Financial advisors deserve to get paid just like any other service. However, if you want an adviser whose interests are aligned with yours, it’s important that you not only know how much your adviser will be compensated, but also the method in which he/she is paid. In general, financial advisors are paid in three ways: commissions, fee-only, and fee-based.
Commission based advisors make money when they sell a product. This compensation is paid in the form of a commission. Commission rates typically range from 3 to as much as 10 percent, depending on the type of product they are selling. For investment products such as mutual funds, the commission is known as a load, which is paid by the client. For example, if you invest $10,000 into a mutual fund with a 5 percent load (sales commission), the actual dollar amount invested in your account would be $95,000. The $5,000 commission is automatically deducted to pay the adviser and or his firm.
A fee-based financial advisor can receive fees paid by the client, and commissions paid to them by a brokerage firm, mutual fund company, or insurance company. They are also not required to inform their clients in detail how their compensation is accrued.
Unlike fee based and commission based financial advisors, a fee only advisor is compensated solely by their clients. They cannot accept commissions or compensation from any other source. Fees are calculated as a percentage of assets under management or on an hourly basis.
Conflict of Interest
The method of compensation should not create a conflict of interest between the advisor and the client. Unfortunately, any compensation in the form of a commission cannot help but present a conflict of interest. If a commission or fee-based advisor can convince a client with $250,000 to invest into a annuity paying an 8% commission, he or she would earn $20,000 in just one day. If the client invested the same $250,000 into a significantly lower expense, no-load annuity, the advisor would earn nothing. Which annuity do you think they would recommend to their client?
Fiduciary versus Suitability
According to Cerulli Associates, approximately 95 percent of financial advisers are compensated in commissions, or a combination of commissions and fees. Only five percent of all financial advisors are fee-only registered investment advisors, and a fee-only registered investment adviser (such as Capital Wealth Management) has a sworn fiduciary duty to put their client’s interest first. The ninety-five percent of commission and fee-based advisors at firms such as; Merrill Lynch, Smith Barney, UBS, Raymond James, Wells Fargo, Morgan Stanley, Ameriprise, and UBS (just to name a few) are held to a lower standard of recommending investments that are only considered as “suitable” to their clients needs.
5 Questions to Ask
When you first meet with a financial advisor, it’s important to ask not only how much his or her fees are, but who actually pays. An advisor’s compensation method can affect the type of advice you get, so you should understand the differences before you choose who to hire. Below are five questions I think people should ask every prospective financial advisor.
- Will you provide a list of the fees and commissions you receive either directly from me or from other sources in writing?
- Are you a Registered Investment Adviser (RIA)?
- Are you willing to accept fiduciary responsibility to manage my investment account?
- Are you willing to disclose any conflicts of interest that may interfere with your acting solely on my behalf?
- Are you willing to provide this information in writing?
If they answer no to even one of the five questions, you may want to consider looking elsewhere.