How Financial Advisors are paid

Newsweek's Jane Bryant Quinn loves Fee-Only planners (see here). Chances are the editor of the business section of your local paper also recommends 'fee-only' as the preferred compensation method. The idea is the advisor is not a salesperson, so has no bias in the advice he or she gives. It's a simple concept and most clients accept it readily, thus enabling the media to further promote an idea which is 'in-sync' with their readers. No downside to anyone except those slimy salespeople pushing for a commission. In reality, it's not quite that simple.

What does 'fee-only' mean? You are used to the fee-only model when dealing with dentists, attorneys, and other professionals who charge by the hour or by the project. They quote a fee for a service; you accept the fee quoted; the work is done and you pay the fee. However, Industry statistics show that this kind of flat fee represents only 20% of the income of 'fee-only' financial planning firms. Where does the other 80% come from? It comes from a fee levied on 'Assets Under Management' (AUM). You, the client, have transferred some assets, usually an investment account, to the advisor to manage. A typical fee is around one percent per year, usually withdrawn straight from the account each quarter. You don't write a check, so it's painless. If the advisor does their job, the account grows and you have no complaints about rewarding their performance. Your interests are aligned with the advisor's - you both want the account to grow during the accumulation phase of your life. Because you know they don't receive a commission, or 'load', on a particular investment, you are comfortable with their recommendations,

Here are the problems with this method of compensation: since the AUM fee represents the majority of their revenue, advisors typically increase the minimum investment level over time in order to maximize the income from the limited number of clients each advisor can service. You may find that an advisor will not take you as a client unless you meet their minimum investment amount. Also, reducing the value of the account reduces their fee. If your fee-only advisor's compensation is tied to the amount invested with them, will they be inclined to recommend you withdraw a chunk of that money? Some financial products, like real estate and insurance products such as life insurance, annuities and long term care, are only sold on commission amd cannot be offered by a 'fee-only' advisor. The opposite of an advisor pushing an unneeded product for a commission is an advisor not telling you that you need a commissioned product they cannot sell.

What about just spending down your investments to support your income? This also reduces your 'fee-only' advisor's income and is going to become a big issue as Boomers begin to take wtihdrawals from their IRA's. Compensation methods are a reflection of the environment. What works well in some environments, say 'Fee-Only' while Boomers are putting money into IRA's, can quickly be changed when the environment changes to pulling money out of the IRA. I predict that either more advisors will include commission sales into their compensation structure, or the industry must come out with fee-only versions of products that are currently only sold on commission.

An alternative to 'fee-only' is 'fee-based'. This is a more flexible approach that adds the opportunity for the advisor to recommend products that have sales commissions. If the client willingly purchases the product through the advisor so that the advisor receives the commission, then all or part of their fee might be rebated to the client. Thus the client is not paying twice, first for the advice and second for the product, which would be the case if the product was purchased elsewhere The key to a successful 'fee-based' approach is the disclosure of all forms of compensation by the advisor, and the client being able to shop around for other products to meet the plan needs.

At Bay Area Planners, we consider it our fiduciary responsibility to recommend the best solutions for your situation and we want the full range of financial tools at our disposal. We disclose to you how we are paid for each product or service. Then you decide what's best for you.

Each of the compensation methods have advantages and disadvantages for the consumer. The best advice for you is going to be based on your needs, not on how your advisor gets paid.

To learn more about our philosophy of offering a full line of financial advice and products, call (408) 725-7135 or click here.

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