My last post (See: ENGAGING ADVISORS- ALPHABET SOUP- PT 1) discussed the two types of financial advisors: The fiduciary financial advisor, and the non-fiduciary financial advisor. This post will discuss the manners in which advisors are compensated.
THERE ARE THREE MAIN METHODS OF ADVISOR COMPENSATION:
*Fee-only Advisors
*Commission-based Advisors
*Fee-based Advisors
*Fee-only:
- The most common fee-only financial advisor structure charges a percentage of assets under management (A.U.M.) The fee is charged annually and is usually deducted from an investor’s account on either a quarterly or monthly basis based on the account value. (In 2021 an investor with a $1 million account paid a 1.02% advisor fee annually, while a $50,000 account holder paid a fee that was closer to 1.2% annually. If you’re interested, a $30 million account holder paid an annual advisory fee of approximately 0.59%annually.) These fees are average percentages paid. All advisors are different and fees and percentages for individual advisors will vary and are usually based on the account value at the beginning of the year.
- The second type of fee-only financial advisor charges hourly or on a periodic retainer basis that’s not based on the size of your account. Fee-only advisors may also charge a flat fee for each type of service provided. This type of advisor may charge several thousand dollars to prepare a comprehensive financial plan, and afterward, charge a flat annual fee to review and update the plan. With this type of advisor, the investor usually implements the plan personally and manages their investments. Because flat-fee advisors have no affiliation with the investments chosen, they are often seen as the most unbiased financial advisors.
*Commission-based:
Commission-based advisors are paid through the investment products that you buy. They’ll receive a percentage of your investment dollars from the investment provider. Usually, commission-based advisors are paid a fee or commission by someone other than the account owner and that usually means that your best interests may not be the commission-based advisor’s highest priority.
Commissions are paid directly to the advisor by the investment company. Annuities are well-known for having high commissions. But mutual funds and bonds may also carry sales loads, fees, and commissions. Account holders don’t see them coming out of their account balance on each statement because commissions are directed internally and directly to the advisor. These fees and commissions will still affect account balances as a negative drag on returns.
Commission-based advisors have been maligned for recommending the highest-paying product, which is best for the advisor but may not be the best product for the investor. But it may not be accurate to say all advisors who work on commissions are putting their own best interests before their client’s best interests.
*Fee-based:
Fee-based advisors collect both a fee and a commission. (This is the main difference between fee-based advisors and fee-only advisors. The fee-only advisers do not charge commissions.) Fee-based advisors may charge an A.U.M. fee while also earning a commission on investment products sold. This type of compensation structure is the most common among advisers. Many firms are dually registered as fiduciaries and broker-dealers. This dual registration allows a firm to work as both broker and fiduciary advisor. This is important because the firm may act as a fiduciary advisor, but may not act in that capacity 100% of the time.
In deciding whether a financial advisor is right for you, it is necessary to evaluate both the fees involved and the value that the advisor provides. In addition to financial plans and investment advice, some advisors achieve higher returns, provide tax minimization strategies, provide portfolio rebalancing, and guide clients through turbulent market conditions.
It is recommended that several potential advisors be interviewed before entering into a financial management contract. Finding the advisor that Is the best fit for your financial management needs is the first step in establishing a long-term client-advisor relationship.
Sometimes the greatest value of an advisor is achieved by preventing the client from making poor investment and management decisions during stressful situations.
When considering engaging financial management through an advisor many important questions should be asked before entering into a client-advisor contract. In my next post, I will discuss pertinent questions and provide an advisor engagement questionnaire for the initial interview.
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