.
What Are Fee-Based Services?
A fee-based service is usually offered by a financial advisor who charges an annual percentage of the client's assets as a flat fee for all or most professional services. The average fee is 1% to 3% of the assets. This isn't the same as a fee-based investment which is a product that may pay a commission to the advisor for selling it to clients.
The Bottom Line
Fee-based and fee-only advisors receive income just as their names imply. Fees are the basis of income for fee-based advisors but they may also receive commissions from sponsoring companies, particularly if they’re broker-dealers. Fee-only advisors receive only fees from their clients.
The Securities and Exchange Commission (SEC) requires that advisors divulge their fee structures but this doesn’t mean that they’ll volunteer the information. Always ask before you commit.
Disclosure: Investopedia does not provide investment advice; investors should consider their risk tolerance and investment objectives before making investment decisions.
