Payment of Investment Advisors, Financial Planners, and Investment Counselors

The economics of the financial advisory industry

Everyone has similar, yet distinct, financial planning needs regarding their families' financial futures and, everyone needs sophisticated financial lifecycle planning. Whether wealthy or not yet wealthy, families need a personalized way to understand how their current financial behaviors could affect their families in the future. However, few people already own enough assets to justify the high cost of a competent and objective advisor.

Does it matter how financial planners and investment advisors are paid?

Yes, it can matter significantly how an advisor is paid. The heart of the compensation issue is an advisor’s potential “conflict of interest” with respect to payments from third parties. If an advisor works on sales commissions or accepts other third party payments, will he still provide the best recommendations based solely on the client’s best interests?

Financial planner and investment advisor compensation paid by clients

There are three primary types of client paid advisor compensation: hourly-fee, fixed-fee, and asset-fee. The decision to pay directly for planning advice may be prompted by disappointment in prior experiences with commissioned advisers.

Financial planner and investment advisor compensation paid by third parties

How an advisor is compensated can be a very important issue. There are three primary types of third party or commission-based compensation: commission-only, fee-based commission, and fee-offset commission. With commission-only advisors, there is no direct cost to the client for planning and advice. The advice appears to be free, but it is not. Most clients find that ‘planning’ conversations focus quickly on the purchase of products through a commissioned advisor.

Can you really get free and objective investment advice, when you pay investment sales loads? (Part 1 of 2)

Most individual investors have a great need for competent and objective investment advice. At the same time, they are suspicious and do not want to pay directly for advice of uncertain value. The industry has found a way to deal with these contractions. The industry directly compensates its brokers and many “independent” advisors who act as sales agents. Commissioned brokers and commissioned advisors promote their “advisory” services as being free and objective – the best of both worlds. They tell you that you are getting good advice without having to pay anything for this good advice. Sales loads have evolved over time to be one of the major forms of compensation for financial services industry sales personnel. However, investment sales loads are anything but free to the consumer. Investment sales loads do not and cannot improve your investment performance. Instead, investment sales loads could do significant and continuous harm your lifelong financial interests. Free advice is one of the most expensive "free lunches" that you will find in personal finance.

Can you really get free and objective investment advice, when you pay investment sales loads? (Part 2 of 2)

The investment advice you get from commissioned advisors is often anything but “objective.” The quality and objectivity of the advice that you get from commissioned “advisors” becomes more suspect, when you consider that advisors who promote investment products with sales loads will not mention or suggest much cheaper, no-load products as an investment alternative. The sole purpose of a sales load is provide revenue to the firm selling the investment product to you. That firm will in turn compensate the broker or advisor who induced you to make the purchase. Think of the word itself. Does a "load" pulled by an animal, speed up or slow down its progress? There is a reason that investment sales loads are called loads.

How expensive is advisor compensation paid via sales loads?

A sales load might be the method that you prefer to compensate your broker or advisor. If your advisor is truly competent and ethical, he may be able to manage properly the inherent conflicts of interest that are associated with commissioned investment product sales. Even if you actually are getting good advice, paying your advisor via a sales load charge is just one of several potential compensation method alternatives to pay for his services. The key question is whether the cumulative lifetime value of the investment sales load charges you pay is reasonable in the context of your lifetime financial affairs. Are there any other cheaper compensation methods? How would the cost of direct hourly service payments compare to the cost of paying sales loads? Does separating advisor compensation from the selection of investments improve the quality of investment alternatives that are suggested to you? You need to have a much better understanding of the lifecycle cost of sales loads, so that you can assess whether the cost is lower than paying for advice directly.

Fee-only compensation aligns the interests of clients and their financial advisors

Several important considerations favor using fee-only advisors over advisors who accept third party commissions and other payments. Fee-only payment arrangements with advisors allow clients to: 1) maintain trust and reduce unethical behavior, 2) separate financial decisions from purchases, and 3) obtain lower cost financial products.

Fee-only financial planner and investment advisor groups

Members of certain advisory groups have chosen to work with their clients solely on a client-paid “fee-only” basis.