How you compensate a financial advisor is arguably the most important
determinant of your level of satisfaction with their services. As the famous
catchphrase “follow the money” from All the President’s Men suggests,
money influences behavior. There is a lot of consumer misunderstanding about how to best compensate an advisor. Most consumers also do not recognize the significant influence compensation has on advisor behavior. Therefore, this step is particularly important. The goal is to find an advisor where the compensation motivates the advisor to do their best work.
How to Think About Advisor Compensation
Keep in mind that the different methods of advisor compensation are not “good” or “bad.” All methods of compensation have inherent strengths and weaknesses. Before we get into the details of how to identify an advisor whose compensation method is best for your needs, an overview of the different ways advisors are compensated may be helpful. There are also hybrid approaches to the three methods as well.
How are Advisor Compensated?
Percent of Investment Assets Under Managed (AUM) - 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 1% of investments managed, then the advisor will charge that client $10,000 per year. According to the 2018 Evolution Revolution report 95.3% of Registered Investment Advisors are compensated by the AUM method.
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 flat fee for a particular service.
Commission-based - Typically associated with insurance products, a commission is based on a percentage 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.
What is the Best Way to Compensate my Wealth manager?
Compensation is inherently intertwined with other aspects of a successful relationship with an advisor, so it’s not possible to isolate compensation and make a definitive recommendation. Further, compensation is very situational. The compensation model that makes the most sense when helping you solve one problem may be inappropriate to help solve a different problem. Also, remember that all compensation models have strengths and weaknesses, so you can’t outright eliminate any single method.
So how do you identify the compensation model that will get you the best possible result when working with an advisor? The key is alignment. You want alignment between the problem you are trying to solve and how the advisor is compensated.
When you have alignment, you are playing to the advisor’s strengths since they are most skilled at the services for which they are compensated. When you have alignment between services needed and advisor compensation, other important aspects of the relationship will fall in line, including expert knowledge, responsiveness, and specific, actionable recommendations.
A further benefit of alignment is that conflicts of interest are often reduced when the service provided and compensation are compatible.
A Guide to Assist You
Our Advisor Compensation Guide summarizes the strengths and weaknesses of different compensation models. This may help you better understand and identify potential conflicts and misalignments. With the pros and cons of each in mind, you should be better prepared to find an advisor who is aligned with your needs.