You may know how your financial advisor is paid. You may know how much your advisor is paid. But, do you know how his method of payment impacts your results?
Type of Advisor
Real financial advisors are paid fees for their knowledge, advice, and services. Salesmen are paid commissions to sell you investment and insurance products. This is an important distinction for the following reasons:
- Salesmen can claim to be financial advisors to hide their real role (selling)
- You may not want salesmen investing your assets
- Salesmen can hide their real role, but they cannot hide how they are compensated
Most people work for the person or firm that pays them. In this case:
- You pay fees to advisors
- Third parties (mutual fund families, annuity companies) pay commissions
You have complete control over the fees that you pay advisors. You have no control over commissions that are paid to salesmen.
Advisors should be accountable for the quality of their advice and services.
- You can stop the payment of fees if advisors do not meet your expectations
- You cannot stop the payment of commissions
- Commissions are paid in advance - consequently, advisors are less accountable
Types of Fees
There are three primary types of fees:
- Hourly fees are charged for planning services
- Fixed fees are charged for planning services
- Asset-based fees (% of assets) are charged for investment services
Types of Commission
There are also three primary types of commission:
- Commissions for the sale of investment products
- Commissions for the sale of insurance products
- Commissions for transactions (purchase and sale of securities)
Some advisors will tell you their advice and services are free because they are paid by third parties. This is a deceptive sales practice for three reasons:
- Product companies increase the fees they charge you to recover commissions
- Product companies may charge substantial penalties for eary withdrawal (7 years or more)
- There are no free lunches in the financial services industry
Why Does It Matter?
Advisors should be compensated for meeting the expectations that they create in their sales pitches. You should be able to stop their compensation if they fail to meet your expectations. You have to pay a fee to control your advisor's compensation.
You should pay a fee for financial advice and services for the same reason you pay fees to other types of professionals (CPAs, attorneys). You want them working for you and not a third party that has a competing interest.