Have you ever wondered how much difference there really is between one financial advisor and another? On one level they all do the same thing - they invest people’s money. However, like every other profession, each financial advisor has their own area of expertise, skill set, experience, training, and educational background.
And just like when seeking professional services in any other industry, it's important to choose a financial advisor that best meets your unique needs. Since a financial advisor you choose can dramatically impact
your financial future -- choosing a competent advisor is crucial. With so much at stake you would think that becoming a financial advisor would be a rigorous educational process, but that is not always the case.
As we covered in Finding A Great Financial Advisor Part 1, the basic licensing requirements to become a financial advisor, we feel, do not fully address the range of experience and ongoing education needed to competently guide an investor. This underscores the need for you to do your research to make sure you are choosing a competent, thoroughly trained, and well-educated financial advisor. But education and training are not the only areas that separate financial advisors.
One big area where financial advisors differ markedly is the fees they charge and the compensation structures they employ. Far more than simply a cost factor, these characteristics may actually influence the financial advice you receive.
In Part 2 of our four-part series, we’ll highlight some of the different ways that financial advisors charge for their services.
What Types of Fee Structures can Financial Advisors Use?
Financial advisors, generally, charge based on one of the following types of fee structures:
Fee-Only (our preference!)
Hourly or Project Fee
A combination of all of the above
The Commission-Based Financial Advisor
In contrast with a fee-only advisor, a commission-based financial advisor makes money depending on which products or services they sell. In our opinion, this creates inherent conflicts of interest; if an advisor is only paid if they sell a certain product, it is possible they could recommend that product even if it's not in their client's best interest. By only receiving compensation for certain investment products - what incentive do they have to not sell that product?
When an advisor's compensation is tied to certain products or services, it effectively ties their hands, rendering them unable to offer comprehensive wealth management advice. If you elect to work with a commission-based advisor (which could include an insurance agent), demand a clear explanation of how they're compensated and ensure that you can identify exactly how much of their compensation comes from commission based security trading, investment products, or insurance products.
The Minimum (or Flat) Fee Advisor
Some financial advisors charge a minimum monthly, quarterly, or yearly fee for working with you. If that minimum is $5,000 per year and your portfolio is $5,000,000, then that may appear to be a bargain rate of 0.1%. But what if you have $100,000 in assets? Then the percentage you are paying increases to 5%! Is having a fee minimum advisor a bad idea? Not necessarily, but this may not be the most cost-effective option for an investor with fewer assets or limited financial planning needs.
The Hourly or Project Fee Advisors
Both hourly and project fee financial advisors will work with you for a certain amount of hours at a predetermined hourly rate, which is similar to how CPAs or Attorneys charge for their services. This may be in your best interest if you feel that you want to make many portfolio decisions on your own.
It should be noted that some financial advisors charge based on a blend of the above methods – and the key to having any of these methods work best for you is full disclosure. As an investor, you deserve to know up front, and in detail, exactly what you are being charged and why. Also, regardless of which compensation structure you choose, ask your advisor if they are limited in the types of products and investments they can offer you; if they are limited, ask them how this may impact your portfolio.
Before you finalize your relationship with your new financial advisor, ask for a clear, written explanation of how they'll be compensated. It is likely in your best interests to identify any potential conflicts of interest before you bring them onto your team.
Working with a Fee-Only Advisor
At Premier Financial Group, we highly recommend working with a fee only financial advisor because, generally, fee only advisors are not paid according to what type of products they sell to their clients. They are also not compensated for how much they sell. Instead, they are generally paid based on a percentage of the assets they help manage.
When your account does better – so does the advisor. This dynamic creates more of a win-win relationship that can help avoid many conflicts of interest that can arise when working with a commission-based advisor.
In Part 2 of our series on choosing a great financial advisor, we've just begun to explore the many characteristics and qualities to seek in a wealth advisor. In our next installment, Finding a Great Advisor Part 3, we'll discuss practical considerations, such as work style, accountability and potential conflicts of interest.