Like the adage says, nothing in life is free. And when it comes to financial advice, this wisdom proves correct. If you have an ongoing relationship with a financial professional, it is safe to guess that you’re paying for it—whether you know it or not. When I meet with new clients, many regret not knowing exactly how their old adviser was paid.
Why does it matter? Knowing how and how much your adviser is paid is essential for a transparent client/adviser relationship. It can also impact the service and advice you’re given. Here’s a quick overview of some common compensation models and relevant considerations:
A commission-based adviser derives their compensation through the sale of investment or insurance products and services. This service model may feel like “free” advice—as commissions are often embedded in transaction costs and not invoiced separately. That said, the presence (or absence) of a commission for a product/fund may present a conflict of interest. Always be sure to ask for full disclosure of fees and expenses. It is also possible that an adviser operating on a commission basis will be narrower in the scope of solutions they can provide (or limited to their own “menu” of offerings). This bears consideration.
A fee-only adviser derives their compensation exclusively from the client—either in the form of flat/hourly fees or as a percentage of assets under management (AUM). Hence, the only compensation is from client fees—serving to eliminate potential conflicts of interest. The adviser has no incentive to recommend one option over another. AUM fees are often debited directly from the account(s) in question, but like hourly/project fees, they can sometimes also be paid by check or credit card.
A fee-based model is a hybrid of the two above approaches. It is easy to confuse “fee-based” and “fee-only,” but there is an important distinction. In this model, the client pays a mix of both annual/AUM fees and commissions on the sale of certain funds/products. As above, such advisers should disclose conflicts when recommending products which intrinsically benefit them.
Not sure where your adviser falls on the spectrum? Just ask. While it may feel awkward, it is important for clients to understand their service model and how it may impact their adviser’s delivery of advice. Here’s a list of questions you can ask your adviser to begin the compensation dialogue:
• How are you compensated?
• Do you receive commission for any of the products or funds I buy?
• How do your fees compare to those of your competitors?
• How will I be billed, and what forms of payment do you accept?
• Do you have any conflicts of interest I should know about?
• Do you include a statement of fees in your regular reporting?
Knowing how (and how much) you pay for advice will help you better understand the value of the service you receive and evaluate its merit on an ongoing basis.
Scott Mazuzan is a certified financial planner for F.L. Putnam Investment Management Company, an independent firm that provides investment management and financial planning services. You can follow his blog at http://www.flputnam.com/blog