How Is Your Financial Advisor Compensated?

There are varying types of “Financial” advisors out there.  How do you know the one you work with is looking out for your best interests and not their own?  How they’re compensated may provide some clues.

The simple way to look at it is that your advisor is either being paid directly by you or somewhere else.  But regardless of what some actually claim, they’re all getting paid somehow!

Your initial response may be that you’d much rather your advisor be paid by someone other than yourself but let’s take a closer look at the potential consequences of this arrangement.  First, understand that if you’re not paying your advisor directly then they’re earning commissions or other transaction related compensation.  Here are a few reasons why this may not be to your advantage:

  1. Some investments pay higher commissions than others and there may be incentive for your advisor to push those that pay more even if another investment option would be more appropriate for you.
  2. If your advisor only gets paid when you make a transaction you may find yourself buying and selling frequently.
  3. Investments that pay the sales agent a commission may be more expensive to own.  For example, mutual funds typically have different class shares.  This classification identifies the internal expenses of owning the fund.  It could be an upfront charge, an early withdrawal charge or redemption fee, or an annual marketing & sales charge (12b-1).  There are “no-load” funds, however, that don’t carry these expenses.
  4. If your advisor is paid his total compensation up front there may be little incentive to give your portfolio much attention after the sale.

It’s important to recognize that you can certainly get good advice from advisors who do not work on a fee-only basis.  With that being said, I believe the interests of both advisor and client are far better aligned when working in an environment absent of sales commissions.  The fee-only arrangement is not perfect but we believe it to be far superior for those who value truly unbiased financial advice.  Not to mention, unlike other investment brokers, the fee-only investment advisor is held to a fiduciary standard which mandates that the client’s best interests be placed first.