As financial services have evolved, so has the way advisors get paid. The original way advisors made money was through commissions; they would earn a sales charge when they sold a product. Now many advisors are charging fees for management and services.
How advisors get paid: Commissions
Some products offered higher commissions than others and unfortunately some advisors chose to sell their clients higher commission producing products, even if it wasn’t the best product for the client (even though it was suitable).
Commissions can be paid by the product company oy by the client. Just because the product company pays the advisor’s commissions, doesn’t mean the product is free to you, commission based investments often have high internal costs.
Thankfully, the industry is evolving and many advisors now earn their compensation through fees.
How advisors get paid: Asset Under Management Fees
Fiduciary and fees go hand in hand. Fee-based advisors make the same amount of money no matter the product the client ends up with. Fee-based advisors will charge a percentage fee based on the assets under management.
This is a benefit to the client because a fee-based advisor is not motivated by commissions or to sell a certain product, because no matter what the advisor makes the same amount of money.
Most fee based advisors have a sliding scale, so the larger the account, the smaller the percentage they charge. Let’s say you have $100,000 IRA and the financial advisor that is managing it charges a 1% asset under management fee. This means that you would pay $1,000 in advisory fees. You would pay the $1,000 in advisory fees whether you chose investment portfolio A or investment portfolio B. The advisor has no financial motivation to steer you one way or another. They are obligated to present to you portfolios that are in your best interest.
When an advisor charges an Assets Under Management (AUM) fee, the fee is deducted from the account. Be sure to confirm where the fee is coming from. If you would rather be billed and pay a check for your advisor fees, ask the advisor if that is an option.
How Advisors get paid: Fee Only
Fee-only advisors charge a flat fee. This can be an annual fee, an hourly fee or a fee for a specific service that you would pay out of pocket, not from your investment account. Some advisors now are charging fees based on a percentage of clients income!
This is a good thing because it is very clear what you are paying. You are paying the advisor for their advice, which is not clouded by commissions.
Costs are a crucial area to understand and it is important for your advisor to be transparent with you about what you’re paying for service. The more transparency you have in the billing, the better. You work hard for your money, and you need to make sure it’s not being eaten up by fees. Be sure you understand any internal costs of your investments as well. This could be a fee assessed for each trade transaction, a required annual meeting fee or a cost inside of the investment in addition to management fees.
Red Flag: The advisor is not clear and concise on their fees and how much you will pay for services.
If they can not clearly explain how they get paid and how much their recommendations and services cost you, then you may want to second guess working with that advisor.