How your financial advisor actually gets paid

If you were to ask your financial advisor how they get paid, they might answer that they charge a percentage of the assets that they manage for you. Or, they might say that you don’t pay them directly; rather, the fund company or the insurance company does.

This might sound simple, but in reality, financial advisor compensation can be quite complex. It’s critical to understand how your financial advisor, or any financial advisor you might be considering using, is paid.

3 main types of advisor compensation

The three main types of advisor compensation are fee-only, fee-based, and commission-based, according to Investor.gov.

They all sound a bit similar, but there are huge differences that impact not only your costs in working with an advisor, but also whether an advisor truly puts clients’ interests first when making recommendations.

Fee-only advisors

Fee-only is just what it sounds like. These advisors are compensated only from fees paid by their clients. These fees might be flat fees for a one-time financial plan or for ongoing advice.

Many advisors charge clients a percentage of the investment assets they manage for them. In some cases, advisors might charge clients an hourly fee for advice.

Fee-only advisors do not accept commission from the sale of products, nor do they take 12b-1 fees from mutual funds they place their clients in.

Most fee-only advisors serve as fiduciaries to their clients; they put clients’ interests first.

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Fee-based advisors

A fee-based advisor will generally charge an advisory fee, such as a percentage of assets managed for the client, while also receiving commissions from selling products such as insurance policies to their clients.

They can act in a fiduciary capacity when managing client portfolios, but then shift to a broker role when selling products. It is questionable whether this “dual role” constitutes acting in a true fiduciary capacity.

Commission-based brokers

Commission-based advisors/brokers make their money from commissions generated when you buy, sell, or trade certain products such as insurance policies, some annuities, mutual funds, ETFs, and stocks and bonds.

They may also earn commissions from ongoing fees generated by certain products, including mutual funds that generate 12b-1 fees and surrender charges on some annuities.  

Commission-based brokers, in essence, mostly generate income when you buy or sell something. This can create an inherent conflict of interest between what is best for their income and what is best for their clients.

This isn’t to say that commission-based brokers can’t have their clients’ best interests at heart, but unfortunately, that is sometimes the case.

Ask your advisor how they are paid

It is important that you understand how your financial advisor is paid and how much they earn from having you as a client.

Some questions to ask include:

• Are you a fee-only fiduciary on all of my accounts and all of my holdings 100% of the time? If they answer anything but an unequivocal “yes,” there are a number of other questions to ask. Even if they say yes, take it a step further and ask: How will you get paid by me, and how much will/do I pay you?
• Are you fee-based? If so, what will be paying you in terms of an ongoing fee or one-time fee? How will I be billed for any commissions from eligible product transactions? Will I incur other fees such as 12b-1 fees from certain mutual funds or similar fees from other products?
• Are you commission-based? If so, how does this arrangement work, and what types of fees can I expect to pay over the course of a year?

Ask the advisor for a breakdown of the all-in cost of working with them on an annual basis.

If they hesitate to answer or you feel they are providing anything other than full disclosure, you might consider working with another advisor.

The bottom line

There is nothing wrong with a financial advisor earning a fair, fully transparent income for helping you grow and protect your wealth. However, how they are paid often dictates how they treat your money.

Push for a transparent, fee-only structure and understand the all-in costs of your portfolio. This helps ensure that your advisor’s primary incentive aligns with your financial success.

Accept nothing less than full fee transparency from your advisor, period.

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