Q31 – What is the difference between fee based and fee only?

Also available as podcast (Episode #31)

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What is the difference between fee based and fee only?

There is a growing debate – amongst regulators, credentialing bodies, industry advocates, etc. – regarding the proper, or for that matter, improper use of “fee-only” vs “fee-based”.  The general argument being made is that unless 100% of any and all revenue you derive is solely from fees, you shouldn’t otherwise hold yourself out as “fee-only.” While that might at first seem to apply to anyone under a Registered Investment Advisor (“RIA”) umbrella, there are some nuances to it that make such a determination perhaps less clear.

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Full Transcript:

What is the difference between fee-based and fee-only? That is today’s question on the Transition To RIA video series. It is question #31.

Hi, I’m Brad Wales with Transition To RIA where I help advisors like you understand everything there is to know about why and how to transition to the RIA model.

Today’s question, it’s related to this whole idea of…kind of being in this fee-based or fee-only world, is this terminology. There’s a lot of chatter out there about this topic and conversation going on about….can you call yourself fee-only or fee-based? You might think we’re splitting hairs here, but I did want to go through some examples of some of the opinions and arguments that are out there and why you want to pay attention to this topic.

There is a lot of difference of opinion (on this topic). Some people would say this is a silly argument to even have. Others are very firm on why it should be one way or the other. I will tell you that these terms are so interchangeably used at times that I, even as I was preparing to make this video I think….”am I going to – I actually might do this – am I going to misspeak at some point during this video and use the wrong phrase when I was alluding to the other one?”

It’s a typical thing out there where these are interchangeably used. The thought is, should that not be the case? Should it be more defined of who and why and when you can use fee-based versus fee-only?

I would tell you this is not something all advisors are necessarily talking about or investors are talking about. Regulators though are talking about it, tossing this around (asking) is this a concern? As well as some credentialing bodies? I believe the CFP board has dove into it and is looking at it and asking….”what are we comfortable with or what are we not?”

There’s certainly a bigger conversation going on out there. So I did want to make a quick video here to go through this and things for you to be thinking through. If you were to go ahead and transition to that RIA model, what do you want to be prepared for from a verbiage standpoint?

The argument out there is that if you’re going to call yourself fee-only, you literally can only, by definition, receive fees. Nothing else. You might think to yourself….”well, yeah, of course I’m fee-only, if I start my own RIA.” One of the beauties of the RIA structure is it’s very clean with a client.

You say….”Client, you pay me the fee,” perhaps it’s 1% of the account value, “and that’s how I’m compensated. That’s the only way I’m compensated. It doesn’t matter what products or services we use, or how frequently we trade or don’t trade or anything like that. The only fee I receive is (for example) the 1% from you, that is it.” If that is truly your structure, then arguably, you can use that “fee-only” verbiage with how you put yourself out there.

However, I will tell you some advisors, they think….”Oh, I have an RIA so I’m fee-only.” But there are some examples to think through that maybe pulls you back from that scenario I described. I’ll give you two of them. I’ve done videos on both of these topics.

There is the ability as an RIA to also have a relationship with what are often referred to as RIA-friendly broker-dealers. I did a video on this. It’s video number 30. If you haven’t seen it, I encourage you to go look at it. It is possible to – even if the bulk of your business is going to be under the RIA – for a multitude of reasons, you might still want or need the ability to either offer commission products or be able to facilitate existing legacy products on an ongoing basis. Maybe you’re receiving trails or something like that.

If that is your arrangement at that point, one might argue….well, you’re not fee-only anymore because in some capacities, you’re receiving commissions – technically trails are considered commissions. Even if it’s 99% over here, the RIA and only 1% here, again, one could argue at that point, you’re not fee-only.

Another example is if you offer insurance products as part of your RIA. I did a whole video on this as well. I encourage if you have any interest in offering insurance products, I did a whole video on how it works and you can certainly go through all the details on that video. A lot of RIAs do offer insurance products. There are absolutely reasons you might want to implement that into your practice. It can be a tremendous value to your clients.

The argument on this fee-based, fee-only debate is….if you are an RIA, and you do offer perhaps term life insurance to your clients and you receive a commission on that, again – even if that’s only a small slice of your business – can you still call yourself fee-only? Because you’re not fee-only. Yes, the bulk of it (your revenues) is the fee from the client, but perhaps at times, you do receive a commission for something. Have you now crossed that line and now at best, you should call yourself fee-based?

This is generally where that term is used as….”the bulk of my business is in fees and only a small minority slice is in something else, perhaps commissions. Bu maybe I should be calling myself fee-based as opposed to fee-only?”

Again, is this perhaps splitting hairs? Fee-based, fee-only? I’m sure I’ve used both of those phrases in conversations interchangeably and generally, there’s not a whole lot of confusion from the person I’m talking to. They know what I’m talking about. I know what I’m talking about (even if I use those terms one way or the other.)

