So, I’ve mentioned in the past that you should find a financial advisor that you trust to help you plan for retirement and invest your money. I’ve had people say to me, “Margo, how come the person who sold me insurance is offering to do a retirement projection for free, but other advisors are charging money to do this?” The answer lies in how different financial professionals are compensated.
This is where it gets a little tricky. It’s not as easy as it would seem to figure out exactly how financial professionals are paid. And, most people would agree that it’s kind of confusing to figure out how to find a financial advisor you trust if you can’t figure out how the advisor is paid! Some people have told me that this prevents them from even trying to find one at all – because when you don’t know how they are paid it’s pretty hard to figure out what it will cost you. To compound the issue, many professionals call themselves “financial advisors,” but they all aren’t created equal. They each may have varying expertise and very different “end games” when it comes to their relationship with you. I’m here to tell you: It’s confusing, and I’ll explain it to you. I’m also going to give you a list of questions you can ask the advisor when you are interviewing them to figure it out, too.
To simplify, we can basically put financial advisors into one of three categories: Commission-only, Fee-only, or Fee-based. Fee-only and Fee-based sound the same, but they are actually quite different! Here are the details:
Fee-only: Fee-only advisors are only paid directly by their clients for the services they provide. This fee is usually represented as a percentage of your account value or an hourly rate. They do not sell any products like insurance or annuities, they don’t represent a bank or any financial institution, they don’t have proprietary funds like mutual funds to place into your investment accounts, and they don’t receive referral fees for sending you to other advisors, like an attorney or insurance rep. In this scenario, the financial advisor only represents the best interests of their client – they aren’t there to sell a product or represent the interests of a bank or other financial institution. Every decision they make is in the best interest of their client because they don’t have any conflicts or receive compensation from any other party or institution. Fee-only advisors are true fiduciaries for their clients.
Commission only: These are your insurance sales-folks and annuity sales-folks. What’s good about them? You need to have certain kinds of insurance: home, auto, health & life, for example. These people have expertise, execution and only indirect cost to you out of pocket. Some of these individuals will offer free financial planning meetings, but beware. Their planning usually revolves around insurance products and getting you to buy one. The reason that they offer financial projections for free is that they use the time to convince you to buy a product that they sell.
Sometimes, in these financial planning meetings, they might encourage you to buy insurance or an annuity that may not appropriate for you because it makes them money. I carefully vet the insurance representatives that I refer my clients to, so I know they aren’t going to inappropriately suggest a product to them, but there are unfortunately people like this out there. I also review all insurance before my clients sign on that dotted line. Having a neutral party who only works for you, and not a bank or an insurance company, review these sorts of things is a very smart move to make so you know it’s actually best for you. And even though you aren’t paying the commission-only advisors directly (out of pocket) for the product they are selling you, you are paying them indirectly because of the fees you are paying upon purchase and/or the life of that product. These products are not inexpensive, and the advisor receives payment from the company offering the product as a result of the money you spend to purchase it.
Fee-based: This is where it starts to get a little more complicated. Fee-based advisors are a mix between fee-only and commission-only advisors. They receive a fee from you directly for managing your investments, usually a percentage of the total dollar amount of your account AND they sell products like insurance, propriety mutual funds, and/or receive referral fees for other professionals they send you to. I know a lot of fee-based advisors who are wonderful – very smart and very ethical. However, if the fee-based advisor isn’t as ethical, you can see where they might get into difficulty. Are the investments they are choosing in your portfolio always the best ones for you? Or are they choosing them because they receive a commission? Are they selling you a product like insurance or an annuity because it makes them a commission? Or are they recommending it to you because it’s actually the best product for you, and it’s the right choice for your goals and risk tolerance? When it comes to fee-based advisors, you are potentially paying them both directly and indirectly for their advice and the choices they make for you/recommend to you. Again, I know a lot of really great advisors who are fee-based, and one of the positives of this model is that they can sell you directly the products you might need to ensure you are comprehensively planning for your future. However, it’s imperative that you find an ethical advisor if you are shopping in the fee-based arena.
If this sounds confusing, you aren’t alone. I’ve been asked the following question by clients pretty often: “How do I figure out which bucket my financial advisor falls into?”
So, I created the following list of questions to help figure it out:
If your advisor is fee-only, the answers to all of these questions are NO.
If your advisor is fee-based, the answer to any ONE of the following questions will be YES: 1, 2, 3, or 7. A YES to any one of those questions means they are not fee-only.
If your advisor is commission-only, they will always answer YES to #1. Another hint: They won’t be charging you an investment management fee, which is how you know they are commission-only instead of fee-based.
Finally, if the answers to #4, 5 or 6 are YES, it’s time to find a new advisor regardless of the way they are compensated.
If you are looking for potential advisors, the initial meeting should always be complimentary. This is an intro meeting so they can figure out your needs and how they might serve you. So, cost shouldn’t prevent you from reaching out to a potential financial advisor and “interviewing” them to see if they are right for you.
In that meeting, use the list of questions I give you here to figure out how they are paid, culminating with the final one: “How much will this cost me, and will you quote me ahead of time, or as we go?”
There are great financial advisors out there, and armed with this information, I am confident you will find the best one for you!
Happy Advisor Shopping!!
Margo is a fee-only financial advisor and mom of two.