It’s important to know how your financial advisor is compensated because it can impact the level of financial advice they provide and types of financial products they recommend. The way your advisor is paid may also impact the legal standard of care required of the advisor when providing you financial advice. The three most common methods of compensation are:
Commission-Based
Fee-Based (Commission + Fee)
Fee-Only
Commission or Fee-Based Advisors
Most people have financial advisors who work with large, well known broker-dealers, who are compensated using Commission or Fee-Based models. With either model, an advisor may earn the majority of their compensation from commissions for selling certain financial products. Most advisors working for broker-dealers are legally held to a "suitability standard." This means that the advisor can recommend any financial products as long as the advisor deems them "suitable" for the client. However, this kind of compensation can create conflicts of interest, because it provides the advisor incentive to recommend funds and products offering them higher commissions. So, it’s important that clients know if their advisor is financially rewarded for recommending certain products and funds. Just because a product or investment fund may be deemed "suitable" does not mean that it is in the best financial interest of the client.
Fee-Only Advisors
Fee-Only financial advisors do not receive fees or commission based on product sales. They are paid directly by the client for investment or financial planning services. Fee-Only financial advisors are legally held to the higher "fiduciary standard" of putting the interests of the client ahead of their own, and always acting in their clients' best interests. This model of compensation is the most transparent because client knows exactly how their advisor is paid. Since advisors are not compensated for selling specific financial products, there is no conflicting incentive to recommend financial products that may not be in the best interest of their clients. This is a significant benefit of working with a Fee-Only financial advisor.
Also, since these advisors are compensated solely by the client, and not by third parties to sell products, the Fee-Only financial advisor may often provide financial planning services whereas many commission or fee-based advisors do not.
Whether you currently have a financial advisor or seek to hire one, it is essential you know three things:
How is the advisor compensated?
Are they held to the "suitability standard" or the higher “fiduciary standard” for their Clients?
Are they a Certified Financial Planner®?