We’ve recently reviewed a great deal of the process of financial planning. I thought today we would examine & answer the following question: How Do Financial Advisors Get Paid?
Financial advisors provide advice and guidance on various aspects of personal finance, including investments, retirement planning, estate planning, tax strategies, and more. They can be compensated through different fee structures, depending on the services they offer and the business model they follow.
Here are Some Common Compensation Structures
Commission-Based Compensation
Some financial advisors earn commissions by selling financial products such as stocks, mutual funds, insurance policies, and annuities. They receive a percentage of the amount their clients invest or the premium paid for insurance products. While this compensation structure can provide potential for higher earnings, it may also create a potential conflict of interest if the advisor's recommendations are influenced by the commissions they will earn.
Fee-Based Compensation
Fee-based advisors charge clients a combination of fees and commissions. They might receive a fee for financial planning services or ongoing advice, along with potential commissions from selling certain financial products. This model attempts to strike a balance between providing objective advice and earning compensation from product sales.
Be careful, however, according to NerdWallet, “This can set up a conflict of interest, as the advisor charges you for advice while steering you toward investment products from which the advisor profits.”
Fee-Only Compensation
Fee-only financial advisors charge their clients directly for their services. They don't earn commissions or other compensation from the sale of financial products. This compensation structure is often considered more transparent and aligned with the client's best interests, as it reduces the potential for conflicts of interest. Fee-only advisors can charge fees based on an hourly rate, a fixed project fee, or a percentage of assets under management.
Assets Under Management (AUM) Fee
Many financial advisors charge a fee based on a percentage of the assets they manage on behalf of their clients. This fee is typically an annual percentage of the total assets under management. The idea behind this compensation structure is that as a client's wealth grows, the advisor's compensation also increases, which can align their interests with the client's long-term financial success.
Retainer Fee
Some financial advisors charge a retainer fee for ongoing financial planning services. Clients pay a regular fee to have access to the advisor's expertise and advice. This structure is similar to hiring an advisor on a subscription basis.
Hourly Fee
Advisors may charge clients an hourly rate for specific financial planning services, such as creating a retirement plan, reviewing an investment portfolio, or providing tax advice. The client is billed for the actual time spent on these services.
Why Do You Need to Know How Financial Advisors Get Paid?
It's important to discuss compensation openly with potential advisors and understand how their payment structure might influence the advice they provide. Choose a compensation model that aligns with your financial goals and values, and always look for advisors who are fiduciaries (the only kind we work with), meaning they are legally obligated to act in your best interest. Keep in mind that regulatory and industry practices may vary by region, so it's advisable to research the regulations and standards in your area when seeking financial advice.
*Not financial/legal advice
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