Understanding Financial Advisor Compensation Models

How to Find an Advisor That’s Best for You

If there ever was a confusing profession to the public, a Financial Advisor compensation would have to be near the top of the list. With a dizzying array of designations, it’s almost impossible to distinguish one Advisor from another. Even those Financial Advisors with the most common and reputable designations may perform their job very differently. Why is that?

One answer may be that Financial Advisors, like any human, will perform in such a way as dictated by their compensation model. In other words, who they work for or how they get paid.

Almost anyone in the U.S. financial services industry can call themselves a “Financial Advisor.” Industry credentials, and the corresponding education requirements, is intended to help differentiate the various areas of expertise. But designations don’t go far enough. A certain designation doesn’t tell you how they get paid, what their biases are, or how they get paid…

Summary of Financial Advisor Compensation Models

One way to help you determine which Financial Advisor compensation model is best for the services that you need is to understand how they get paid. So, let’s demystify the confusion around credentials and get to the bottom line of the underlying motives for their behaviors. There are three basic categories of compensation:

Commission-based
Fee-based
Fee-only

This summary table should help in deciphering the various information out there, including information coming from the advisors themselves.

Financial Advisor Compensation

It’s that last row that so confusing…Almost anyone in the U.S. can use the term “Financial Advisor.” I stress the point of “in the U.S.” because several countries have banned the term “Financial Advisor” for usage by anyone that receives a commission for financial advising. In other words, some countries clearly distinguish between “Advising” and “Selling.” The U.S. is lagging in this regard to make it crystal clear to the public as to how Financial Advisors get paid. And the professional designations don’t have any bearing on how they charge!

Let’s look at the various compensation models a little deeper and further understand the motives and behaviors of the various types of Financial Advisors.

Commission-based Financial Advisor

Generally, a commission-based Financial Advisor is highly compensated salesperson representing a firm or product company. Commissions may vary greatly by firm and the type of product you are buying. The total fees you are paying such Advisor or firm may be very difficult to determine from your quarterly statements. Ask a lot of questions before purchasing!

If a commission-based firm or Advisor also provides financial services, such as financial planning, be certain to determine if those services are skewed toward certain types of products or a firm-sponsored product. A clue: If a Financial Advisor says, “Our financial planning services are free,” be sure to dig a lot deeper using these questions and also the helpful guide from NAPFA discussed below.

Is the commission a one-time only or will you be paying on-going?
What exactly is the percentage and dollar amount?
How does the commission being paid affect the performance of the product?
What would the performance of the product be without the commission component? (they generally can’t or won’t answer this one)

Fee-based Financial Advisor

Fee-based can be very confusing. Some firms have an overlap of commission and straight fee compensation models by using the term Fee-based.

For example, a firm may have a commission-based model that highly incents the Financial Advisor to sell certain products to the client. The firm may also have a straight fee when performing certain functions such as financial planning. The client dilemma is, how do you determine if their financial planning services is skewed toward a strategy or product that the rep or firm gets commission on.

Likely, the Advisor will present a multi-page legal document disclosing their terms when they are acting in your best interest and when not.

Fee-only Financial Advisor

The #1 Distinction: Fee-only Financial Advisors are legally bound to never take commissions or referral fees from anyone.

The only compensation allowed is that received directly by the client. These advisors are generally more consultative-type Financial Planners with the task to always put the client’s best interest before their own, in all circumstances. They may also perform Investment Management Services, such as Assets Under Management with a strict adherence to a fee schedule and never with commissions.

The #2 Distinction: Fee-only Financial Advisors are also able to sign a Fiduciary Oath.

A “litmus test” to know if you are working with a Fee-only Advisor is to ask him or her to sign a Fiduciary Oath, such as this one: Fiduciary Oath.

The #3 Distinction: Fee transparency. Ask your advisor for a list of their fees. Ours is located here: Services

How to Seek Out a Financial Advisor

It’s very helpful, as a client, to have a basic game plan as you seek out professional financial advice:

Know what you want, need, and expect from your chosen advisor
Know that there are Advisors with different compensation models, biases, credentials, and skills
Have a framework of questions to interview each advisor you are seeking out

For example, if you are seeking out a strategy and Plan to meet your retirement goals, you may need a financial professional that can run various “what-if” scenarios for you, show you some future projections based on your current situation, perform some tax planning, estate planning, and possibly create a written Plan for you. The professional you need to do all that work may be very different than the professional that receives commissions selling life insurance or other financial products.

Knowing how a professional gets paid is KEY to knowing the type of service you can expect!

A Consumer Tool to Help Compare Advisors

The National Association of Personal Financial Advisors, NAPFA, has a document that you can download here, NAPFA Comparison Tool. The tool has a number of capabilities, allowing you to evaluate a Financial Advisor. You can use it on your current Advisor or several that you are comparing to take your future business. There are 25 questions in total among 4 categories:

10 questions on the services that they offer
3 questions on their education and experience
9 questions on compensation
3 questions on their regulatory compliance (i.e. business succession planning)

About Kastler Financial Planning

We are a fiduciary firm, providing fee-only, professional financial services with affordable and transparent fees. Our core purpose is to help improve your financial situation and to help you Get Retirement Ready. We do not sell financial products. We believe everyone should have access to financial advice without the pressure or bias of product sales or commissions. KastlerFinancialPlanning.com

We perform these services either as hourly, a one-time fee-only project, as on-going financial planning, or Assets Under Management (AUM), depending on your needs. Whether you live in our backyard or across the country, we aim for a pleasant client experience through our secure, all-digital Financial Planning Process.

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