How Financial Advisors Are Compensated—Info You Need To Know!
The more you know about how advisors get paid—and how that can affect their advice—the better.
How does your financial advisor get paid? The answer may have a direct impact on your portfolio’s performance over time.
The type of compensation your advisor receives can affect the advice they give and the products that they recommend. Some compensation models reward advisors for recommending certain investments rather than others. As a result, the advisor may have an incentive to put you in an investment that isn’t the best for you. Likewise, under certain compensation arrangements advisors are paid more for steering clients into savings vehicles with high fees or expenses that may reduce portfolios’ overall returns.
On the other hand, some advisors are paid only by their clients. As a result, the advisor has a strong incentive to deliver advice that’s in their clients’—and only their clients’—best interest.
Make sure your advisor’s fee structure works for you.
A fee-only advisor accepts compensation only in the form of an hourly rate or a flat fee. Fee-only advisors don’t sell investment or insurance products that offer them commissions, and operate under a fiduciary standard that holds the client’s best interests above all else.
Investment advisors or broker-dealers may receive a commission when they sell certain financial products. (Commissions on mutual funds are called loads.) You can think of commissions as kickbacks from companies that provide the products. The problem is that commissions can create conflicts of interest for the advisor.
Consider this example: Your advisor considers two very similar mutual funds for your portfolio. One has no sales load—that is, no commission—while the other carries a 1.5% load. The advisor must choose between a lower cost for you or a commission for himself. If the advisor’s income relies on commissions, it might be an easy choice to choose the fund with a load—and that money comes out of your pocket.
An advisor who is a fiduciary is legally required to put his or her clients’ interest first. Fiduciary advisors are much less likely to consider investments with commissions. (In fact, investment advisors working with retirement accounts act as fiduciaries and are not allowed to offer products that result in commissions to themselves.)
Advisors who operate under a fee-based model represent a mix of the fee-only and commission-based models. They can sell you a product while collecting a commission, or they also can charge you a fee calculated as a percentage of assets in your portfolio, or they may do both. Because fee-based advisors can go between “fee” and “commission” pay structures, this can be quite confusing for a client.
The terms “fee-based” and “fee-only” may sound very similar, but there are key differences between these two types of financial professionals. Fee-based advisors can be vulnerable to the same conflicts of interest as the commission structure entails. Fee-only conduct business under a “fiduciary duty” and must operate with their clients’ best interest at heart.
Just know that there’s no need to rush your decision. Be sure to take the time to research and discuss payment structure with your advisor before signing any contract. It’s best to become familiar with all the payment structures to decide which one is the best for you, your goals, and your financial situation.
Shore Financial Planning is a fee-only financial planning firm located in Monmouth Beach, NJ.
Joseph Vecchio CPA, CFP®, MBA is the firm’s President and has dedicated his professional life to the finance and accounting professions.
Joe believes that people are being exploited by financial salespeople who are merely motivated by quotas, product sales and commission-based income! Shore Financial Planning was founded to provide peace of mind through conflict-free, value-added advice.