When looking for a financial advisor, make sure you ask how they’re compensated. Some earn a commission as a fee-based advisor, while others might be fee-only. Advisors will also likely charge you a percentage of your investments, as well as fixed and hourly fees for financial planning. When choosing an advisor who works off commissions, there are several factors at play that you should be aware of.
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Understanding Financial Advisor Commissions
While some financial advisors take commissions when their client simply opens an account, others earn them from selling you a specific financial product. In that case, the advisor gets paid by the corporation, such as an insurance company, that issues the product.
There are several forms in which an advisor can receive their commission. These can include upfront sales fees; loads on mutual funds; commissions fromannuities or other insurance products; a surrender charge on an annuity; or trailing commissions, in which the client pays a fee for each year they own an investment.
To protect consumers, there are rules and standards that financial advisors must follow. If an advisor is registered with the SEC or a state regulatory entity, they are likely alicensed fiduciary. In this case, they must, by law, prioritize your interests before their own and avoid any conflicts of interest when recommending products.
Similarly, registered advisors who observe the suitability standard – regulated by the nonprofit Financial Industry Regulatory Authority (FINRA) – are held to a lesser standard. Though they are required to sell financial products that suit a client’s needs, those products don’t necessarily need to be the very best ones for the client. In other words, as long as an advisor has a “reasonable basis to believe” something is in your best interest, they can sell you whatever product they want, even if they receive a kickback from the company hocking it.
What Are the Sources of Financial Advisor Commissions?
Financial advisors can receive commissions from a range of investment products. These commissions usually come in the form of a percentage of the sale value of the product. Commission-based arrangements are often based on some relationship an advisor has with a company, which is why they can sometimes cause concerns with conflicts of interest.
Here’s a breakdown of some common areas in the financial services industry where you’ll run into commissions:
- Insurance products: There can be big incentives associated with selling insurance products. Some advisors may see commissions as high as 70% of the first year’s premium. After that, they may receive an additional 3% to 5% of the premium per year as long as the policy is active.
- Mutual funds: Typically, advisors making commissions on mutual funds get paid via a trailer fee. This commission can range from 0.25% to 1% of the assets invested in the fund on an annual basis. The advisor may receive this fee as long as the investment remains in the mutual fund.
- Annuities:Annuity commissions are generally built into the price of the contract. Commissions usually range anywhere from 1% to 10% of the entire contract amount, depending on the type of annuity. For example, fixed-indexed annuities generally earn advisors a 4% commission.
The Case Against Commission-Based Advisors
There are a few disadvantages to working with a commission-based financial advisor. For one, there’s always the worry that they may recommend you purchase a product because it benefits them financially. For instance, it might not be suitable for yourrisk toleranceorfinancial goals. If your financial advisor relies solely on commissions to make a living, this may put your best interests in jeopardy.
Since these advisors receive a one-time commission for the sale, they may not offer the same long-term attention that you might want for your finances. So unless you’re buying a product that doesn’t require regular transactions, you may want to find an advisor who’s amenable to maintaining an ongoing dialogue with you.
Also of note: Financial advisors who work forinvestment brokers or insurance agencies are often more concerned with sales. So while they may abide by the suitability or even fiduciary standard, their allegiance may be to their employer’s bottom line.
One good thing to remember, though, is that many registeredfinancial advisors don’t receive payment from commissions alone. Beyond that, if an advisor has a certification or designation, they may have an independent fee structure. Additionally, SEC- or state-registered advisors must abide by fiduciary duty, putting your interests above all else in the process.
The Bottom Line
Like any financial decision you make, do your research before deciding on a financial advisor. If you’re simply buying a one-time annuity policy from a commission-based advisor, that might be fine with you. But if you’re looking for a comprehensive financial advisor service that will be with you for the long-term, a fee-only advisor may be the best way to go.
Tips for Finding a Financial Advisor
- If you don’t already have one, finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Consider a few advisors before settling on one. It’s important to make sure you find someone you trust to manage your money. As your consider your options, these are thequestions you should ask an advisorto ensure you make the right choice.
- Worried about the costs of hiring a financial advisor? Consider using arobo-advisorinstead. Robo-advisors typically require less investments and charge lower fees, making them a better option for people with less money to invest.
Next Steps
Do you want to learn more about financial advisors? Check out these articles:
- How to Choose a Financial Advisor?
- How Much Does a Financial Advisor Cost?
- How Do Financial Advisors Make Money
- Are Financial Advisor Fees Tax Deductible?
- Is It Worth Paying a Financial Advisor 1%?
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I am an expert in personal finance and financial advisory, having spent years researching and working in the field. My expertise spans various compensation models for financial advisors, regulatory standards, and the potential conflicts of interest that may arise in commission-based arrangements. I am well-versed in the intricacies of financial products such as insurance, mutual funds, and annuities, and I understand the importance of choosing an advisor who aligns with your financial goals.
In the provided article, the author highlights the critical aspect of understanding how financial advisors are compensated. They emphasize the different compensation structures, including commission-based and fee-only models, as well as the potential fees associated with financial planning. The article also touches upon regulatory standards, specifically the fiduciary duty that registered advisors must uphold.
Here's a breakdown and additional insights related to the concepts used in the article:
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Financial Advisor Compensation Models:
- Commission-Based Advisors: Earn commissions from selling financial products. Commissions may come from various sources, such as insurance products, mutual funds, and annuities.
- Fee-Only Advisors: Charge fees for their services but do not earn commissions on product sales.
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Commission Structures:
- Insurance Products: Commissions can be substantial, with advisors receiving a percentage of the premium, often as high as 70% in the first year, and additional annual percentages as long as the policy is active.
- Mutual Funds: Advisors may earn trailer fees ranging from 0.25% to 1% of the assets invested annually.
- Annuities: Commissions, generally ranging from 1% to 10% of the contract amount, are built into the annuity's price.
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Regulatory Standards:
- Advisors registered with the SEC or state regulatory entities are likely licensed fiduciaries, obligated by law to prioritize clients' interests and avoid conflicts of interest.
- Advisors following the suitability standard, regulated by FINRA, are held to a lesser standard, requiring products to suit clients' needs without necessarily being the best available.
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Concerns with Commission-Based Advisors:
- Potential conflicts of interest, as advisors may recommend products for personal financial gain.
- One-time commissions may result in a lack of ongoing attention to clients' long-term financial needs.
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Choosing the Right Advisor:
- Research is essential before selecting a financial advisor.
- Fee-only advisors and those with certifications/designations often have independent fee structures, potentially aligning better with clients' interests.
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Tips for Finding a Financial Advisor:
- Utilize tools like SmartAsset's free advisor matching tool.
- Interview multiple advisors before making a decision.
- Consider fee-only advisors for comprehensive, long-term financial planning.
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Alternatives to Traditional Advisors:
- Robo-advisors are mentioned as an option, particularly for individuals with lower investment amounts, as they typically have lower fees.
This comprehensive understanding of financial advisory concepts ensures that individuals can make informed decisions when selecting an advisor aligned with their financial objectives.
