Carefully planning your financial future helps you meet goals and provide for loved ones and future generations. However, choosing the right types of investments, insuring your livelihood and possessions appropriately, minimizing tax liabilities, and crafting an estate plan can be difficult without a strong background in personal finance or economics. Financial planners fill this gap.
These professionals put their skills to work to help you avoid poor financial decisions that could cost you big over time, but at what cost? Many choose not to engage because they don’t want to pay a fee for financial advice or assume it's a very costly service. While this seems like a savvy choice on the surface, there are many benefits to working with the right financial advisor that generate peace of mind and confidence beyond strong returns on investments.
So how do financial advisors get paid, and how can working with a financial planner enhance your financial future?
Do Financial Planners Get Paid?
The short and accurate answer is yes, they do get paid. Follow-up questions like how and how much get more complex and have led some to build a negative perception that it isn't worth paying for financial advice.
For the purposes of this article, we're going to use the term financial advisors to generally reference financial planners, investment advisors, and wealth managers as well. While the specific services may vary, understanding the ways they get paid are similar and can apply across the board, helping you make informed decisions.
How do you pay for an advisor? A financial advisor’s exact fee structure can vary depending on the types of services offered and the model they use to run their business. One of the best ways to evaluate whether an advisor is a good fit for you is to understand the ways they make money and if that aligns with your values.
What Are the Ways Financial Advisors Get Money?
The three main ways advisors get money are via commission, hourly-based fees, and advisory fees. Rates and average fees within these frameworks can vary widely, and some advisors may combine two or more structures. Once you're familiar with these frameworks, be sure to ask a potential advisor exactly how they get paid so you can better understand incentives, bias, and possible conflicts of interest.
Commission-based fees are one of the most common ways run-of-the-mill investment advisors make money. They may charge a commission based on transactions, trades, or for purchasing specific products such as an annuity, mutual fund, or insurance policy within your larger financial plan. It's important to note that no matter how "nice" the advisor at the firm is or how great the products are, it's a simple conflict of interest that creates easy opportunities for biased advice. When working primarily for a commission, it's human nature to recommend products or investments that may be "suitable" for the client, but also enhance the company's bottom line, even if it isn't truly the best option for the client.
What can this look like in practice? Let's say your advisor is deciding between recommending Fund A or Fund B to you. Both have a similar rate of return that match your allocation strategy and neither carry undue risk. While Fund A has minimal long-term management fees, Fund B carries some of the highest in the industry. But Fund B is managed by a partner of the firm, and the company and advisor will get a kick-back commission each time they move a client into it.
Although what is truly best for the client would be Fund A, commission-based fee structures can lead to a recommendation that is "suitable" (doesn't put you at major risk or move you outside of your investing strategy) but does cost far more over time when there's a better option available.
Flat, Hourly or Service-Based Fees
A flat fee structure is fairly self-explanatory. A firm offers a set level of services for a flat fee, no matter how much you are investing or what you need done. There are benefits to this model in that the firm is not incentivized to devote less time to a smaller client, and they are not biased to recommend products they'll get commission on, but many with more complex or unique needs could be looking for more.
When you're looking to work with an advisor on a one-time project rather than a long-term collaboration, you might opt for an agreement with an hourly rate. This could be to cover something like assist in to crafting your estate plan or to integrate proceeds from the sale of a business into your investment allocation. Remember that hourly rates and service-based fees can vary widely depending on the type of project and the level of expertise required.
Hourly fees address the conflicts of interest created in a commission environment, but don't often make sense for long-term financial planning or wealth management needs because you don't want to be constantly adding more hours on to tackle your needs.
The third way financial advisors get paid is through advisory or management fees. Similar to retainer fees, these fees are most often associated with long-term wealth planning and management. The fees are typically based on a percentage of assets under management, with a tiered fee schedule where the more you have invested, the lower the percentage.
There are two primary benefits to this structure: First is consistent access to your financial advisor without additional fees no matter what your next big financial goal is. Second, because they aren't getting paid to recommend a specific product, they are only incentivized to do what is truly best for your plan, offering genuinely independent advice. Because there are usually minimums, this model may not be a great fit for those just starting out.
Which Payment System Should You Choose When Working With a Financial Advisor?
Is one payment system better than another? The honest answer is it depends. What makes sense for you when you are in your 20's just starting to save for retirement may not make sense for you as your investments grow and financial plan becomes more complex. Generally, you want to make sure your financial advisor and the way they earn money is aligned with your goals and best interests.
How can you vet that? Consider finding a fiduciary wealth management firm to ensure your financial advisor isn’t seeking product kickback commissions or in a situation where they might offer biased advice.
A fiduciary is a financial professional who has a legal obligation to make decisions solely for the benefit of their clients. For this reason, many fiduciaries are fee-only firms, meaning their only source of compensation is the fee they charge. As outlined in this blog from our Chief Investment Officer, you should be wary of wealth management firms that are dually registered as advisors and brokers. Dually registered means they must act as fiduciaries when helping you create a financial plan but can also earn commissions as a broker. Conflict of interest is possible in these situations, and you might not get the service you expect or relying on folks to do the right thing without being held to a standard.
How To Start Working With an Advisor
Now that we’ve answered the question of how do financial planners get paid, the next step is determining how to choose the right advisor for your needs. Remember that when working with a financial advisor, you aren’t simply paying someone to manage your investment activity. A good wealth manager will also use their expertise to provide expert guidance and ensure you make solid financial decisions. Seek advisor firms that emphasize transparency in their philosophy and methods and are willing to meet to discuss your specific goals before you sign an agreement. If you have family and friends already working with a financial advisor, you might ask them for recommendations.
With the knowledge on how financial advisors get paid, you can narrow the list by researching their fee structures. If the advisors don’t advertise their fees on their website, send an email or call them directly. They should be able to simply and easily articulate how and how often they get paid, and you shouldn't be afraid to ask tough questions like whether they get commission on any of the products or services they recommend.
Fact check what you're hearing with the Form ADV filing website to see if the advisor is a registered investment advisor with the U.S. Securities and Exchange Commission. This form outlines the advisor’s fee structure and provides additional information to help you make an informed decision.
If you can’t get answers about fees from any advisor or team of advisors, consider looking for financial planning help from another group or individual. You need trust and transparency when it comes to your financial plan.
With a narrowed list, see who takes the time to answer your questions and offers clear paths to how you can meet your financial goals. A reputable and knowledgeable advisor should be able to make strong recommendations and explain why those recommendations will benefit you and why their fees are a worthy investment.
Already working with an advisor but not sure how they make money? Ask! If the model doesn't put your needs first or align with your values, it may be time to make a switch to a new advisor.
At Plancorp, we follow a high fiduciary standard that is CEFEX certified to deliver advice that puts the best interest of our clients first every time. We offer comprehensive financial planning through wealth management services that go well beyond investment management, incorporating benefits maximization, tax strategy, estate planning, charitable giving and more.