How you compensate a financial advisor is arguably the most important decision point when it comes to your level of satisfaction with their services. Advisor compensation can be structured a variety of ways. No matter the compensation method, before hiring an advisor, be aware of any potential conflicts of interest and ensure your needs are aligned with the advisor’s financial motivation.
As the famous catchphrase "follow the money" from All the President's Men suggests, money can influence behavior – sometimes in negative ways. All the more reason to pay special attention to compensation when evaluating an advisor.
With over 30 years in business, I’ve learned how to identify a really good financial advisor. Our guide showing the strengths and weaknesses of different compensation models can help you better understand and identify potential conflicts and misalignments. The attributes of an advisor and the type of relationship you need matter, but compensation should seal the deal.
Here’s a quick rundown of what you need to know to identify your ideal advisor.
How are Advisors Compensated?
Advisors are generally compensated one of three ways:
Percent of Investments Managed - The fee is based on a percentage of the assets managed for the client. For example, if an advisor manages $1 million for a client and the fee is based on 1% of investments managed, then the advisor will charge that client $10,000 per year.
Hourly/Retainer - Hourly rates generally range from $150 to $500 per hour. If an advisor does 20 hours of work, the fee would be between $3,000 and $10,000. Alternatively, some advisors charge a set fee for a particular service.
Commission-based - Typically associated with insurance products, a commission is based on a percent of the premium paid. For example, for an insurance product with a $20,000 premium, the advisor’s compensation would typically be in the $6,000 to $10,000 range.
Most advisors who work with high net worth households are compensated by a percent of investments managed. Many hybrid approaches to compensation incorporate elements of these more traditional models.
Two Aspects of Compensation Stand Out
When evaluating advisors’ compensation methods, look out for: 1) conflicts of interest, and 2) a misalignment between your needs and the advisor’s compensation.
Conflicts of Interest
Conflicts of interest can result in less than optimal or downright bad advice, costing you time and money and slowing progress towards your goals. Generally, a conflict causes an advisor to make more or less money, depending on their recommendation. For example, a fee-based advisor recommends you roll an old account into the portfolio of assets they now manage for you and their compensation increases.
Misalignment between your needs and an advisor’s compensation can lead to poor client service, including vague recommendations, lack of follow through, or simply ignoring your needs. For example, if you are looking to plan your financial future and want to uncover all opportunities for improvement, an advisor who is paid based on a percent of investments managed may not be a good fit. Investment management is a very lucrative business and human nature can cause the advisor to focus on that aspect and miss potential ways to improve your financial position, such as reviewing tax returns for tax reduction opportunities.
How to Think about Advisor Compensation
Keep in mind that the different methods of advisor compensation are not necessarily “good” or “bad.” All advisors have some detrimental aspect of their compensation. The goal is to minimize the degree to which advisor conflicts and misalignment may harm the quality of the advice you receive.
You can review the strengths and weaknesses of each potential advisor’s compensation method as shown in our guide. With the pros and cons of each in mind, you should be better prepared to find an advisor who is aligned with your needs.