Updated: Mar 4, 2021
Compensation can be a driver of behaviors, like an hourly worker eagerly accepting overtime or a salesperson paid on profit not discounting a sale. In the world of personal finance, an important figure is the financial advisor. It’s easy enough to understand that they get paid, but it’s more complicated to understand exactly how. And knowing that compensation drives behaviors, we must ask the question: how are financial advisors paid?
Commission Only: Some advisors receive money for selling financial services, like insurance products. Another way they get commissions is on securities trades, which could encourage the advisor to make unnecessary trades on your behalf . Another type of commission would be a percent of the money you’re investing, i.e. 5% of $3,000.
Commission and Fees (also called Fee-Based): These advisors get a fee for developing a plan, then commissions, which are often stated as a percentage of assets under management, i.e. 1.35% of the portfolio they manage. This is the most common way advisors are compensated.
Salary Plus Bonuses: Some advisors receive a base salary and get bonuses for new clients or selling products. I have not as yet come across an advisor who is paid this way.
Fee-Only: These advisors are paid to provide advice and have no financial stake in the recommendations they give you. There seems to be a general movement in this direction.
Hourly Fee: You pay these advisors based on how much time they spend with you or how much time they spend working on a plan. This is good for people who want to mostly do everything themselves but want a professional’s sign off.
Flat Fee: This method of pay is like the hourly fee. You pay for something specific. The pricing probably very closely aligns to what the advisor would make hourly.
Retainer Fee: Usually calculated based on a percentage of something like net worth or income.
Knowing how your financial advisor is paid is important. It is human nature to behave in a way that rewards us the most. If an advisor makes money only on commissions on securities trades or insurance product sales, where is the incentive for them to advise you to invest in physical real estate? If an advisor gets paid to sell you insurance products, won’t they recommend them every time? Many financial advisors are fiduciaries, which means they are legally required to act in your best interests. Proving whether they are acting in your best interest can be a gray area though. It could be difficult to prove that buying an insurance product, for example, is not in your best interest.
Because of the inherent tug and pull between what is lucrative for the advisor and what is right for the client, I tend to favor the fee-only approaches, however, I’m yet to select and work with a financial advisor myself.
If you enjoyed this and want to know more, check out Questions To Ask a Financial Advisor or How To Prepare for a Meeting with a Financial Advisor.