How financial advisors get paid

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Often there’s not much transparency when it comes to letting clients know how advisors are compensated.

Advisors and brokers often dance around the issue and are hoping clients don’t ask them that question.

I know that was the last question I wanted to hear when I worked in the bank. It was one of the reasons I knew I had to get out of there and needed to switch to a planning and fee based business model.

(To be fair, these days, most banks offer fee based programs although I’d say it makes up a minority percentage of their business)

Cut and dry issue

These days, for me, talking compensation (generated from client asset management) is a very cut and dry issue. The overwhelming majority of my clients fall into one of two ‘fee based’ categories:

• My clients are charged a fee that is a flat percentage of the assets I manage for them. For example, I may charge a client 1% of the underlying portfolio value, annually. I use ETF’s to create the investment portfolio. This accounts for over 90% of my business.
• Much less frequently (less than 2% of the time), I use C share mutual funds, where the client pays nothing up front and must hold the investment for a year to avoid penalty. I am paid 1% upfront, for the first year, and a 1% trail starting in the 13th month by the mutual fund companies used in the allocation. From time to time, I’m open to using annuities if the situation is optimal.

How ‘fee based’ advisors get paid

Here’s an example from start to finish of how it works for me…

A client has a portfolio worth 210K where they are charged 1% or $2,100 a year. From this $2,100 a minority percentage goes to my broker dealer for providing all the services that allow us to run our business (trading platforms, back-office, compliance, clearing, client reporting, etc.) So I’m left with $1,680 after a 20% haircut for all that.

From this $1,680, I have to pay all my business expenses, which include, rent, office expenses, technology, communication, corporate accounting, corporate taxes, insurance, etc. I think you get the idea. At this point I am left with less than $1,000, which passes through the corporation to my personal tax return. On which I am taxed like everyone else…

Now the manner in which I’m compensated is the way most fee based advisors are compensated. I think it’s fair to say, the planning based business model is well suited for ‘fee based’ programs, mainly for the ‘alignment’ reasons I detailed in the previous post.

How ‘fee only’ advisors get paid

In the last few years, a new way, for planning based advisors, to be paid has also emerged. A growing segment of planning based advisors are choosing ‘fee only’ business models.

The whole idea behind ‘fee only’ is the nature of the planning relationship. Since the advisor is paid directly by the client, and not a third party, the advice is considered to be ‘uncompromisingly’ objective. Whether this is true or not is open for debate.

A growing segment of ‘fee only’ advisors prepare financial plans for their clients and charge an hourly rate for their services. From what I’ve read, hourly fees typically range anywhere from $100/hr - $500/hr. The fees may vary based on the complexity of your situation or how long it takes to provide services, there are additional fees for ongoing planning services. Here’s a link to an article that talks more to fee only planning and the topic of this post.

(As I write these posts new ideas always pop in my head. My inspiration for new posts often comes while writing something else. Along those lines… I will dedicate a post to ‘fee based’ vs. ‘fee only’ financial advisors.)

Now I’ve made the following statement before… ‘many people don’t fully trust the person that manages their money. Why is this?’

How ‘commission based’ advisors are paid

Well most of these non-trusting clients seem to come from the last category I’m going to cover in this post. A group I refer to as the ‘non-planning’ segment of the financial services business; a segment that rarely uses a financial plan as the basis for developing client recommendations.

I’m mainly referring to ’stockbrokers’ and advisors found in wire houses and banks that generate a lot of business via re-occuring one time commissions. What do I mean by that? Here’s an example…

Commission based brokers recommend stocks, bonds, mutual funds, annuities etc. and are compensated when the client purchases a product. Lets use XYZ as an example, a client purchases 500 shares of XYZ on his brokers recommendation, the broker charges a commission.

Lets say XYZ goes down in value and has a poor quarter, the firm’s research department changes their rating on the stock to a sell. Your broker calls you and recommends that you sell the position, again making a commission on the sale.

In summary, your broker made a commission on the way in and on the way out. So things worked out well for him and not so good for you. His performance had no effect on his compensation, whats to stop him (or her) from calling you up and repeating this process? Now this kind of thing goes on all the time with stocks, mutual fund switches, 1035 exchanges, etc.

A possible bias

I’m sure some people will accuse me of being biased but I call it the way I see it. I’m sure there are some ‘fee based’ and ‘fee only’ advisors that charge their clients way too much too; but I believe there are far fewer abuses on the planning side of the fence.

If more advisers switched to a fee based or fee only business model my industry would have a far healthier image…

Tags: Advisor Compensation, Featured, Financial Planning Retirement and Now!