How Is Your Financial Advisor Compensated?

Are you confused by what financial advisors are supposed to do and how they charge? What services they offer, how they help you and knowing what questions to ask? There has been a checkered history for Wall Street—high expenses, low transparency and fraudulent business practices. Over the next few blog posts we will help explain the landscape of the financial services industry, how they work, how they charge and important issues of which you need to be aware.

First and foremost, you should understand that we have a bias—we do not like most of Wall Street. They get a bad rap and they deserve it. Secondly, while we provide financial advice, we operate very differently from the way a Wall Street firm operates.

So, let’s get started. For most people, the goal is get their personal financial house in order and manage it in an efficient manner, to build savings accounts and investment portfolios to meet your future needs, and to make smart financial decisions to put them in the best financial position to succeed.

Today, you have access to thousands of financial and investment options and a lot of complicated investment and tax strategies, making advice from advisors more important than ever. How can you know you are working with the right advisor and you are paying a fair fee for their services?

Let’s look at the three main types of financial advisors and how they operate.

Commission-based Fee Structure

Brokers generally are paid on commission. If they sell a product, then a percentage of the sale is paid in the form of a commission. Different products have varying commission structures, which can and does lead to conflict of interest. The broker might be recommending a product because it pays a higher commission, even if a lower commissioned product might be better for the client. Legally, the broker only needs to meet the “suitability” standard that is required by law. They do not have a fiduciary obligation to put your interest first—scary thought.

Keep in mind; higher commissioned products often have higher expenses (because there is no free ride), which clients must pay one way or another. Commissioned products can also lead to the advisor to encourage more trading or switching of products. This gives them an opportunity to earn another commission, otherwise, they don’t get paid.

Fee-only Fee Structure

We operate under this structure and feel it provides the best protection for individuals. Because we are regulated as Registered Investment Advisors, we’re held to the “fiduciary” standard rather than the “suitability” standard. We are legally obligated to put your interests above our own, unlike the suitability standard. Because no commissions are earned, this helps reduce conflicts of interest.

You can pay an hourly rate or a percentage of the assets that the advisor manages for you. While this is a much better way to work with a financial advisor, there are still conflicts of interest of which you need to be aware.

Fee-based Fee Structure

This has grown out of the “me too” mentality for Wall Street advisors. Since the public is starting to wake up to the fiduciary issue and is beginning to think twice about the commission model, these advisors can now say that they charge a fee too—but still accept commissions as well. Come again? Yes, many advisors are paid a combination of fees and commissions and can wear both the fiduciary and suitability hats whenever they choose.

Is this legal? Yes. You need to ask questions so you understand thoroughly whether the relationship falls under the suitability or fiduciary standard. So when working with a Fee-Based advisor you need to ask the question “are you giving me this advice in your capacity as my fiduciary or as a broker with suitability standard? Sound ridiculous? It is!

If you are going to work with an advisor, know that they should be legally required to act in a fiduciary capacity so you get objective advice that is in your best interest—not Wall Street’s. It is our strong belief that individuals are best served by working with fee-only advisors.

You must determine what your needs are with regard to obtaining financial advice. We will go into more detail about the advisory landscape in our next few blog posts. Up next we will take a deeper dive into the Suitability vs. Fiduciary issue.

To your prosperity!