‘FO’ Won’t Necessarily Mean Friend to Your Assets

In business, you are supposed to get what you pay for.

In the financial advice business, though, it’s often hard to see how you are paying or what you are paying for.

That uncertainty is at the center of a controversy that has turned various types of financial advisors against one another, each claiming some form of higher moral ground in an argument over a development that is sure to both entice and mislead consumers.

If you work with a financial advisor or expect to someday, the debate is almost certain to affect you.

In May, the National Assn. of Personal Financial Advisors unveiled a new professional designation, the “FO,” which stands for fee-only. The group, whose members all work on a fee-only basis, recently registered a trademark for the term “fee-only,” a move that outraged a number of other financial service groups, most notably those representing accountants.

NAPFA will make the FO mark available to any advisor--regardless of NAPFA membership--who passes an independent certification process proving that he or she provides financial advice based on fees, never on commissions.

Clearly, this move is well-intentioned. Alas, it may not solve the problems. Here’s why:

* Although NAPFA supporters say they provide “conflict-free financial advice based on fees,” they know as well as anyone that there is no such thing as investment counsel free from any potential for conflict of interest.

Charging flat fees--either a set dollar amount, an hourly rate or a percentage of assets under management--does eliminate the two most obvious conflicts: churning (the turnover of holdings solely to generate commissions) and unsuitable investments recommended only because they generate fees for the advisor.

With those invitations to trouble gone, fee-only service does indeed reduce conflict.

But fee-only advisors still have an incentive to get as much of your money under management as possible.

Say you come into an inheritance and ask whether to invest the money or pay off your mortgage. It would be in the advisor’s interest for you to invest the money, since that would be likely to increase his or her fee.

There are other, less obvious ways for there to be a potential for conflict. Suffice it to say, however, that getting the FO designation is not akin to affixing an advisor with a halo.

* An argument that focuses on how an advisor is paid, rather than what an advisor is paid for, may miss the point.

This situation parallels the story in the mutual fund world. Most early funds were load funds, charging upfront sales fees. But as the investing public grew increasingly uncomfortable with commission-based sales, fund companies created other types of payment systems, notably different share classes for pay-as-you-leave fees, higher expenses in lieu of sales charges, no-load funds that charged marketing fees and so on.

Then came financial planners who blurred the distinction even further, selling no-load funds but still charging a fee based on a percentage of the assets their clients held in them. The fee isn’t a load, but it still constitutes paying a charge to invest in funds.

Not surprisingly, the result has been confusion.

Today, many investors focus first on loads, even though most experts agree that issues such as performance, expense ratios and the total cost of ownership are more important. To say you avoided a load is no badge of honor if you settled for lesser funds in the process; results, not fees, matter most.

That applies to financial planners too.

* Professional credentials and designations should be about education and experience.

An advisor can’t become a certified financial planner without meeting education, experience and examination requirements. That gives the CFP mark some oomph.

An FO is based entirely on compensation, no expertise necessary. As a credential on a business card or in a brochure, that makes it as convincing as, say, an emblem telling you that the advisor accepts payment by MasterCard. It says nothing about the advisor’s abilities, although it could conceivably mislead consumers into believing otherwise. “Fee-only” does not equal “good advisor,” any more than “commission sales” equates to “rip-off.” The quality of the advice depends on the individual counselors, not the way they charge for their services.

In spite of these drawbacks, NAPFA has persisted in pushing the fee-only trademark and designation issue. Privately, members say the move is designed to preempt one by big brokerage firms--the Merrill Lynches and Smith Barneys of the world--to change the definition of “fee-only.”

The brokerage houses are rejiggering compensation schedules and moving from commissions toward fee-based compensation. Just as the load-versus-no-load issue got blurred, the matter of how an advisor is compensated will soon get murkier.

“Until someone comes up with a way to X-ray the human heart, we won’t have any procedural guarantees whatsoever about the advisors we choose to work with,” says Robert N. Veres, publisher of Inside Information, a newsletter that follows the financial planning business. “What we are left with are half-solutions, which I think are better than zero solutions of doing nothing, but which clearly aren’t the absolute answer.”

Consider the case of Irene, a Chicago-area retiree who paid $500 for an advisor to prepare and implement an investment plan producing a moderate income. For continuing services, Irene now pays 1% of her assets--or about $500 more--each year. The problem is that those continuing services consist of telling Irene to stay the course.

Irene acknowledges that her advisor is “very nice and helpful,” but she questions why she is paying for service that always boils down to the same four words: Don’t change a thing.

It’s a common situation. Like those of many investors, Irene’s finances are so plain and average that she could go a year or two between check-ups and save a bundle. If, however, she needed a planner to actively work on a range of issues, such as living wills and long-term-care insurance and medical powers of attorney--services that financial advisors should provide and update as a regular part of their counsel--the annual fee would not seem quite so onerous.

In fact, if an advisor is merely picking investments, commission-based sales can be fine. It’s a once-and-done charge, which is better than an ongoing fee paid for what amounts to no service.

*

Charles A. Jaffe is personal finance columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, MA 02107-2378.