Based on last week’s article, I got the following questions –
- Which payment type is best?
- What are the pros and cons for the different ways advisors get paid?
I thought these were good questions and will briefly try to answer them here.
The payment type that is best for you depends upon your situation and what you are looking for from the financial advisor.
Commission Only – This payment type is common for life insurance, annuities, mutual funds, equities, Exchange Traded Funds (ETFs), bonds, and Unit Investment Trusts (UITs). It can be a one-time commission or it can have a “trail” where the advisor / product seller receives a commission each year for a certain time period. With Life insurance and annuities this is the standard payment type so there is not too much choice there.
Mutual funds with a commission payment are common for people who want advice yet do not have a large amount of wealth and advisors want to give advice and get paid in some way for their service without having to provide more long term and active management.
Commission only payments are not always as transparent and clear as to how much you are paying the advisor. (They can be clear, but not always.) When you buy the investment product there is an exchange of money with one company and then the advisor is paid the commission by the company you paid. The advisor is not paid directly from you. This is an advantage for those who don’t want to pay two separate people and / or who don’t want to see this separate cost.
Often you do see the commission for investment products on your statement or trade confirmation and it is included in your cost basis.
Commissioned products are good for people who have a buy and hold strategy and do not plan on making a lot of changes or executing many transactions and do not want consistent management or oversight of their investments.
The disadvantage to this payment structure and something to be aware of is that a registered representative may recommend and encourage more transactions and changes so that they can get paid more.
Fee-Only Financial Advisors charge primarily in three ways:
1. Hourly Fees – You pay for the time that a financial advisor works on your case and / or spends with you. Hourly based pricing is best for: People who have specific questions about one or a few financial topics, such as education planning, deciding on a retirement pension option, or how much life insurance they should have.
A do-it-yourselfer who wants a professional’s opinion as a double check to make sure they are not missing anything major.
People who are just starting out and/or don’t have a lot of money but want an expert to provide analysis and advice to make sure they are headed in the right direction.
The advantage of the hourly fees is that it SHOULD be cheaper than the other methods to get your specific needs met but you should confirm that before moving forward.
Another advantage is that you can know that the advice is objective since the advisor is not going to get paid on selling any of the products they are recommending. For example, you can assume an hourly fee-only financial planner who gives you life insurance recommendations and cannot sell it to you, will be much more objective than a life insurance sales person who will make more money based on the amount and type of insurance they sell you.
A disadvantage of this is that the actual hourly cost may be much higher than expected or estimated in the beginning. Some advisors give binding quotes so you know it will not be more than expected.
Another disadvantage of the hourly fee is that you will pay for the advice and then you may have to pay someone else for the commission on the recommended product such as life insurance. Some people want to pay the hourly fee to make sure they are getting the best, most objective advice.
A third disadvantage of the hourly method is that the advisor may give the advice and then it is up to you to implement it on your own, i.e. make the investment changes, buy the insurance, set up automatic savings etc. Some people are better at execution than others without having someone else following up or doing it for you. It is good to be realistic about what you are comfortable with and if you will DO what needs to be done. Having good information but then not taking action does not help you accomplish your goals.
2. Flat fee service – This is where an advisor provides a package of services for a specified flat fee. This is often true with a comprehensive financial plan. With the flat fee service is assumed it is not automatically recurring.
Be sure you understand what will be provided and what they will be doing for that flat fee.Does it include specific investment recommendations?Will they help with execution of the given recommendations?
This service is often best for people who need specific advice or services and feel confident that it will be cheaper and / or provide more desired service than the hourly method.
The advantage of this method is that you know exactly what you will be paying since it does not depend on the hours spent with you or on the amount of your assets.
A common example is that a financial planner may give you a binding quote for a comprehensive financial plan of X dollars.Then every time you come back to them for an update of the plan they charge Y dollars.
The flat fee service is similar to the hourly fee and is best for do-it-yourselfers or those who don’t have a lot of money and / or have specific questions they want answered.
3. Retainer Fee – This is where the fee is calculated based on a percentage of something such as your assets, net worth, income or some combination of these. This fee type is assumed to be recurring and you will be billed automatically every month or quarter and the fee may be pulled automatically from one of your accounts if this is how it is set up.
This fee type is best for people who need, want and can afford for a financial advisor to manage their financial affairs. It is often for people with a certain level of wealth, more complex situations or for those who do NOT want to do it themselves and / or believe having someone else manage it on a consistent on-going basis will help them accomplish their goals more quickly.
The flat fee retainer service is where an advisor charges a specified fee each year. This is becoming rarer but may make more sense for high or ultra-high net worth clients that want high levels of service and can find an advisor that does not charge a percentage based on the asset level.
Commission and Fees or Fee Based Advisors – The advisor can be paid by some combination of commission and fees.
The advantage of this is that you can work with one person who will give you professional advice and can also sell you the products they recommend – one stop shopping.This should help with ease of implementation and it could be cheaper than paying for an hourly or flat fee and then pay the commission on the recommended product but not necessarily.
The disadvantage of the fee based advisors is that you may not get completely objective advice and could may pay more than separately paying for hourly advice plus commission if you get more products or more expensive products than if you had obtained the objective advice and only got what you really needed.
I hope this helps give you some ideas of where different pay models make more sense than others depending on your needs and asset level and also some of the advantages and disadvantages of the different pay methods.
To me the most important thing is to like and trust the person you are working with. If you don’t feel good about working with your financial advisor, then keep looking or go somewhere else.
Phew. I thought that was going to be much shorter and quicker than it was…sorry.
I would love to know what questions you have or any ideas for future articles.
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