Choosing a Financial Advisor: Part 4 - How Financial Advisors Get Paid
By Gary Silverman, CFP®
At this point, you have found a financial advisor who can help you with your questions and concerns. Now is the time to find out how much they will cost. A simple way to do this: Ask.
“How do you make money from me?”
Be especially observant about how they answer this question. If the advisor gets fidgety, defensive, or side-steps your question, keep asking. If you hear, “I don’t cost a thing,” keep prying until you can trace how money makes it from your hands to theirs. Trust me. Advisors do not work for free.
Even if your company is paying for this service, you should still ask the question. It cues you into the main source of bias an advisor might have which might not align with your interests.
There are three typical ways your financial advisor might get paid: commission, fee-only, or fee-based.
Commission: Depending on what you buy from the advisor or the company, you usually pay the advisor a percentage of the product sold.
Fee-Only: These advisors are paid either on an hourly basis or they charge a percentage of the investments they are managing for you or a percentage of your net worth. They do not receive commission from any product sales.
Fee-Based: The advisor charges in the same manner as fee-only but may also make a commission on investment or insurance products you buy. The fee may or may not be reduced based on the commissions received.
So, are commission-compensated advisors biased and working against their clients’ best interests? That’s a common belief, but as a fee-only advisor, let me assure you that this is not true in many cases. While there are issues in the commission world, trust me, there are biases in both situations. I know many advisors paid on commission who put their customers’ interests ahead of profit while I have also seen former fee-only advisors who did not; they are now sitting in prison for theft and fraud.
In Washington, the term fiduciary standard is thrown around. A fiduciary is required to act in the best interest of clients, something that proponents say should be more important than bigger advisor paychecks. Only a subset of financial advisors is required to act as a fiduciary. The rest are held to a lower suitability standard, where advisors ensure their recommendations are suitable to your situation even if another course of action is better (cheaper?) for you.
Arguments abound in the financial industry as to whether all financial professionals should adhere to the stricter fiduciary standard. Some believe it would cause the middle class to effectively be ignored by the industry. We are not going to argue that now (we’ll save that for another time).
So, whether an advisor must follow a fiduciary or a suitability standard, you can ask this question: “Regardless of a requirement to act as a fiduciary in regard to me, will you always put my interests above your own and your company’s?” You see, there are financial professionals who are held only to a suitability standard that nevertheless puts their clients first. Their company may not allow them to put this into writing, but that does not stop them from acting in a fiduciary manner (though it gives you little recourse if they lie).