How are financial advisors paid? Learn about 3 of the common compensation structures and the questions to ask your advisor.
When choosing to work with a financial advisor, it is important to know just how that advisor and the firm that employs them are compensated. Although all conflicts of interest cannot be removed, transparency from your advisor on how they are compensated is critical to ensure you are not paying excessive, hidden, or unnecessary fees.
An advisor who is “commission only” will earn a commission on the investments or products that they recommend or sell to clients. For example, an insurance salesperson will earn a commission when selling someone a life insurance policy or other form of insurance. Some advisors will earn a commission when buying a stock for their client or place their clients in different types of higher cost mutual funds (such as “A Shares” which pay the advisor an up-front commission or “C shares” which pay them a “kick back” every year).
Most of the time, commission only advisors are going to do transactional business. A main conflict of interest here is that commission only advisors must continuously sell products to their clients to earn their compensation.
An advisor who is “fee based” typically charges an hourly rate, flat fee, or percentage of assets under management fee for their advice. A fee based on a percentage of total assets under management is typically less than 1.5% of the total amount of dollars that are invested with that advisor. On top of the fee that they charge, these types of advisors can also earn a commission on certain products, as stated above.
It is important to know if the advisor you are working with is compensated more to recommend certain products. For example, many insurance companies will pay their advisors less on their investment business until they hit their insurance quotas, or they will pay bonuses based on the amount of new clients that they gain in a year. Meanwhile, a bank owned broker dealer may pay bonuses to their advisors who recommend that their clients open bank accounts or originate mortgages with the bank that employs them.
If your advisor is fee based, you’ll want to know if your advisor will be compensated in addition to the fee that they are charging when giving their advice.
A “fee only” advisor does not earn a commission on any products that they recommend and is compensated through one of the following ways: an hourly rate, flat fee or percentage of assets under management fee. By removing the commission portion of their compensation, advisors can eliminate a main conflict of interest between themselves and their clients.
There are pros and cons to each type of fee structure and the right structure for you will be based on the level and type of advice you are seeking. Some of the questions to ask your advisor include:
Regardless of the fee structure that is chosen, it is important that your advisor is transparent about the fees they are charging and that they disclose any conflicts of interest that are created by that structure.