You must understand “How do financial advisors get paid” before hiring a financial advisor. The stress of entrusting your hard-earned money to a financial advisor and trusting them to protect and grow it can be nerve-wracking at best, and paralyzing at worst.
Just like understanding the fees associated with any service, grasping the various ways financial advisors are compensated can clear up confusion and help you make informed financial decisions when choosing the right person to help with your money. The way an advisor gets paid can actually significantly impact the type of advice they provide and whether their recommendations are truly in your best interest.
While financial advice can feel expensive, it’s interesting to note that a 2021 Advisory HQ study found the average person is likely already paying between 0.59% and 1.18% in asset-based fees whether they work with an independent advisor or not. These advisory fees are often buried in the fine print of things you’ve likely already invested in, such as mutual funds or target-date funds typically offered in employer-sponsored 401(k)s. And those who choose to take on the complexities of the market themselves don’t necessarily make better financial decisions with their money.
Fee Structures: Decoding the Ways a Financial Advisor Gets Paid
There are three primary fee structures commonly used within the world of financial advice: commissions, fee-only, and fee-based. Let’s unpack each model to understand their implications.
Commissions: The Potential for Conflicts of Interest
Commission-based compensation means your financial advisor earns a percentage or a flat fee for selling you certain financial products, often ones that create a kickback or finder’s fee to the advisor. This could range from investments like mutual funds or annuities to insurance policies.
This payment model can create a conflict of interest. Although advisors are legally and ethically obligated to recommend suitable products, there might be a subtle push toward options that generate higher commissions for financial advisors, potentially at the expense of what might truly serve you best.
Imagine you’re buying a car, and the salesperson only shows you the most expensive models, downplaying perfectly suitable but less-profitable vehicles. This scenario illustrates how commissions could incentivize certain recommendations, even if there are less expensive, equally good options.
Fee-Only: Aligning Incentives with Your Best Interest
In the fee-only model, advisors receive payment directly from their clients for the financial advice and services rendered, and that’s it. There’s no compensation tied to selling you any specific financial products, greatly minimizing potential conflicts of interest.
This model is similar to how you pay for a doctor’s appointment; you are there for advice and services without the expectation that they are trying to upsell you something for their own financial benefit. You’ll commonly find that fee-only financial advisors will have established advisor firms to streamline their services.
But how your financial advisor gets paid in this structure can look a few different ways: a percentage of the assets they manage for you, a fixed annual or project-based fee, or by the hour. Fee-only financial advisors prioritize acting as a fiduciary . Fiduciary means a person or firm has the legal and ethical obligation to always act in your best interest, even when it conflicts with their own financial gain. All Registered Investment Advisors (RIAs) are held to this fiduciary standard.
Fee-Based: Hybrid Approach with Transparency Key
As the name suggests, this is a blend of commission and fee-only structures. Fee-based financial advisors can charge clients a fee for creating their financial plan while also potentially receiving commissions from the sale of specific products, such as mutual funds or insurance policies, they’ve recommended as part of your overall strategy. This combination brings both benefits and drawbacks, requiring an extra level of transparency from both parties.
You may be asking why someone would choose this method if it reintroduces potential conflicts of interest present within the commission-only model. In short, a fee-based model may offer investors a wider variety of services from one professional rather than creating a situation where someone might need an advisor for investing but also a separate person for insurance needs.
When interviewing a fee-based advisor, it’s even more important to understand where potential conflicts lie. Are they a true Certified Financial Planner (CFP) , or just someone with a life insurance license giving financial advice? Is a large percentage of their annual revenue generated by selling proprietary investment products or products offered by a strategic partner? Understanding what percentage of their business comes from commissions vs. fees, along with what products those commissions are derived from, can illuminate whether their incentives align with your own.
Why Should You Pay For Advice? Isn’t That What I Could Do Myself?
The world of investing has opened up to more individuals. People now have more direct access to sophisticated trading platforms and a wide array of investment options. With this comes the tempting thought, “Why should I pay for advice when I can just do it myself?”
The reality? Most investors let their emotions get the best of them, jumping in and out of investments at all the wrong times. Fear and greed frequently dictate their behavior rather than making thoughtful, strategic decisions.
The result is many do not make the best long-term decisions. The investor behavior research firm DALBAR conducted a study of average investor returns for the 20 years ending December 31, 2017, and found investors who took a do-it-yourself approach earned, on average, 2.56% less than the S&P 500. 2While that difference may not seem like a huge amount year over year, over the course of a 30-year period that could mean a gap of over $300,000.
Another interesting data point from Fidelity suggested that people in their early 60s should be aiming to have at least eight times their current salary saved for retirement. That goal increases to ten times their salary saved by the time they hit 67, making every percentage point count when trying to create true financial security.
The Value a Financial Advisor Provides
There’s a human element involved in sound financial decision-making that goes well beyond simply picking the right investments. A qualified advisor can guide you, offering unbiased advice, educating you about different aspects of your financial life, and helping you remain focused on your goals and objectives. This is especially true when you are seeking more than just investment advice, such as comprehensive financial planning.
