How much are you paying for financial advice?
Ten to 15 years ago, my experience was that many people were stumped by that question. In fact, many of them didn’t seem to realize they were paying anything at all, although let’s get this straight: Something in exchange for nothing simply doesn’t happen in the world of investments.
Times change, though. In the last five to 10 years, I am finding that many investors I talk to – helped no doubt by the Internet placing so much information at their fingertips – have grown more savvy about the compensation systems for their advisers, who generally are paid either by commission or by fee and, in some instances, a combination of both.
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Each method works in a different way.
Commission-based compensation
Financial professionals who are paid based on commission, such as stock brokers or insurance professionals, are paid when a transaction happens, or the commission is built into the financial product. For example, a mutual fund could come with a sales charge or commission. The investor pays the load (commission), which goes to compensate a sales intermediary, such as a broker or financial adviser, for his time and expertise in selecting an appropriate fund for the investor.
The investment products a broker sells have to be suitable to your needs, although they aren’t required to be the least expensive or best option for you. In addition, if you’re changing your investment mix often, you could end up paying more in commissions. In today’s investment world, we tend to make allocation changes based on market conditions and our future outlook.
Now, if you happen to be one of those people who makes an investment and hangs onto it for 30 years, this could work out for you. In that situation, you’ll likely spend less over that long time frame than you would have with a financial professional who is paid by fee for assets under advisement.
Fee-based compensation
I think many of the people who opt to connect with an adviser who charges a fee do so because fee-based or fee-only advisers put the professional on the same side as the client. The fee is based on the value of the client’s investments, or sometimes the client is charged a flat fee. Fee-only advisers don’t make a commission on the purchase or sale of any investment.
Financial professionals charging a fee also usually have a fiduciary responsibility, meaning they are required by law to do what’s in the best interest of a client. By comparison, a commission-based professional is required to do only what’s suitable for the client.
A combination approach
Some professionals work on a combination of the two compensation methods, collecting both fees and commissions. For example, a client may be charged a planning fee and then a commission for insurance and fee for assets under management. Advisers are generally compensated on insurance products via a commission from the insurance company. If the adviser is making financial planning recommendations (such as life insurance), the combination of a commission on the insurance product and a fee for assets under management might be the approach the adviser takes.
One of the advantages I see to the fee side of things is it tends to stretch the role of the professional beyond just recommending a certain stock or fund to buy. There’s financial planning, asset allocation and retirement planning that are incorporated by most fee-based professionals. The client and adviser tend to form a true, lasting relationship over the years.
While a lot of the interactions between adviser and client can take place via phone or email, personally, I like to meet clients face to face. After a while, you get to know them, their kids, and their passions in life and that can help give you a greater perspective about their needs and how your financial advice fits into that.
The bottom line
To sum it all up, there are a lot of pros and cons to the different compensation methods. The best one for you depends on your specific situation (age, risk tolerance, time frame, investment needs, etc.). Our industry has changed dramatically over the last decade and continues to evolve. The fee-based or fee-only adviser has become increasingly popular, and I see this continuing. The fiduciary standard is where the industry is heading as a whole.
Jason Mengel holds a Certified Financial Planner designation, and is a member of the Financial Planning Association. In 2010, he co-founded Fusion Capital, which operates with three locations in South Carolina.
Rozel Swain contributed to this article.
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