Money Mondays: How Exactly are Financial Advisors Paid? And By Who?

Hi friends!

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:

compensation of financial advisors

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.

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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:

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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

HEADSHOTMargo is a fee-only financial advisor and mom of two.

Momday Hacks: Repairing Your Credit Score

We are in a judgement free zone here.  Everyone, and I mean everyone, makes bad financial decisions as a teenager and young adult.  I walked onto my college campus at University of Miami, and on the first day got offered a credit card through Capital One.  You’d be wrong if you didn’t think that I used that card like it was free money for the first month and then was horrified when I realized I needed to pay it back with 24% interest!  (Yikes!!)  Then, as an adult?  Life happens.  Jobs come and go, (and sometimes marriages come and go) but life expenses don’t.  Sometimes this can cause our credit scores to tank.

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Why do we care about our credit score?  First of all, if you have a bad credit score, it means you will pay more to borrow money than someone with a good credit score.  If you walk into a used car lot with a bad credit score and finance the purchase of a $10,000 car, you will end up paying more for that car than if someone with a good credit score walked in the same day to buy the same car for the same amount of money.  Why?  You’ll be offered a higher interest rate for that financing and ultimately make higher payments over a period of time.  Also, nowadays, when you are interviewing for jobs, most potential employers run your credit score before deciding to hire you.  Seem unfair?  Perhaps, but it’s a common practice because they want to know if you are reliable.  Finally, if you are looking to rent a home, they’ll run your credit score too.  These are just a few examples.  Your credit score follows you everywhere, and, like an annoying little sister, it doesn’t care whether you want it there or not!

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For most people, there will be times when their credit score is less than stellar.  However – Don’t despair!  The great news about your credit score is that you can ALWAYS take steps to repair it.

What are those steps?

  1. Online Auto-Bill Pay: This is the most important one.  Set this up immediately!  Remember, online bill pay is different than automatic-debit.  Automatic debit is when you allow a creditor (like your cable company or electric company) to TAKE money from your account on a monthly basis.  (I don’t want you to do automatic debit, and I will explain why.)  Online bill pay is when you schedule to SEND money every month to a creditor from your bank account.  So, why is online bill pay better for your credit than automatic debit?  The credit bureaus are computers, and they track your reliability as a credit-worthy consumer based on the regularity with which you make payments on the exact same day every month.  When you allow automatic debits from your account, the cable company likely takes your monthly payment on different days every month based on its business schedule.  Sometimes it’s the 1st, sometimes the 2nd or sometimes the 3rd depending on the month.  The credit bureau doesn’t deem you as reliable when your payments are taken this way.  When you set up online bill pay to send your payment every month on the 1st of the month, the credit bureaus will deem you more reliable more quickly, and your credit score will improve much faster.  Bottom line: Cancel ALL of your automatic debits and instead set up online bill pay through your bank for at least the minimum payment every month on the exact same day.  Then, once a month go in and adjust the amount you will pay depending on the fluctuations of what you owe (like for your electric company).  Watch your credit score improve in the months to follow!
  2. Pay your credit cards down to less than 50% of the total limit. Here is another important one.  Credit bureaus deem you worthy of an improved score when you have all of your credit card balances down to less than 50% of the total limit.  This is indeed the magic calculation.  Of course, it’s always preferable to keep your credit card balances down to zero because they are high-interest rate debt vehicles, but realizing that’s not always possible, try to focus on keeping them down to 49% of limit or lower.  For example, if you have a credit card with a limit of $5,000, be sure to keep your balance at $2,499 or less.Image result for gifs for credit cards
  3. Pay at least the minimum you owe on all of your bills every month.  This seems like a simple one, but some people don’t realize how important it is.  Don’t avoid your bills – they won’t go away.  They’ll only get worse!  If you can’t afford the minimum payments, call the creditor and ask them for options.  Proactively addressing these issues is always seen in a more positive light, and the creditor is less likely to send you to collections when you do this (which will cause a decline in your credit score.)
  4. Monitor your credit score, pull your report once a year and dispute any fraudulent (or wrong) charges. Image result for gifs for stolen identityThere are truly free companies that allow you to do this, and you should.  I know someone who looked at their score to find that someone across the country had used their information to get a knee replacement, and never paid for the surgery.  This is a huge pain in the butt to comb through the report and make disputes, but this is an absolute necessary exercise to ensure you aren’t being punished for fraudulent activities, or in some cases, mistakes of companies who report to the bureaus.  Keep in mind, if a company who claims to provides “free” reports asks you for your credit card information to sign up, they will at some point start charging you for the service.  And, it’s very hard to cancel.  So, don’t do that.  There are also businesses that you can pay to dispute charges – but why pay someone else to do it when you can easily do it yourself?  All it takes is some time and a little bit of patience.  An example of a company to check out for this service once a year is: freecreditreport.com.
  5. Stay away from bankruptcy: Yes, sometimes it is necessary to consider this, but it should ALWAYS be a LAST RESORT.  Bankruptcy is very, very hard to recover from.  You should always consult a financial advisor and an attorney if you are considering going this route, however, remember that there are a bunch of steps you can take to climb out of a bad financial situation that don’t include bankruptcy.  It takes between 7-14 years for your credit score to bounce back from bankruptcy.  Don’t make this decision lightly.

The bottom line is that ignoring your credit score is like ignoring poor heart health.  Just because you ignore it, doesn’t mean it will go away, and ultimately it will harm you significantly if you don’t address it proactively!  It’s not as hard as you think, I promise!

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Your friend,

Margo