How Your Advisor Gets Paid
When working with a professional to help you with your money and investments, you need to understand their motivation. Understanding your advisor’s incentives helps you to know why they are helping you and if what they are saying or doing is in your best interest.
There are two main methods of compensation for advisors: fee-only advisors and commission-based advisors.
One method of compensation is not more wrong than the other method. There will always be good and bad apples of each type. Understanding what drives their fees will, however, give you insight into their motivations.
We will look at these two methods of collecting fees and which types of advisors typically fall into each category. It is also important to understand that everyone is going to get paid; there are no free lunches in this world.
What is Fee-Only
The Certified Financial Planning Board defines fee-only as a, “professional may represent his or her firm’s compensation method as “fee-only” only if: a) The professional and the professional’s firm receive no Sales-Related Compensation; and b) Related Parties receive no Sales-Related Compensation in connection with any professional services the professional or the professional’s firm provides to Clients.”
Simply stated, that means that a fee-only advisor cannot accept any payments beyond what the clients themselves are paying.
If you’ve ever wondered why an advisor placed you in certain investments or referred you to certain professionals, you can rest assured that a fee-only advisor is not making decisions because they are getting referral fees or kickbacks.
A fee-only advisor can get paid in several ways if the payment is coming from the client: an hourly charge, monthly subscription, or a percentage of assets under management.
An hourly fee is based on the amount of time it takes to work on a client’s project or planning arrangement. This is similar to the way a lawyer would bill out to their clients. The advisor would tally the total number of hours that they worked on that project, multiply it by their hourly fee, and then bill the customer. The Garrett Planning Network has built a network of hourly only financial planners.
A new type of payment method making its way through the advisor world is the monthly subscription method. Monthly subscriptions used to be reserved for gym memberships but can now apply to every aspect of your life, from monthly subscription boxes to monthly memberships. A monthly subscription to an advisor is growing in popularity and quickly becoming the norm.
How an advisor arrives at the rate of their monthly subscription is a little more ambiguous. You must talk with the advisor directly to understand exactly how they derived your fee. Some advisors have complex formulas into which they can plug your information. Some have set benchmarks based on your amount of assets or the approximate time needed to work your case. Bullogic Wealth Management bases its fees on a percentage of net worth and income. This method works for us because it allows the fee to grow and shrink as your financial situation in life grows and shrinks.
The most common way for investors to charge is based on assets under management. From the old broker/dealer days, a fee on assets under management is the simplest methodology and the easiest to understand. The typical fee is 1% but this percentage can vary based on the amount of assets held with the advisor. This type of fee requires you to move your assets to the advisor so they can take the fees directly out of those assets. If the fee the advisor makes comes only from your assets, they can still be fee-only.
Professionals that can be fee-only are typically financial planners and investment advisors. These two types of professionals don’t sell or collect referrals from products so they can remain fee-only. Because the fee-only method of compensation is becoming popular in the news, advisors that are fee-only will typically have it on display in their brochures, documents, or website. When discussing fees, it is always a good idea to probe deeper to understand who is paying the advisor for their time.
Why is Fee-Only Important
The fee-only method of compensation is important because it limits the conflicts of interest that your advisor may have. There will always be some conflicts of interest for an advisor, but how they get paid does not have to be one of them.
A typical conflict of interest for an hourly advisor may be that they work more hours on your case than they should so they can boost your fee. For a subscription based advisor, they could inflate how they calculate that monthly fee to charge you more. An asset under management pay structure could want you to keep more assets with them instead of deploying that cash in other areas.
A fee-only financial advisor cannot get commissions or kickbacks from selling you various products. Some of the biggest commission-based products can be forms of life insurance, specifically whole life insurance, and annuities. Commissions to salespeople can range from 35% – 60% of the premium paid by the client.
Commissions don’t just come from insurance products. Commissions can also come from various investment products and mutual funds into which the advisor wants to place your money.
Fee-only advisors also cannot receive kickbacks for recommending you to a different provider for your needs. A recommendation to an estate lawyer, tax accountant, insurance broker, etc. cannot result in compensation for the advisor if you choose to use their services.
This doesn’t mean that your situation doesn’t require a life insurance product, annuity, or the expertise of an outside provider. Every situation is different. This just means that when a fee-only advisor recommends those products or actions, it is probably because they believe it is in your best interest and not because they are getting paid more money.
The Downside to Fee-Only
It is not all rainbows when it comes to fee-only advisors. There are some downsides to only being able to accept payment from your clients.
The biggest downside is that a fee-only advisor will have to rely on outside sources to help complete a project for the client. If you come into a fee-only advisor’s office and you need insurance, that advisor will have to farm that part of the project out to someone else. You will have to work directly with two individuals and companies to meet all of your needs.
