Fee-Based and Commission-Based Financial Advisors
The question is: How are financial advisors being paid? There are many misperceptions about financial advisors’ compensations. I sincerely hope this post will provide more clarity about this very important question.
The financial advisor-client relationship is essentially a long-term partnership based on ethical principles and standards of professional practice that include financial advisor’s compensation. Financial advisors fall in these three categories: fee-only, fee-based and commission only.
Fee-only advisors charge an hourly fee to analyze your assets and create comprehensive financial plan. To manage your portfolio on an ongoing basis, they typically charge an annual percentage of your assets under management. Fee-based advisors charge a percentage of assets being managed and also collect third party commissions for selling insurance and investment products. Commission-based advisors charge their clients for trades and the funds they recommend.
According to the report released by the Boston based research firm*, investors would rather pay commissions for the financial advice they receive than a fee based on assets under management. About 47 percent of 7,800 households surveyed prefer paying commissions, compared with 27 percent that would rather contribute a fee based on assets. About 18 percent said they prefer paying retainer fees, which are generally lump sums negotiated between advisers and clients, and 8 percent said they opt for an hourly fee structure.
Almost every personal finance book written for “do-it-yourself” crowd or advice on how to find the right financial advisor seems to have built in bias against commission-based advisors. Any financial adviser’s compensation method can create a conflict of interest between what is best for you, the client, and what is best for the adviser’s wallet.
A commission-based advisor might recommend fund or other investment or insurance product that is not the best choice for you because she or he is earning a higher commission on it. Many of these products have charges that include commissions paid to financial advisors. Insurance products and annuities include surrender charges in which client forfeits percentage of the funds they contributed if they cancel their policy or take the money out before certain number of years. In the case of front-end load funds investors typically pay 3 to 6 percentage of the amount they are investing, some of which gets passed to broker in the form of commissions. Based on the contract with the broker-dealer, commission-based advisor gets only certain percentage of it. Also, you will pay transaction fee each time you trade security which typically range from $10 to several hundred dollars depending on the type of services you are receiving from your broker.
Management fees are also known as AUM (Assets under Management) fees. These fees are period-based fees and are commonly charged quarterly, though other frequencies such as monthly, semi‐annually or annually are also used. The driver for management fees is typically the size of the asset or fund in terms of the market value for which the fee is being charged. Management fees may vary depending on various factors and fee schedules and may range from a few basis points to a few percentage points. The industry average is roughly 1%. ** That may not sound like much but percentage you pay makes a big difference in long term return. For example, an investor with $500,000 portfolio earning 8% per year would have $1,079,462 after 10 years. Had she paid advisor 1% of his assets during these years, however, her account value would fall to $895,423-a difference of $184,039.
Some typical situations where asset-based fee compensation poses conflicts for advisers will be those that decrease assets under management (e.g. when advising not to buy home or to pay off mortgage even when the mortgage carries high interest rate; when advising against making a large charitable contribution to get a tax deduction, etc.)
The majority *** of wealthy people or those who wish to be wealthy are already using the services of financial advisor. Most**** of those advisors require a minimum of $500,000, some even require a client to have $1 million, before they’ll manage your money or offer financial planning advice.
Many of the services I perform for clients depend on an integrated plan that goes beyond investments (e.g., life and family protection, assets protection, etc). Trying to answer one issue in isolation can be difficult. I offer comprehensive financial and retirement planning services and make them accessible to all. To serve more people and charge for my services in the most appropriate way in every given situation, I can work on both fee-only and fee/commission basis.
I will not make you rich overnight through brilliant stock selection or by my knowledge of some secret investment. Sorry, but that’s not the case. There are no quick, painless solutions to complex financial issues. I am an experienced financial planner who demonstrates fiduciary duties and responsibilities and has character, integrity and competence. I look not only on your ability to accumulate wealth but more importantly how to protect your principal, distribute income as required, and potentially distribute balance to your heirs. I integrate investment management with tax and estate planning.
Financial planning is not a sprint; it’s a marathon! It requires your long-term commitment, discipline, focus and –ACTION!
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*Source: Cerulli Associates, Jun 8, 2011 ** Forbes, May 27, 2013 ***The Wall Street Journal, December 3, 2007 ****Barron’s, September 19, 2013, FDDT