There any many ways that financial advisors can be compensated. Is a fee only financial planner the way to go for you? What does that mean and what are the differences in the fee only world vs other models?
Fee only financial planners offer financial planning services as the name implies – for a fee. There are many different shades of this, so here are some of the specifics in the fee only financial planning world:
A flat fee advisor will offer to do financial planning for a single amount based on the amount of work that they estimate you need. Some flat fee advisors will have different tiers and charge, for example, $3,000 for a simpler case, and perhaps $5,000 for a more complicated case. That is an annual charge that clients can choose to continue in the future or not.
A fee based financial advisor will charge a fee based on something. Those somethings can be the amount of time – in which case they’d be an hourly fee based advisor; the amount of assets you have – in which case they’d be an assets under advisement fee based advisor; or the amount of assets they manage for you – in which case they’d be an assets under management fee based advisor. The exact rates can vary in all of these situations based on the hourly rate or based on the amount of work.
A commission based financial advisor gets paid predominately through the company whose product they sold. For example, insurance companies can pay a commission for life insurance, annuities, disability insurance, etc. In a similar fashion, mutual fund companies can pay a commission for the sale of a mutual fund and pay either an upfront commission (A Share) or pay an ongoing commission (C Share).
A hybrid advisor can get paid in any of those ways and can cater to each individual client’s situation personally. They may charge a flat fee for a financial plan and then charge a smaller amount for ongoing investment management, or they may charge you a fee based on the assets they manage but then also get paid a commission for helping to sell an insurance product.
How can you tell how someone is compensated?
To answer this question so you can figure out if an advisor is a fee based financial advisor, or a fee only financial advisor, or a commission based financial advisor, I go back to the question of how are they legally able to get paid – through a license! If you find out which licenses a financial advisor holds, you can often find out how they are getting paid.
If someone has an insurance license, they can get paid for business as a commission. A life insurance license allows an advisor to sell life insurance and fixed or indexed annuities, while a life and health license adds on the ability to sell long-term care insurance and disability insurance. If a financial advisor has a Series 65 or Series 66 securities license they can get paid to give advice, and this is frequently the license that flat fee advisors rely on. If a financial advisor has a Series 7, or in some cases a Series 6, securities license, it means they can be paid on commissions through stock trades or product sales, such as mutual funds, UITs, closed-end funds, etc.
What is the best model of paying your financial advisor?
Is a fee only financial advisor the best way to go for you? Possibly. I think the best model should fit your needs as a client. An analogy I like to use compares getting a financial advisor to buying a car:
A flat fee financial advisor is like the car consultant that works with you to determine the best vehicle that exists to meet your needs. They figure out your proclivities to speed, comfort, reliability, and brand and then provide you with a recommended 2 or 3 cars for you to consider. They are motivated to give you good choices that meet all your needs.
A fee based financial advisor is like the car consultant that works with you to determine the best vehicle that exists to meet your needs. Then they also provide you with a couple of options, but then if you choose an option, they get paid an annual percentage of the value of the vehicle. They are motivated to give you good choices that meet all your needs and that have the greatest resale value over time.
A commission based financial advisor is like the car salesman that works for a dealership. They work to understand what you desire to have in a vehicle and match you to the best fit that they offer. They are motivated to give you good choices that they hopefully have available to them, but they are biased to their cars on their lot and not another lot.
At the end of the day, you should have an advisor in your corner that gets paid fairly based on your needs. Know the differences and ask good questions. Common questions to ask:
How do you get paid, and what licenses do you hold?
In what situations may there be a conflict where you are incentivized to put your needs above mine?
How do you compensate for those situations and make sure that my needs will always come first?