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As you begin your search for a financial professional it’s going to be important to know how the particular professional you choose will get paid. It will also be important to ask questions not only in regards to their compensation, but who actually pays the adviser. There are generally three ways in which financial advisers and planners get paid.
Commission: An adviser that’s paid on commission generally gets paid based on the underlying product they sell. Commission rates vary depending on the product sold – anywhere from 5% to 50%. Term Life insurance for example, will have roughly a 40% commission rate on the annual premium for the first year. Whole Life insurance is generally 50% the first year. The difference being Term Life may have an annual premium of $1,000 where Whole Life may have an annual premium of $5,000. It can be difficult to be objective when an adviser can make $2,500 versus $400 in commissions. Other commissioned products include load mutual funds that charge a load or commission on the initial purchase (i.e. a $1,000 investment with a 5% load means your net investment is $950), annuity products and individual stocks and bonds purchased through a broker.
Fee-Based: Fee-based is essentially a combination of commissions and fees. Generally speaking a fee-based adviser will get paid on commissions on certain products, and will get paid a fee on different products. For example, an adviser that sells life insurance and annuities as well as investment management can get paid commissions for the life and annuity products, and can choose to be paid a flat fee or percentage of the assets in the investment management account. Some products are fee-based, but pay the adviser a commission to sell them. For example, you invest in an asset management account where the annual fee is 2% to have your money “professionally managed”. You may only see a 2% charge for your fee, but the adviser that sold you the program, may receive a commission. This is generally seen in proprietary asset management programs of various companies and brokers. In both circumstances, the adviser is compensated by the product sold.
Fee-Only: Fee-only means that your adviser or planner gets paid directly by you. Therefore, fee-only advisers and planners are compensated for their advice, not on a product they sell. Fee-only advisers get paid a few different ways. The first way is strictly on an hourly basis, similar to how an attorney gets paid. Generally they will give you an estimate that will show you a range of what your fee will be such as $500-$950 for a financial plan. Another way that advisers get paid is via a flat fee for any assets (investments) of yours that they manage for you. This can range from .25% to 2% depending on the amounts invested. Some planners have minimums (i.e. you need $50,000 of assets to work with them) and some do not. Most will have a graduated fee schedule where the more money you invest, the lower your fees get based on certain thresholds.
Many fee-only advisers will take you “off the clock” meaning that once you become an AUM client (assets under management); they will no longer charge you by the hour for advice and questions. Be careful of advisers that “double dip” by charging fees for both managing your money and by the hour for other questions and planning. Make sure their advice is worth the extra money.
Finally, fee-only is very transparent, meaning that you see exactly what you’re paying either from your checkbook or from your quarterly statement.
Of the three, fee-only is arguably considered to be the most objective, yet not 100% perfect. Think of it this way, it can become extremely difficult (although not impossible) for a commissioned adviser to be truly objective when they only way they are compensated is if they sell you something. It becomes even more difficult if their job is on the line, they have a quota to meet, or an incentive such as a company trip dangling in front of them. That being said, all three ways have their advantages and disadvantages. It all comes down to what you’re comfortable with, and whom you’re comfortable with. Do your homework, ask lots of questions. Above all, any adviser no matter how they get paid should put your interests first – above all else. Consider an adviser or planner that is a fiduciary. This means that they are legally obligated to put your interests first.
Lastly, an advisers commissions and fees are not inclusive of the expense ratios and fees of the products they put you in. For example, you could pay a 1% fee to a fee-only adviser but they have you in a mutual fund that charges 1.5% in expenses. Or a commissioned adviser could sell you an annuity that had fund fees of 1.5% and policy charges of another 1.25%. This is another 2.75% of charges annually in addition to the commissions paid! Read the fine print and know all of what you’re being charged. Good professionals deserve to get paid, but their goal should be to have more of your money working for you, not the other way around.