There is no such thing as a free lunch, as they say, and that maxim certainly applies to investing. When you use the services of an investment advisor, you pay a fee—but it may not always appear that way. So, how do financial advisors get paid?
There are two main ways financial advisors are paid: commissions (including both product and per-trade commission); or fees paid directly by you, the client. Within these two options there are some variations, so let’s break them down.
Most Americans are still in the dark about their financial advice. According to our 2019 Financial Trust Survey, one in five people surveyed don’t actually know how their financial advisor is paid.
Hiring an advisor who is paid by product commissions can feel like a win-win, if you are a client. What could be better than using the services of a financial professional and having the fees paid by the company selling the investment products? Well, there are some potential drawbacks, and the biggest one is the conflict of interest this payment approach potentially creates.
If one financial product is offering a 3% commission and another is offering a 5% commission, which do you think your commission-based advisor will recommend? To help ensure you receive the best product for your situation, ask your advisor about the commission differences between products and why the selected product is the best fit for your financial situation.
Broker-dealers are commission-based advisors.
Another common commission structure is per-trade commission, where investment advisors make a commission for every trade. This can lead to over-trading, however, so it’s important to know if your advisor is compensated in this way.
Advisors who charge a fee for their services provide advice that is not influenced by product or per-trade commission. There are three main ways to pay these advisors. They include:
- Percentage-based: This approach is typically based on a percentage of “assets under management,” which is the total amount of money you have given your advisor to invest. This fee can sometimes be based on your total net worth, but that is less common.
- Flat fee: Some advisors offer to handle your financial affairs for one package price. This fee might be paid quarterly or annually. If you need services that extend beyond the scope of your package, you’ll likely incur additional fees, probably at an hourly rate.
- Hourly fee: This fee is easy to understand—you simply pay an agreed upon hourly rate for the advisor’s time, including the time you spend directly with the advisor and any time spent working on your account. Hourly fees are typically only used for consultations or special projects.
Fee-only advisors use several different titles. If you are unsure, just ask your advisor if they are fee-only.
Personal Capital is a fee-only, fiduciary advisor. We are transparent and up-front about our fee, and as fiduciaries, act in our client’s best interest. Learn more about our wealth management services here.
Another common compensation approach is a combination of commissions and direct fees. In this instance, your advisor may still collect a commission on some products but is also providing advice for a direct fee. Advisors who operate under this business model often refer to themselves as “fee-based” advisors.
If your advisor is registered as a broker-dealer, a hybrid approach of both commissions and fee-based is common.
How Much Will You Pay a Financial Advisor?
In addition to the various styles of compensation, how much financial advisors charge also varies.
For example, compensation based on assets under management (AUM) is also widely varied. Typically, the highest fees are about 1.5-2% of your total investment portfolio, although 1% is common (0.95% is the National average). The variance depends on a few things. One is the size of your portfolio. For example, investment portfolios over $1 million often receive a discount—and the percentage fee further reduces as the size of your portfolio increases.
Another variable is the type of advisor you use. For example, fees for human advisors tend to be higher than fees for robo-advisors. Deciding which is best for you mostly depends on personal choice.
Our Take: How Do You Choose What Type of Advisor to Use?
There is no “perfect” choice for everyone because each person’s financial circumstances are different. However, making the right choice is much easier if you understand your options and can ask the right questions.