How your financial advisor gets paid can directly impact the level of support they provide. An advisor being compensated by a set fee, for example, may be more likely to answer any and all questions you have without worrying about whether an hour on the phone will “eat” into their potential for commissions that week. They are often more focused on building lasting relationships by providing true wealth management.
They will consider various elements of your life when crafting a financial plan that supports your goals and risk tolerance, not just the things they specialize in or get paid a commission for.
Additional Benefits
The value an advisor adds might not be as quantifiable but can contribute significantly to the success of a plan, such as:
- Behavioral Coaching: A good advisor will offer a steadying influence, providing rational, objective perspectives and actionable strategies when markets get volatile. According to a 2020 report from Vanguard , advisors can potentially increase returns up to 3% by offering personalized behavioral coaching that minimizes the risky, emotion-based decisions DIY investors often make.
- Objectivity: Removing emotion from investment decisions is a challenging but essential component of reaching long-term financial goals. Advisors provide a detached, unbiased viewpoint, helping you steer clear of common behavioral pitfalls that can jeopardize long-term growth.
- Accountability: Sticking to a plan over the long term can be difficult. Having regular check-ins and support from your advisor provides accountability, reinforces positive behaviors, and motivates you to stay on track.
- Expertise: Financial advisors bring specialized knowledge of investments, tax planning, and other important areas that DIY investors often find confusing. AnADV Part 2A can help clarify an advisor’s specialties and expertise. For instance, it can detail whether the advisor or their advisor firm specializes in retirement planning or has experience in managing a registered investment.
- Holistic View: Advisors can view your financial life as an integrated whole. They’ll take the time to create a coordinated plan, integrating investing with other aspects of financial planning, such as tax optimization, retirement planning, or estate planning. This “big-picture” view is essential as you move into more complicated financial phases.
Making a Choice When Fee Structures Aren’t Clear
Sometimes you need to do a little detective work if an advisor is vague about how their fees work, which in itself could be a red flag that they are hiding something. In those instances, their Form ADV, which every SEC-registered advisor is required to provide, can help cut through any financial jargon. The ADV filing clearly breaks down all fees the advisor or firm is compensated for and their sources.
A recent initiative within the financial industry aimed at clearing up consumer confusion is Regulation Best Interest, adopted in June 2019. While still fairly new, it requires broker-dealers and their financial professionals to place their client’s interests above their own when recommending any securities transaction or investment strategy. In these instances, advisors are required to adhere to a “best interest” standard for the recommendations, regardless of their individual compensation structure or the incentives within the firms they represent.
FAQs about How your Financial Advisor Gets Paid
How do I find a good fee-only financial advisor near me?
Two national organizations support fee-only advisors, providing search features on their sites to locate one in your area: The National Association of Personal Financial Advisors (NAPFA) and The Garrett Planning Network . While there may be some overlap between advisors within these networks, this is a great starting place to locate those committed to the fee-only model.
Another starting point could be reaching out to groups that provide resources to Certified Financial Planners to see who in your area specializes in the areas you need help with, as there are frequently local chapters in large cities or areas with a heavy concentration of CFP professionals. You can also inquire about their fee structure and if they offer their services at an hourly rate.
What’s a reasonable amount to pay a financial advisor?
A study conducted by Advisory HQ in 2021 suggests someone paying an asset-based fee will likely pay between .59% and 1.18% of the assets a financial advisor is actively managing on their behalf. The average retainer fee for ongoing planning and investment management was between $6,000 – $11,000 annually.
Hourly rates ranged greatly, averaging between $120 an hour to upwards of $300 per hour, depending on factors such as location and years of experience, making finding someone with the experience level appropriate for your current financial situation incredibly important to getting the most for your money.
Is there a database or website to easily see how much an advisor charges?
While there is no centralized source or database that publishes an advisor’s fee schedule, two excellent resources are a firm’s website or by researching through Form ADV filings. Advisor websites will often have a section on the way their firm charges clients, while their Form ADV (a form provided by the SEC and required for all investment advisors) should clearly define the firm’s fee structures. Make sure you review the ADV Part 2A as this specific document will contain information on an advisor’s fee schedule, services offered, and how they get paid.
My advisor keeps mentioning that they are held to a fiduciary standard. What does “fiduciary” even mean, and is this something I should care about when choosing someone to work with?
A “fiduciary” means a financial professional is legally and ethically bound to put their client’s needs ahead of their own when offering financial advice or making recommendations regarding investment actions. For you, it should offer an added layer of confidence that they are recommending strategies and investment options with your needs in mind rather than their own compensation or incentives provided by the companies whose products they recommend. When financial advisors don’t put their client’s needs first, it can often result in clients not getting the best advice.
Many choose to work exclusively with advisors who are held to this fiduciary standard. Although it doesn’t mean mistakes won’t happen, it can provide some peace of mind knowing that a professional is making decisions with your well-being in mind, and when conflicts do occur (which they will) they are legally obligated to disclose those to you and can be held responsible when they don’t.
Conclusion
Understanding how your financial advisor gets paid should be as important as evaluating the way any professional prices their products and services. Are they looking out for your best interests? What are their true incentives? Transparency is paramount when navigating complex financial waters and planning for your future. Don’t be afraid to ask questions and make sure you feel comfortable with their answers, after all, it is YOUR financial future at stake.