It does impact a few things. The regulators and the credentialing boards are looking at this.

A couple other things to keep in mind. It’s important as an RIA – one of the main structural parts of having an RIA is your ADV. This is something you work with your compliance consultant with on the front end to get set up and then on an ongoing basis to make sure the verbiage in your ADV is accurate.

I’ve done a number of videos on working with compliance consultants and how it works and how much they cost. You can certainly dive into those as well.

You want to make sure the verbiage in your ADV is accurate. With that verbiage – again, you’d be working with the compliance consultant on it – if there’s references to you being fee-only, but arguably, you’re not, because you’re offering an insurance product, could that create issues for you down the line that your verbiage in your ADV is not accurate?

Same thing on your website. If you do have one of these situations that arguably you’re more fee-based than fee only….should you on your website be holding yourself out as fee-only for the public to see that or your clients to see that?

That applies to the rest of your marketing materials as well, whether it’s social media or brochures. Shouldn’t you be making sure you’re using the correct vernacular in that? If you’re fee-based, you’re fee-based. If you’re fee-only, you can use fee-only.

So who would take issue with this if you get it wrong? Two examples, I talked about earlier….the regulators – I will lump these together, the regulators and the credentialing bodies – will in part determine how this continues to evolve, and what actions they may or may not take if they feel you’re improperly using fee-only when maybe you are truly actually fee-based.

It’s something to be aware of. If your regulator has a concern with that, that could be a problem for you. That’s why this is not simply splitting hairs, why are we even having this debate? Certain people take issue with it. Whether you agree or not, you’re going to have to play by the rules.

The other example – and this would be unfortunate to see happen, but in theory, it could happen – is let’s say you have a client and let’s say you do have an arrangement where you arguably are fee-based, not fee-only, but you’ve gone and held yourself out as fee-only.

Let’s say for whatever reason, that relationship with the client goes sideways. The client takes issue with something you’ve done. Maybe they’ve now run out and they got an attorney and they want to sue you. Which of course, could be entirely frivolous. We all know, unfortunately, that happens in the industry. It’s potentially possible.

I know I’m digging for an example here, but could that opposing counsel try to make an issue – especially if whatever you did for that client involved something with a commission – could that opposing counsel try to say….”Mr. or Mrs. Advisor, I see on your website you claim to be fee-only, and my client believed you were fee-only. Now you’re telling me you receive something other than fees? You receive commissions?”

I think we can argue that would generally be unfair for an opposing counsel to try to make that argument. But it doesn’t matter what I think, it doesn’t matter what you think, it doesn’t matter what’s fair or not. The opposing counsel could still try to do something like that. That could cause you challenges from a defense perspective, or however it is that situation gets resolved.

I know that’s a pretty narrow example, but you always want to be properly and transparently holding yourself out to clients and prospective clients. You never want to do anything that could potentially put you in a position that your own words could be used against you.

So in my opinion, it is important to be aware of this topic. Whether you agree that this should even be debated or not, you still need to be cognizant of the fact that it could create challenges, and maybe it’s simply not worth fighting the fight over.

Your compliance consultant will help you with all this. They’ll be aware of – as they help you set up the RIA or help you maintain the ADV on an ongoing basis – they will be aware that you’re doing (for example) insurance products. They will be aware that you’re doing commission products with an RIA-friendly broker-dealer. They’ll help you with all of this.

It is something to be aware of yourself as well though, as you might be guiding the ship on (for example) how your website is created and things like that.

I’m of the belief this is an important topic to be aware of. I think it’s going to continue to evolve. We’ll see where it goes from here.

With that, like I said, my name is Brad Wales. I’m with Transition To RIA where I help advisors like you understand everything there is to know about why and how to transition to the RIA model.

Today’s topic is more something to be aware of for after you make that transition, but part of the transition involves setting up a website, what services do I want to offer, etc. Do I want to offer insurance products or these sorts of things?

This is a great example of the variables you need to think through about potentially moving from whatever your current arrangement is, your current affiliation option is to the RIA model. This is exactly what I help advisors understand is, all of these variables. Let’s go through them one at a time. Let’s make sure you understand them. Let’s make sure you can make informed decisions about what the best path might be for you going forward. I’m more than happy to have that conversation with you as well.

If you’re not already there, head on over to TransitionToRIA.com. You’ll see plenty more videos I’ve done. I’ve mentioned some of them here. Also some economic whitepapers you can take a look at.

The easiest and quickest thing to do is right there at the top is a contact link, click on that. You can instantly and easily schedule a specific date and time that we can have a conversation just like this. Whether you want to debate the topic I’m talking about here and say you’re fee-based versus fee-only, and would it apply to you – or you want to have a conversation about any other topic regarding what might it look like if you were to move and transition to the RIA model, I’m more than happy to have that conversation with you.

With that, I hope you found value in today’s video, and I’ll see you on the next one.

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