What if you need a financial plan, property insurance, and disability insurance? Now you will most likely have to work with three or more individuals and companies. That may mean filling out forms three different times, signing three different agreements, and having to talk with three different people about your situation. This is a real hassle when there are one-stop shops out there that can do all of these things for you.
If a financial advisor obtains their insurance license to better serve their clients, they can no longer be called a fee-only advisor. This is a problem. Even if they don’t receive any commissions for insurance sales, there is no governing body that has the resources to sort through all the advisor’s insurance sales to ensure they didn’t accept commissions. The easiest course of action for the governing bodies is to say that if a financial advisor holds an insurance license or broker license, they are no longer fee-only.
What is Fee-Based
Commission sales are referred by a lot of different titles. The most common title is fee-based. It wasn’t until recently that the Certified Financial Planning Board decided to rename fee-based to fee and commission. They came to realize that the terms fee-only and fee-based were too similar and confused clients. I can verify the confusion as I am often described as fee-based by clients when they mean to say fee-only.
The Certified Financial Planning Board describes sales-related compensation or commissions as, “more than a de minimis economic benefit, including any bonus or portion of compensation, resulting from a Client purchasing or selling Financial Assets, from a Client holding Financial Assets for purposes other than receiving Financial Advice, or from the referral of a Client to any person or entity other than the CFP® Professional’s Firm. Sales-Related Compensation includes, for example, commissions, trailing commissions, 12b-1 fees, spreads, transaction fees, revenue sharing, referral or solicitor fees, or similar consideration.”
Simply put, if you receive any money that didn’t come directly from the client, you are now a commission-based advisor. Again, this includes sales of insurance products such as car insurance, life insurance or annuities. It also includes some investment products that kick back fees to the advisor, or if the advisor recommends you to an estate lawyer that pays a fee for the new business.
A fee-based or fee and commission advisor can be paid in multiple ways. They can have the same basic fee-structure as a fee-only planner and layer their commissions on top. On the surface, it is typical for a fee-based advisor to be cheaper when compared to a fee-only advisor. That is because they can offer “free” services such as a financial plan, but then suggest an annuity, for which they would receive a commission, to be apart of that financial plan.
The Advantages of Fee-Based Services
The biggest advantage of a fee-based service is the ability to offer a one-stop shop, especially when it comes to insurance products. No matter how you feel about owning different types of insurance, you cannot escape their importance in planning for downside risks.
As mentioned before, another advantage of a fee-based service is that it can be cheaper to you. It is cheaper if the money is not leaving your pocket, but you must understand that you may be paying for the service in some other way.
The Downside of Fee-Based Services
The biggest downside to fee-based services is conflicts of interest. Not all people who take commissions are doing so with ill-intent. As stated above, there are good and bad apples of every type of advisor. However, the opportunity to abuse the system is always present.
You may always wonder if the investment that person placed you in was because it was the right investment for you or because the advisor made the largest commission from it.
By digging further into disclosure documents, you can begin to understand how fee-based companies can profit from these revenue-sharing structures.
Here is an exert from Edward Jones Revenue Sharing Disclosure, “Edward Jones receives payments known as revenue sharing from certain mutual fund companies, 529 plan program managers and insurance companies (collectively referred to as “product partners”). Virtually all of Edward Jones’ transactions relating to mutual funds, 529 plans and annuity products involve product partners that pay revenue sharing to Edward Jones. We do not receive revenue sharing payments on assets within investment advisory programs. We want you to understand that Edward Jones’ receipt of revenue sharing payments creates a potential conflict of interest in the form of an additional financial incentive and financial benefit to the firm, its financial advisors and equity owners in connection with the sale of products from these product partners. For the year ended December 31, 2018, Edward Jones received revenue sharing payments of approximately $205.9 million from mutual fund and 529 product partners and $7.0 million from annuity product partners. For that same period, Edward Jones’ net income was $990.1 million.”
Approximately 20% of Edward Jones’s overall revenue is achieved through revenue-sharing. The disclosure goes on to state that the revenue sharing from their mutual fund partners ranges from 0.035% to 0.13%, and commissions from annuity sales can be as high as 0.25%. It can be difficult, but not impossible, to remain unbiased when faced with these types of incentives.
Understanding how people get paid goes a long way to understanding the motivation behind a person’s decisions. Conflicts of interest don’t necessarily indicate ill-intent, but the opportunity is there. There may always be conflicts of interest when working with any advisor.
An advisor who charges by the hour wants more hours, and an advisor who charges based on the assets under management wants to manage more assets. They can go out of their way to inflate and increase both metrics for higher fees. Not all insurance salespeople are out to do harm, we rely on insurance salespeople all the time to help our clients.
Understanding how your advisor is getting paid is key. No matter which type of advisor you choose, you want to make sure you know how they are getting paid and what drives their motivations.