You wouldn’t choose an advisor at random, but do you know how they are paid?
To nobody’s surprise, some people take advantage of other’s lack of knowledge when it comes to different subjects. This happens constantly in the financial sector to people not completely realizing what they are signing up for when deciding to work with a financial advisor. Today, we are going to walk through how advisors are paid.
When you hear fee-only, think of an advisor that works for their clients and doesn’t receive compensation for the products their clients’ purchase. They typically charge a percentage based on the assets they manage. This incentivizes the advisor to grow the account to increase the amount they are ultimately paid. They may also charge by the hour in the instance of a client wanting a one-time financial plan created. They have a fiduciary responsibility and are required to act in the best interests of the client.
When you hear commission, think broker-dealer. Advisors who work for a broker-dealer receive compensation based on the broker-dealer’s incentive structure. Compensation is often sales commissions of products that the broker-dealer has a relationship with. The commissioned products can vary from proprietary products, mutual funds, life insurance products, stocks, ETFs, etc. Commissions are often baked into the sale of the product or have markups/markdowns that the client does not see. These broker-dealers can also receive 3rd party compensation for using other financial institutions’ products.
Fee-Based advisory firms are a hybrid between fee-only and commission based. They typically decide on how they would like to charge a client, such as commissions, a fee, or both. These advisors are required to be dually registered.
When meeting with an advisor for the first time, it is important to understand how you are paying them. Not knowing this can ultimately set you back on achieving your goals without your even knowing it.
It is also important to understand the level of service you will be receiving. Will the advisor be offering investment management only? Will they provide financial planning? Knowing this can help you understand if you are overpaying or receiving the service you need.