How Do Financial Advisors Get Paid?

In the financial advice world, probably the most popular question is “how do financial advisors get paid”?

As the financial industry has evolved, so too has the manner in which consumers pay for financial advice. Generally speaking an advisor will fall under one of these models:

  1. Commissions only (i.e. buying and selling financial products),
  2. Fee only (which could be asset-based, hourly, or flat), or
  3. Some combination of commissions and fees (called “fee-based”)

You know you have to pay for the advice one way or another, so why does it matter? What difference does it make? In a nutshell, how your advisor is compensated can show you where their incentives are – are they motivated to sell you something (commissions), or are they motivated to grow your account and/or spend time creating a financial plan (asset based or financial planning fees). To be clear – there are good and bad advisors on both ends of the spectrum. The point is, you should be sure to understand how your financial advisor gets paid before working with him or her.

What is a commission-based advisor?

Commission-based advisors can mostly be found at large Wall Street firms, banks, and insurance agencies. As the name implies, they are compensated for initiating transactions with consumers. In the old days these types of professionals were referred to as “brokers”, but now they are generally called financial advisors, wealth advisors, financial consultants, so on and so forth. 

Many commission-based advisors are licensed to sell a cornucopia of products such as stocks, bonds, mutual funds, life insurance, and annuities. However, they often stand to make a higher commission if they sell one product over another. Life insurance and annuities are typically the most lucrative – on average, according to thebalance.com, commissions on variable and fixed index annuities can range from 4%-8%. For example, a commission-based advisor might stand to make between $4,000 to $8,000 for selling you a $100,000 annuity. It is probably not a coincidence that the more expensive/higher commission products also tend to be the most complex and confusing.

how do financial advisors get paid

While commission-based advisors often help clients with comprehensive financial plans, some focus more on your investment portfolio because buying and selling products is how they are paid. This can create a conflict of interest. Consumers should therefore be vigilant as to whether such an advisor’s recommendation is truly in their best interest, or whether the advisor is attempting to fit a square peg into a round hole – or in other words, justifying a high-commission product as the right course of action even if more practical (or cheaper) alternatives are available.

Of course, this is an extreme example and usually not the case in real life; advisors under a commission model are capable of providing honest, transparent advice. The point is that these are important questions to keep in mind.

What is a fee-only advisor?

Fee-only advisors are usually found at smaller, independent companies known as Registered Investment Advisory firms (RIAs). 

The term “fee-only advisor” can mean many different things: some charge flat hourly fees for their advice (similar to a lawyer), while others charge flat retainer fees (usually a few thousand dollars per year), or – most commonly – a flat or tiered annual fee based on a percentage of the money they manage for you (called asset-based or asset management fees, which are usually around 1.00% -give or take, depending on the size of the account – check out our fees here – (FAQ #6))

Fee advisors are regulated by the Securities and Exchange Commission (‘SEC’), which holds its advisors to a “fiduciary” standard, meaning they operate under a legal obligation to work in their clients’ best interests at all times. Perhaps unsurprisingly, higher-cost products usually does not make the cut when put under this level of scrutiny.

As opposed to commissions, where incentives are at worst hidden or at best just downright confusing, fee-only structures tend to be more transparent. This is because the fee is typically agreed upon at the start of the client-advisor relationship and is visible to the client on their monthly/quarterly statements. Compare this to commissions, which are typically charged on an ad-hoc, per-transaction basis (and might not show up on a statement).

The most popular method for fee-only advisors tends to be the percentage fee on the assets they manage for you. Generally speaking this type of arrangement can put clients and advisors on the same side of the table, because not only does the advisor have a legal obligation to put the clients’ interest first, the advisor also stands to earn a higher fee as the account grows in size (and vice versa if the account goes down).

Commissions, on the other hand, are oftentimes paid upfront so any gains or losses past that point generally won’t affect how much that advisor gets paid.

What is a fee-based advisor?

What’s the difference between a fee-only and a fee-based advisor? As if the financial world didn’t already have enough jargon, you should know fee-only and fee-based are not the same thing.

Fee-based advisors can be paid via commissions and asset management fees (or hourly planning fees, etc.). A common scenario is an advisor who charges a percentage fee on the assets they manage for you, and at the same time he or she also has an insurance license and can sell insurance policies or annuities if need be. For example, this type of advisor could charge a 1% annual fee to manage your portfolio, and also earn a commission off selling you a life insurance policy.

Fee-only advisors generally don’t have the proper licenses to sell insurance. If one of their clients ends up needing insurance, the fee-only advisor may simply refer them to a third-party insurance company (this is what we do!).

There are plenty of good (and bad) advisors no matter how your financial advisor gets paid. The takeaway is that no two advisors are the same – either in how they are compensated, the services they provide, or in their general approach to financial management. Choosing the right investment advisor is not a decision to be made lightly. Considering how many options consumers have when it comes to getting financial advice, it is important to do some research and ask plenty of questions before signing the dotted line!

Taylor Hoffman is a proud member of the fee-only advisory community. To learn more about our fiduciary financial planning services and our investment management approach, contact us today!

Disclosures:

Taylor Hoffman is an SEC registered investment adviser with its principal place of business in the State of Virginia. Any references to the terms “registered investment adviser” or “registered,” do not imply that Taylor Hoffman or any person associated with Taylor Hoffman have achieved a certain level of skill or training. Taylor Hoffman may only transact business in those states in which it is registered /notice filed, or qualifies for an exemption or exclusion from registration /notice filing requirements. For information pertaining to the registration status of Taylor Hoffman or for additional information about Taylor Hoffman, including fees and services, please visit www.adviserinfo.sec.gov.

The information contained herein is provided for informational purposes, represents only a summary of the topics discussed, and should not be construed as the provision of personalized investment advice or an offer to sell or the solicitation of any offer to buy any securities. The contents should also not be construed as tax or legal advice. Rather, the contents including, without limitation, any forecasts and projections, simply reflect the opinions and views of the author. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change without notice. There is no guarantee that the views and opinions expressed herein will come to pass.

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