Pay Me Now: Pros and Cons of Adviser Compensation Models

Everybody wants a financial adviser, but nobody wants to pay for one.

Or maybe it’s just that most people may be unsure of the best way to pay.

When someone does finally decide to hire a professional, the varying compensation structures, job titles and securities licenses can be confusing and overwhelming. And every professional out there is convinced that his or her approach is best.

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But, despite what you may hear from the nearly 300,000 financial advisers available in the U.S., there’s no perfect form of payment. Generally speaking, there’s no hurdle-free way of getting past conflicts of interest, and the models that limit conflicts — in some circumstances — may also reduce options for clients.

To find the best fit for you, educate yourself about the pros and cons of each payment structure, and the experience and licenses required to perform these roles. Here’s a breakdown.

Fee Only

• What it is: A fee-only adviser is paid by the client and not from the sale of any investment product. The adviser collects a fee in one of four ways: a flat consultation charge, an hourly charge, a charge for each service, or a payment based on the percentage of the assets managed.
• Pros: This adviser has a fiduciary responsibility to his clients and is invested in helping you achieve your monetary goals. If the adviser is being compensated based on the percentage of assets managed, the more money you make, the more money he makes. He shouldn’t be swayed to offer higher commission securities or insurance products because he can’t collect a commission.
• Cons: You could be stuck implementing the plan yourself, so if you aren’t a savvy investor, that’s a downside. Also, the fee-only professional may have more limited offerings when it comes to securities and insurance products. And he may not have an incentive to recommend certain money moves — such as paying off your mortgage or buying guaranteed insurance products (backed by the financial strength and claims-paying ability of the issuing institution) as well as life, health, disability and long-term care insurance — because that puts the money in someone else’s pocket instead of his managed investment portfolio. You may also find this adviser is incentivized to be more aggressive with your portfolio in order to grow his fees.
• Licenses: Series 65 and possibly a non-producing insurance license (in some states).

Commission Based

• What it is: Typically, a financial professional who sells financial products and in return is paid by commission. She may get a certain percentage of the client’s assets based on an upfront fee deducted from the client’s money before it is invested; she could be paid by the financial institution on the back end for selling a product to her client; or the client might be charged for every stock purchase or sale.
• Pros: If appropriately licensed, this professional may offer greater diversity in product offerings, including the risk-management strategies you might want, including life, health, disability, annuities and long-term care insurance.
• Cons: A commission-based professional is held to a suitability standard (recommendations are suitable in terms of the client’s financial needs, objectives and unique circumstances) vs. the higher fiduciary standard (she is ethically and legally required to manage the assets for the benefit of the other person rather than for her own profit). She may be incentivized to churn accounts to generate additional commission, and there is potential for conflicts of interest when it comes to directing clients toward higher-commission products.
• Licenses: Series 7, Series 66 and/or producing insurance license.

Fee Based

• What it is: This hybrid compensation structure can be the most confusing, but, in my opinion it also has a lot of advantages. The adviser often starts with a base fee for a financial strategy, and if implemented, he may receive a commission or fee for the assets being managed.
• Pros: This adviser can access a wide range of investment and insurance tools for his client and can offer different payment options depending on that client’s financial plan. He is held to the fiduciary standard when recommending securities products. He has skin in the game when it comes to managing the client’s life savings, but he also can offer a wide range of risk-management solutions, such as buying guaranteed insurance products as well as life, health, disability and long-term care insurance.
• Cons: He could be swayed to offer products that come with a commission (i.e., insurance products). And he might be limited in some of the securities he can offer (load-based mutual funds, load-based variable annuities and some alternative investment options, such as Real Estate Investment Trusts and Limited Partnerships).
• Licenses: Series 65 and possibly producing insurance license.

Clearly, it’s important to ask about a professional’s compensation structure before you put your life savings in his or her hands. There is no right answer on this one; it’s often more about where you are in your life or what type of individual you are. If you’re just starting out, you might not meet the required account minimums of a fee-based professional, so you may wish to turn to a commission-based professional. If you’re about to retire, you may want a fee-based professional who can offer a variety of financial products. And if you’re a knowledgeable individual and a high earner, you may choose a fee-only adviser and implement the strategy yourself.

Whatever way you choose to go, the most important factor to consider will be the relationship you will have with this person – hopefully for years to come. If you have trust, communication and a good fit with that person’s personality and philosophy, you likely can work out the rest from there.

P.S.: Here’s how you can tell where your professional lands. Ask them what licenses they hold. What securities license do they have? Do they hold both an insurance and securities license? If they only offer you insurance products, maybe they don’t hold a securities license. If they only offer you securities-based options with no guarantees, maybe they are only securities licensed.

Casey B. Weade is president of Howard Bailey Financial Inc. in Indiana and author of the book The Purpose-Based Retirement. Weade holds a CERTIFIED FINANCIAL PLANNER™ (CFP®) certification in addition to being a Retirement Income Certified Professional® (RICP®). He is also an Investment Advisor Representative (IAR), as well as life, accident and health insurance licensed and Long-Term Care Certified.