Working with a financial advisor is a good idea if you need help managing your investments or creating a financial plan for the future. But before you work with a financial advisor, it’s important to understand how they get paid. Not only do you want to know how much you’ll pay in fees, but you should also understand how other forms of payments could incentivize them to make certain recommendations. Here’s a look at the different ways financial advisors earn money.
How Do Financial Advisors Get Paid?
There are three main ways financial advisors make money:
Many financial advisors and firms will earn fees directly from their clients. A management fee (for investment management services) is frequently charged a percentage of the assets they’re managing on your behalf. If a financial advisor is managing $1,000,000 worth of investments for you, and they charge a 1.5% management fee, you’d pay $15,000 on the year. Often those fees would be charged on a quarterly basis.
Fee percentages might differ depending on how much you have invested with an advisor, with many firms lowering their percentage for larger account balances.
Some advisors also include performance fees in their fee schedules, allowing them to charge additional fees to clients in exchange for exceeding certain return benchmarks.
An advisor might also charge a flat or hourly fee, usually for financial planning services. For instance, a firm may charge $250 an hour for financial planning, or a flat fee of $1,000 for a specific service.Commissions
In this type of fee arrangement, a financial advisor makes their money from commissions. These fees are earned when they recommend and sell specific financial products, such as mutual funds or annuities, to a client. For example, you might invest $5,000 into a mutual fund your advisor recommends; in turn, they receive a 3% commission fee, earning them $150. Similar commission may come their way if they sell an annuity to a client.Salaried advisors
Some advisors are paid a salary from the investment firm that employs them, rather than earning commissions or charging fees. These advisors may also have opportunities to earn bonuses or incentives for meeting certain milestones, such as onboarding a certain number of new clients each year.Fee Structures: Fee-Only and Fee-Based
A firm’s sources of income determine whether they are considered a fee-only or fee-based advisory.
A fee-only financial advisor doesn’t get paid via commissions. Instead, the sole source of income are fees charged to clients for the services they provide (again, potentially including both percentage-based management fees and flat or hourly financial planning fees).
A fee-based advisor, by contrast, earns revenue from a combination of client fees and commissions. They charge fees to you directly for managing your assets or providing financial planning, while also earning some commissions on the side.
Commissions represent a potential conflict of interest: They incentivize your advisor to recommend certain transactions and products. And you want to make sure the advice you’re getting is tailored to your needs, and not tied into how much money the advisor could potentially make if you choose to buy an annuity. With this in mind, some experts recommend only using a fee-only advisor.
One important thing to note when comparing fee-only and fee-based advisors has to do with whether or not your advisor is held to a fiduciary standard. A fiduciary is held to a higher ethical standard and is required to act in your best interests at all times. Any registered investment advisor (RIA) is held to such a standard as part of their registration with the SEC. This standard might be a mitigating factor when considering a fee-based advisor; while such an advisor is incentivized to recommend certain transactions, those transactions must still be in your best interests.What It Costs to Hire a Financial Advisor
Again, there’s no set answer to this question since financial advisors can assess their fees differently. On average, you can expect to pay between 1% and 2% for an advisor who uses a percentage of assets as the basis for making money. An advisor who charges by the hour, on the other hand, might fall into the $100 to $300 range. For advisors who charge a flat fee, the cost may range from $1,000 to $3,000.
A good way to keep the fees in perspective is to consider what you’re getting in return. Say you come across an advisor that’s fee-based, charging both commissions and fees, and this advisor charges a high 3% management fee for their services. Now, if that advisor is able to help you realize a 12% or 15% net gain in your portfolio year over year, that 3% fee could be well worth it. On the other hand, you might be more comfortable with a fee-only advisor if you it’s important to you that you’re receiving unbiased opinion.How to Compare Financial Advisor Costs
If you’re looking for an advisor to work with, there are a few ways you can research how they make money. The first is to check their Form ADV filing if they’re registered as an investment advisor with the U.S. Securities and Exchange Commission. This form is a public disclosure that outlines, among other things, how the advisor makes money and what fees they charge.
You can also review an advisor’s fee schedule online if they advertise their fees. And if they don’t, the next step is to ask them directly. Ideally, you want to work an advisor who’s transparent about how they’re paid and what it will cost you to be their client. If an advisor dodges questions about fees or seems reluctant to share how they make money, that’s a sign that you may want to look elsewhere for financial planning help.The Bottom Line
Tips for Finding a Financial Advisor
Financial advisors can make money in a number of ways and what’s important as an investor is to find the one whose fee structure aligns with your needs and budget. As you’re reviewing fee schedules, be sure to ask about any fees you don’t understand. If you’re working with a fee-based advisor, it’s also helpful to ensure that they’re held to a fiduciary standard; you might also ask how they determine which investment products to recommend. Doing your research on advisor fees beforehand can help you understand both what you’re paying and how your advisor is incentivized.
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