As you go through the process of selecting an advisor (See Article: Choosing A Financial Advisor), it is a good idea to start looking into how they are paid.
There are various methods by which financial planners are compensated. The most common ways a financial planner or investment manager is compensated is by salary, hourly fees, fixed fees, assets under management, and by commissions. When choosing a financial advisor it is important to consider how they receive their pay, and if this poses any potential conflicts of interest in the relationship. It is important to make sure that your advisors interests are not being placed in front of your own financial well-being through high-commission inappropriate investments and strategies.
Inquiring with an advisor on how they charge clients is a completely acceptable question, and we encourage clients to ask their advisors this question before making the final decision to work with a particular financial consultant. The method by which a financial advisor is paid can also be found on the Form ADV which is filed by the Registered Investment Advisor (the financial advisor’s employer) associated with your planner. These compensation methods vary from company to company and from planner to planner.
There are the four primary ways that financial advisors get compensated for their services.
Financial Advisor Compensation Methods
- Fee-Only – Fixed fees, hourly fees, or fee based on Assets Under Management
- Fee-Based – Some services are based on fees and other services are on a commission basis
- Commission Only – Financial advisor is compensated solely through the investment products that they offer (be cautious)
- Salary – Paid an annual salary from their employer
Many of the larger advisory firms and institutions pay their advisors a salary. Some type of commission structure is usually built into the compensation of the advisors through a bonuses and incentives for high-producers. These incentive structures aren’t necessarily bad as long as they do not involve the sales of high commission-based investments.
Most independent financial advisors operate as fee-only financial planners. Fee-only financial planning involves charging a client based on the services they provide, either hourly or as a fixed fee. Rather than receiving compensation through commissions or through selling certain products, fee only financial planners make money by providing a specific service to their clients. Some financial planners create comprehensive financial plans and reports which are unique to each client. They may charge clients on an hourly basis depending on the complexity of their case.
If a financial planning professional is also acting as the investment manager for the client’s investment assets, they may also charge a percentage of assets under management (AUM). The a portion of the annual fee for managing the portfolio is usually taken out quarterly based on the agreed upon rate between the client and the advisor. Investment advisory firms usually charge from 0.50% – 2.5% of assets under management each year. The rate usually depends on the amount of assets being managed. Caution should be used when asset manager fees exceed this common industry range.
Fee-Structure for Investment Management Services
- Fee ranges from about 0.40% (40bps) – 2.5% (250bps) of assets under management
- Should not exceed 2.0% (be cautious of advisor fees over 2.0%)
- Decreases as amount of assets under management increases
- Charged on a quarterly basis in advance or arrears
Some individuals claiming to be qualified financial consultants are simply advisor-like salespeople working for investment companies or funds. These individuals are usually paid on a commission basis and get paid more for selling certain products regardless of how appropriate it may be for their clients. Some things to watch out for are advisors which only recommend only one specific mutual fund family to their clients. Another warning sign are investment advisors which urge clients to purchase mutual funds with a front-end or back-end sales load. A portion of these fees and sales loads usually end up in the hands of the advisor or person who recommended the product. There are thousands of mutual funds and other investment products available to investors. If recommendations seem biased or if high-commission based products seem to present a conflict of interest, make sure the suitability is right for you and that you are comfortable with your advisors decision.
It is important to make sure that your advisor is working in your best interests. Fee-only financial planners present the least conflict with respect to the products and portfolio recommendations offered to clients. Stick with advisors which make diverse recommendations of different types of investments. Ask if your planner or portfolio manager why they choose certain products if recommendations appear to be biased.