The old adage states that if you want to know how things really work, you follow the money. In the financial services arena, I'll add, if you want to understand your financial advisor, understand how he or she gets paid.
Truth be told, I'm not sure the issue of how their advisor's may be compensated even dawns on many prospects or clients. But, trust me, it is one of the key issues financial services prospects and clients must understand when seeking financial advice. Understanding this issue sheds light on your advisor's motivation, recommendations, and your ongoing relationship.
Let's face it, the entire landscape of financial services and their delivery has changed. In the past two decades, alone, the Glass-Steagall Act has fallen, there have been major advances in technology and communications, and, of course, the internet has democratized access to information. The settling dust has revealed a transformed financial services industry.
New competitors have entered the industry, consolidation has created financial supermarkets, product offerings have exploded, and, yet, it's still a sales profession -- one where the traditional methods of compensation have changed dramatically, as well.
What once was a transaction oriented industry compensating advisor's solely via sales commissions, has slowly morphed into a more consultative industry with many different forms of compensation. Commissions, fees for assets under management, hourly fees, and fee and commission combinations are all ways that advisor's can be compensated today.
Which is best? There may not be a right answer, except the one that's right for you. What is vital, though, is that the advisor you are considering fully discloses how they charge, that you understand the pros and cons of each form of compensation, and that you chose the arrangement that best suits you.
COMMISSIONS
Commission based advisor's are compensated by the commissions that are contingent on the purchase or sale of financial products. In other words, your advisor only gets paid when you buy or sell something. This approach may create a conflict of interest because the advisor may be tempted to push securities or products that may not be in the best interests of clients.
FEES FOR ASSETS UNDER MANAGEMENT
Fee Only advisor's charge an annual fee based on a percentage of the client's invested assets that the advisor is managing. Some say this removes the conflicts of interests inherent in commission based arrangements. But, others say that advisor's would be tempted to keep as much money under their management as possible, even when it may be best allocated elsewhere.
HOURLY FEE
Hourly consultation fees are simple arrangements that may best serve those needing limited advice. The hourly approach is flexible and removes conflicts of interest, but does not encourage a long term relationship between advisor and client.
FEE AND COMMISSION COMBINATIONS
Under this arrangement, an advisor may charge a fee for some service, such as developing a financial plan, and charge commissions on financial products bought or sold. The drawbacks of this are similar to those of a commission based advisor.
Is this a lot to consider? It may be. But, after finding an advisor who is competent, objective and ethical, it may be the last thing you'll need to consider. Bottom line: What feels right for you and the working relationship you'd like to develop with your advisor, regardless of the type of compensation, is ultimately what will be best.
Gary O. Clement, CFP® is President of http://www.clementassetmanagement.com
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