When working with a financial advisor, one of the most important questions to ask is how exactly the advisor will be making money. Broadly speaking, there are two ways financial advisors get paid: commissions and fees. Commissions are fees paid by the client for completing a discrete transaction, such as buying shares of a mutual fund or an insurance policy. Fees, on the other hand, are ongoing payments based either on time spent working or on total assets an advisor is handling. To find a financial advisor in your area, use SmartAsset’s free matching tool.
What Is a Commission-Only Advisor?
Commission-only advisors make all of their money from commissions. These generally come from buying and selling securities, insurance or other financial products. A commission-only advisor will generally work through a major financial firm or brokerage to initiate these transactions. For instance, they might be a New York Life insurance agent or a securities representative of LPL Financial. However, they don’t earn a salary from these firm, as they only use them to facilitate the purchases.
Commission-based advisors get paid every time they perform a specific transaction for you. After that commission is paid, you don’t owe them any more commissions until they perform another transaction for you.
What Is a Fee-Based Advisor?
Fee-based advisors make most of their money from fees, though some may also earn commissions. Generally speaking, an SEC- or state-registered fee-based advisor is bound by the fiduciary standard, meaning they have to act in the best interests of their clients. However, there is still an inherent conflict of interest in that they could make more commissions based on what they recommend to a client.
If the above is the case, the fee-based advisor would be affiliated with a registered investment advisor (RIA) and also be either a broker-dealer, insurance agent or both, earning commissions through these roles. Keep in mind that a fee-based advisor is different from a fee-only advisor. A fee-only advisor earns money only through the advisory fees, which means they avoid all commissions.
Fees for fee-based advisors will normally fit into one of four categories:
Time-based fees: In this arrangement, clients may pay an hourly rate for individual services. For instance, let’s say an advisor charges a $250 hourly fee for financial planning. They then spend three hours working on your plan, so you’ll owe $750.
Flat fees: For this, clients pay one total rate for a service, regardless of how long it takes. Using the situation above, an advisor might charge a flat rate of $1,000 for a financial plan. In turn, you’ll pay that rate regardless of whether it takes your advisor one hour or 15 hours to finish it. The flat rate will likely be determined by the complexity of the work the advisor is doing, and is agreed to in advance.
Asset-based fees: This common fee structure means clients will pay fees quarterly or annually based on the total assets the advisor is managing for them. These fees typically work like income taxes, meaning your assets will fall into specific brackets that are paired with fee rates. For simplicity’s sake, let’s say your advisor charges a rate of 1% annually. If you have $100,000 under management with that advisor, you’ll pay an annual fee of $1,000. This may be split up over four quarters, though.
Performance-based fees: With this setup, clients are charged fees based on how well an advisor does relative to preset expectations. If the performance fee is 20% on all money earned above expectations, and your portfolio gains $10,000 more in value than the baseline, you’ll owe a performance fee of $2,000.
Pros and Cons of Fee-Based Advisors and Commission-Only Advisors
There are a few things to consider when choosing which type of advisor to use. With a commission-only advisor, you won’t be paying anything when your advisor isn’t actively working on your behalf. If you plan on putting your money into a few products or securities and leaving it there for a long time, this can be appealing, as you won’t be paying for someone to simply steward your money.
On the other hand, a commission-only advisor may not be a fiduciary. That means they may not have to act in your best interest. In fact, they have even more incentive than a fee-based advisor to suggest the products that make them the most money. Before you buy a product from a commission-only advisor, ask them whether they abide by fiduciary duty.
A fee-based advisor will make money no matter what they suggest to you. That’s because you’ll be paying an advisory fee based on how much money they’re managing for you. This disincentivizes them from making suggestions that aren’t optimal. However, these advisors are often more expensive.
You can take things a step further by only working with a fee-only financial advisor. Remember, these advisors have no insurance- or investment-related conflicts of interest, which makes them more trustworthy to some.
A financial advisor can make money in a variety of ways but generally, from either commissions or fees. The types of income streams an advisor has determines their overall fee structure.
An advisor oriented more towards commissions may result in lower total cost, but may be riskier because of the incentive structure. A fee-based advisor could have higher total costs, but they might be less incentivized to recommend financial products based on commission size. A fee-only advisor would have zero incentive to push any specific security or financial product.
Tips on Picking a Financial Advisor
Deciding what kind of financial advisor to engage can be confusing, even frustrating. However, finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Fees are not the only way to categorize types of financial advisors. Check out SmartAsset’s guide to various financial advisor categories.
Fee-structure is one of just a few questions you need to ask when you work with a financial advisor. There are a number of other important questions you should be asking as well.
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