Do You Know How Your Financial Advisor is Paid?
Tim Randak, MSF, CFA®, CFP®
Often, financial advisor compensation is misunderstood. A 2023 survey (1) found that 36 percent of investors were confused about how they were paying their advisor. In the survey, 20 percent believed their advisor’s services were complimentary. Advisor compensation varies, but almost certainly, such services are not free. Most advisors are paid in one of the following ways:
FEE-ONLY
Fee-only financial advisors receive compensation solely from their clients, not from a brokerage firm, a mutual fund company, an insurance company, or any other source. They cannot accept sales commissions or compensation for investment or insurance product sales. The fees paid to such advisors can be a percentage of the assets they manage, a flat annual fee, or an hourly rate. These fees are fully disclosed and are agreed upon in advance.
Fee-only advisors have a fiduciary duty to their clients. A fiduciary duty is a legal obligation of one party (the financial advisor) to act in the best interest of another (the client). Advisors with a fiduciary responsibility must place the best interests of clients ahead of those of the advisor or the advisory firm.
FULL COMMISSION
Full commission financial representatives, or brokers, receive compensation for buying and selling investment or insurance products on behalf of their clients. Full commission brokers are paid by a brokerage firm, an investment company, an insurance company, or any company whose products they buy and sell for their clients. The compensation for these advisors is tied to product sales and transactions.
Full commission advisors do not have a fiduciary responsibility to their clients. Instead, they are held to a standard of “suitability.” They must prove only that their actions or recommendations are “suitable” for a client. They are not required to disclose all sources of compensation or potential conflicts of interest.
FEE-BASED
Often “fee-based” is confused with “fee-only.” Perhaps a better description for this type of advisor is “fee and commission.” These financial representatives can collect a fee from clients, as well as commissions for the investment or insurance products recommended to clients.
Fee and commission advisors can be held to two legal standards. They can face a fiduciary standard when giving advice but only the standard of suitability when working for a commission. For example, a fee and commission advisor can be held to a fiduciary standard when building a financial plan for a client, but only to the suitability standard when recommending investment products within the financial plan.
When it comes to managing your money and your retirement, the stakes are high. Above all else, financial advice should come from a knowledgeable, honest, and trustworthy source. These are must-haves. Before choosing your advisor, consider the source of his/her paycheck. It can influence both the advice you receive and the investment products recommended.
References
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