Choosing An Advisor, Part 4

How Financial Advisors Get Paid

You’ve come to the point where you think you’ve found a financial advisor who can help you with your problems. Now comes the time you’ll want to find out the cost. A simple way to do this? Ask, “What will this cost me?”
 
There are three typical ways your financial advisor might get paid.
 
Commission: Depending on what you buy from the advisor or thecompany, you usually pay the advisor a percentage of the product sold.
 
Fee-Only: These advisors are paid either on an hourly basis or they charge a percentage of the investments they’re managing for you or a percentage of your net worth. They do not receive commission from any product sales.
 
Fee-Based: The advisor charges in the same manner as Fee-Only, but may also make a commission on investment or insurance products you buy. The fee may or may not be reduced based on the commissions received.
 
So, are commission-compensated advisors biased against their clients’ best interests, and the fee-only advisors not? That’s a common belief, but as a fee-only advisor, let me assure you that this is not true. While there are a few more issues in the commissioned world, trust me, there are biases in both situations. I’m familiar with many advisors paid on commission who put their customers’interests ahead of profit, and I’ve seen former fee-only advisors who didn’t; they’re now sitting in prison for theft and fraud.
 
In Washington, there’s a lot of discussion about something called a fiduciary standard. A fiduciary is required to act in the best interest of clients, something the proponents of the standard say should be more important than bigger advisor paychecks. Only a subset of financial advisors is required to act as a fiduciary. The rest are held to a lower suitability standard, where advisors ensure their recommendations are suitable to your situation even if they feel another course of action is better for you.
 
Arguments abound in the industry as to whether all financial professionals should adhere to the stricter fiduciary standard. Some believe it would cause the middle class to be effectively ignored by the industry. Let’s not argue that now.
 
So, whether an advisor must follow a fiduciary or a suitability standard, you can ask this question: “Regardless of a requirement to act as a fiduciary in regard to me, will you always put my interests above your own?” You see, there are financial professionals who are held only to a suitability standard that nevertheless puts their clients first. Their company may not allow them to put this into writing, but that doesn’t stop them from acting in a fiduciary manner.
 
Personally, I think you should request that they, in action, act as a fiduciary. But that’s up to you.

Either way, one last question you need to ask your prospective advisor: “How do you make money from me?”

Be especially observant on how they answer this question. If the advisor gets fidgety, defensive, or side-steps your question, keep asking. If you hear, “I don’t cost a thing,” keep prying until you can trace how money makes it from your hands to theirs. Trust me. None of us worksfor free.

This article was published under the title "How financial advisers get paid"in the WichitaFalls Times Record Newson July 17, 2011.