As confusing as financial planning can be, it is not nearly as confusing as advisor’s compensation models. Many individuals do not know how to pay for advice. Advisor compensation models come in all shapes and sizes which can leave your head spinning. Of all things to inquire about, you should have a firm understanding on how your advisor charges. I believe it to be the foundation of your decision process when selecting an advisor.
Let’s break out the compensation models into 2 categories.
Under this model the advisor can be compensated by selling you an insurance and/or investment product as well as charge a fee for the work they perform.
Commission – The advisor is compensated by a 3rd party for the products they have sold. An example of this is the insurance you buy from your advisor. The advisor will make a commission based on the amount & type of insurance purchased. It can also be an annuity you might have purchased or even investment products such as certain types of mutual funds. The key to this model is the more you buy the more money the advisor makes. This can create an environment where the advisor’s needs come before the client’s.
Fees – As I mentioned above, advisors can sell commissionable products and they can also charge fees. Many advisors are utilizing this model as it gives them more flexibility for compensation. Many advisors charge a percentage of assets but they can also charge a flat onetime fee, yearly fee or a hourly fee.
Fee-Based is not the same as Fee-Only. There is a distinct difference between the two compensation models. Fee-Only advisors have made a commitment to be paid solely by their clients. This is important because under this model the Fee-Only advisor closes the door to many of the conflicts of interest that can arise in a Fee-Based model. There are no incentives to work for anyone else but the client. They work for the client and only the client.
There are many advisors out there with many different ways they charge for their services and it can be confusing. You should know where the advisor’s interest lie before you engage their services. Of course there are many other things to consider (check out this WSJ article How to Choose a Financial Planner) but this should be the first box checked in your hunt for the right advisor.