Fee-Based and Commission-Based Accounts - What are the Advantages and Disadvantages of Each?
You encounter many important decisions when evaluating your finances. Among these is deciding how you want to access and monitor your investments. While expenses accompany the work of financial consultants, their services can support you and your efforts as you make critical decisions about your financial future.
Fees paid to financial investors largely fall into two basic categories: commissions or fees. It is critical to understand the differences between these two types of accounts, so you know which option is best for you and your needs. The arrangement you select will guide the relationship between you and your advisor. It will determine how your consultant gets paid and which services can and will be provided for you. Read on to learn the advantages and disadvantages of each type of account.
Fee-based consulting has become more popular in recent years. With fee-based accounts, clients either pay a flat fee for financial guidance, or they pay a percentage fee based of their accounts’ assets. This fee can be negotiated between the consultant and customer and often covers all assistance and time provided to the investor. The advisor’s compensation is not connected to commission payments from the sale of any services or products.
In general, fees do not fluctuate according to the kind of investment the advisor encourages or selects. Consultants working under a fee-based model are obligated to the fiduciary standard. This law requires financial planners to act in the best interests of their clients, and to place their clients’ welfares above their own.
The chief advantage of the fee-based model is objectivity and unbiased advice. The financial interests of the consultant and the client are aligned as payment to the advisor is not contingent on how or where customers decide to invest their savings.
If utilizing services based on a percentage of your assets, the advisor gets paid more when your account increases in value. If your account drops in value, the consultant’s payout is subsequently lowered. So, fee-based planners are paid to grow their client’s portfolio and save them money. This alignment can create a more amicable working relationship with less possibility for disagreement or conflicts of interests. Another advantage to the fee-based model is that trades are usually free. So, you can buy and sell regularly, and receive no additional cost for the transactions.
Commission-based consulting was the norm for many years. Commissions are still popular, but less common than in years past. Advisors operating under this model are paid when clients open accounts or purchase products. So, each time an investor buys something within his/her account, there is additional cost. Charges are dependent on the number of shares purchased or the earnings from the sale of an investment.
A problem with commissions is the inherent tendency to direct customers toward products that compensate consultants the most. This inclination can easily conflict with the best interest of the client’s finances. Also, commissions can encourage recurrent trading which is seldom valuable for long-term stock holders.
Fee-Based or Commission-Based?
In deciding which type of account is best for you, you need to consider how often you trade. A commission-based account is a better bargain for clients who have smaller investment portfolios, trade rarely, and require little financial management. If you trade regularly, a commission-based account will accrue more cost for each transaction. These fees can quickly add up and reduce your gains by a considerable amount.
An advisor paid to push a product without additional compensation after the sale is less likely to maintain proper monitoring of the product. So, if you maintain a fee-based account and depend on financial supervision and support, stick with what you have. On the other hand, if you aren’t dependent on financial advice, a commission-based account might be a better option for you.
Deciding if a commission-based model or a fee-based model is better with tax deductions is hard to determine. Tax benefits from commissions are only deductible when the investment is sold which may be many years after the commission expense is paid. Tax advantages for investment fees can be deducted in the year they are paid. Commissions offer a straightforward tax advantage with a reduced capital gain. However, wealthier investors are unlikely to receive benefits from these fees as it is difficult for them to accumulate deductions that exceed the necessary 2% of their adjusted gross income.
In a Nutshell
There are pros and cons to both types of investment fee structures. To determine whether a fee-based model or commission-based structure is best, it is important to consider many variables. This includes income level, financial goals, age, risk tolerance, and your desired level of involvement. Like most modern-day businesses, the financial industry continues to grow and progress. While it’s important to be in-the-know in order to make sound and fruitful financial decisions, it’s more important to find an investment professional you can trust and communicate with openly and honestly. Contact Chesapeake Investment Planning and receive the attention and guidance you need to make financial decisions that are best for you and your future!
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Chesapeake Investment Planning, LLC is not affiliated with Kestra IS or Kestra AS.
Todd Wilhoit contributes articles for Investopedia.com. See this one and more here.