I previously wrote about What to Look For in a Financial Advisor. In that post I briefly talked about how the advisor gets paid. I want to expand on that topic today. Overall, there are three main ways an advisor is compensated.
When an advisor gets paid by commission, they are getting paid by placing you into specific investments. Most times, the firm the advisor works for has a deal in place with a fund company to earn a commission. The advisor could also earn a commission in the trades they place.
While there are many great advisors out there that are commission based, I have a hard time trusting them. My reasoning is because you are entrusting them with investing your money to do what is best for you, the client. It can be very easy for an advisor to place you in a decent investment that he gets a kickback on and not in a slightly better investment that he does not get a kickback on.
A fee-based advisor is one who gets paid by charging you a fee on assets under management. The fee might be around 1% and decrease as your assets grow in value. Understand that this fee is not set in stone. You can negotiate for a lower fee. Many times just questioning the fee a little bit is enough to get it lowered.
A fee-based advisor is a better choice in my eyes. This is because it is in the advisor’s interest to increase the size of your portfolio. Look at it this way: If you have $50,000 to invest and get charged 1%, then you are paying your advisor $500. If your assets increase to $100,000 then the fee increases to $1,000. But, should the assets decrease down to $25,000, the advisor is only getting paid $250.
A fee-only advisor is one that charges an hourly rate to clients. They are like attorneys in that you pay them for the time they work on your portfolio. Many investors choose this type of advisor over commission-based advisors because these advisors are more objective in their recommendations. There is no compensation that leads the advisor to choose the investments he is putting you into.
It is important to ask and to know how an advisor gets paid. If they are commission-based, ask them if they are getting compensated for placing you into the investment they chose. On the other hand, if they charge an hourly fee, make sure you know how much the fee is and how it gets charged.
There are great advisors in each of these categories as well as not so great advisors as well. The key is to find one you are comfortable with and whom you trust the most.