One of the biggest financial decisions (and maybe mistakes) that you can make is choosing a financial advisor. While not everyone needs a financial advisor, avoiding the wrong advisor is very important. Choosing the right advisor can save you thousands of dollars over time as well as save you numerous headaches. There are a lot of factors that go into choosing a financial advisor. But one of the biggest is understanding how they are compensated. So let me show you the three ways that financial advisors are paid.
How Financial Advisors Get Paid #1: Client Fees
This is the most common way that financial advisors are compensated. Ever since the implementation of Regulation Best Interest (often referred to as Reg BI), most financial advisory firms have moved to this model.
Reg BI says a lot of things, but the jist of it is that financial advisors must do what is in the best interest of their clients before they do what is in the best interest of themselves.
So because of this, most financial advisors have moved to a client fee compensation model.
Client fees can look like a lot of different things but typically they are usually in the form of “assets under management” (or AUM).
What this means is that the advisor will generally charge a flat fee for all of the money that you have invested with them.
For example, if you have $250,000 invested with a financial advisor and they have a 1% AUM fee, then you will pay $2,500 over the course of a year. These fees are generally split into quarterly payments and taken directly from your investments.
And FYI, the average AUM fee is about 1% in this industry.
It is important to know that this fee will be taken out of your account no matter if your account goes up or goes down. This isn’t necessarily a bad thing depending on what the overall market is doing.
Other client fees that are sometimes used are:
- Hourly consulting fees
- A fixed fee regardless of your portfolio size
- A performance fee if the benchmark is outperformed
Generally, these fees will not stack on each other. You will usually have to pay one of these fees, not all of them.
How Financial Advisors Get Paid #2: Commissions
I’ve said it before, and I’ll say it again. There is nothing wrong with commissions in most cases. When I purchased my house, I paid a commission. When I purchased my truck, I paid a commission. As long as the person who is selling you the item has your best interest in mind, there is nothing wrong with paying a commission.
However…
Because the financial world is convoluted and difficult to understand, a lot of people do not understand what they are paying a commission for or if the financial service that they agreed to is in fact in their best interest or not.
That is why Reg BI was introduced and passed into law.
Unfortunately, there were a lot of financial advisors who were charging outlandish commissions for services that were not in the best interest of their clients.
Paying commissions to financial advisors is pretty uncommon now. But there are still some advisors who charge commissions for various services/products.
The commissions can range in percentage and dollar amount for the given service or product.
Just make sure that if you are paying a commission, that the financial advisor is working in a fiduciary capacity with you. (This will force them to make decisions based on your best interests and not their own.)
How Financial Advisors Get Paid #3: Salaries
It largely depends on the financial advisory firm, but there are a lot of financial advisors that get paid a regular salary.
They might get a regular salary as well as some AUM fees, commissions, etc. though.
This is extremely common with financial advisors who are early in their career.
Often, when a financial advisor is hired at a new firm and does not already have a book of business, they are given a modest salary for a period of time.
Final Thoughts
Not everyone needs to have a financial advisor. However, at some point, you will likely reach a level of wealth and a level of confusion in your portfolio that you need to call in an expert. And you need to make sure that you know how that person is being compensated to understand how their interests line up with yours.
You can do this!
I am here for you!
Until next time!
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