How Financial Advisors Get Paid
The job of a financial advisor is to create a personalized financial plan based on each client's income, long-term goals, and financial situation. It may include a budget and a strategy for saving and long-term investing. Depending on the client, it may include recommendations for life insurance, a college savings plan, a portfolio of investments, and more.
Advisors may steer their clients toward specific investments, such as certain mutual funds. If they are also registered traders, they may execute trades in the financial markets by proxy for their clients. In such cases, they may receive compensation by the sponsor.
Registered financial advisors may follow either of two standards:
The fiduciary standard requires them to act in the best interests of the client in recommending investments. They are compensated only by their clients.
The suitability standard requires them to recommend investments that are suitable to the client's situation. They may receive payment from companies for recommending their products.
Stephen Rischall, CFP®, CRPC
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If your financial advisor is a broker, the answer is yes. Brokers are paid commissions based on the products they sell and are oftentimes incentivized to sell certain products over others. When you purchase a mutual fund with a sales load, part of that additional expense is used by the mutual fund company to pay a commission to the advisor. Additionally, most mutual funds charge a 12b-1 fee as part of their expense ratio collected each year. Part of that fee goes toward paying the broker a trailer commission, so long as the client remains invested in the fund.
In contrast, if your financial advisor is a fee-only, fiduciary advisor, then they do not receive commissions or compensation from outside parties.
How Financial Advisors Earn Trailer Fees
Mutual funds pay financial advisors ongoing trailer fees, ranging from 0.25% to 1% per year of the amount invested. The fees are intended to motivate financial advisors to recommend that their clients invest in their mutual funds.
As long as the client remains invested in the fund, the fund pays the financial advisor the percentage fee.
How Financial Advisors Earn Load Fees
Mutual funds charge their investors front-load fees when they buy into the fund and back-load fees when they leave it. Every time an investor buys or sells shares of the fund, they are charged one of these fees.
A financial advisor receives a small share of both of these fees. It is termed a contingent deferred sales charge by the mutual fund company.
How Do Financial Advisors Get Paid?
A financial advisor may get paid in one of several ways. If it is not immediately clear, the client should ask.
A fee-only fiduciary advisor is paid only by the client.
A "fee-based" financial advisor may be paid by both the companies that sponsor investments the advisor recommends and by the client.
A commission-based advisor is paid only by the companies that sponsor investments the advisor recommends. The service is free to the client.
What Percentage Do Financial Advisors Charge?
If a financial advisor charges a flat annual fee, the average cost is 1% to 3% per year of the assets in the account. That generally covers most advisory services, investment research, and trading.
The client may choose to be billed hourly fees.
Which choice is better depends on the amount of service you expect from an advisor. If you want frequent contact with an advisor and frequent changes to your investments, the flat fee might be best. If you want help drawing up a long-term financial plan but expect to leave your investments alone for the long haul, the hourly fee may cost you less.
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Is It Worth It to Pay a Financial Advisor?
How confident are you in your ability to handle your finances independently? If you're not all that confident, a session with a financial advisor can get you on a long-term spending and savings plan that is feasible and makes sense for you and your family, given your current income and future goals.
The advisor will want to know if you have sufficient life insurance to protect your family; whether you're saving enough towards retirement; whether you're a homeowner or want to be, and much more.
This may turn into a long-term relationship with a financial advisor, or not. Your plan should change with your circumstances over time.