When you’re looking to hire a financial advisor, it goes without saying that you want someone you can trust. Part of building that trust comes down to understanding how your financial advisor gets paid. It’s a question that cuts to the heart of an advisor’s motivation: What drives him or her in offering the financial advice that can impact your life dramatically — both now and into retirement?
The answer is not always simple, but it’s worth doing your homework.
Three Types of Financial Advisor Compensation Structures: Brokers, Fee-Based, and Fee-Only
Take it from Dave Ramsey, a personal money-management expert, author, and national radio host, who says a successful investment strategy involves spending money to make money. But you must be smart about it.
“I know it’s hard to understand exactly how an investing advisor gets paid — and what you’re getting for your money,” Ramsey writes on his blog. “But I also know that successful investors work with financial advisors they trust. And if you’re going to reach your dream retirement, you need an advisor you can trust on your side.”
Financial advisors typically fall into three broad categories when it comes to compensation: brokers, fee-based, and fee-only. These all sound quite similar, which can cause some confusion among clients, but they are, in fact, very different.
This type of advisor is commonly referred to as a stockbroker, though often they sell other types of securities as well. Brokers are paid solely by the commissions they earn from trades. The size of these commissions can vary widely based on the product and the size of the trade. For example, a loaded mutual fund could pay a broker upwards of 5% of an initial sale, while a low-cost ETF might pay less than 1% or offer no commission at all.
This type of compensation structure can create a serious conflict of interest between what is best for the client and what is best for the advisor. Even the most well-intentioned broker can find themselves leaning toward one product over another because of the potential to earn more from the sale.
Additionally, brokers are not held to a fiduciary standard – a legal obligation to act in the client’s best interest, without regard to the advisor’s compensation. Instead, their recommendations must be “suitable.” There are many types of investment products, and these are offered by many different companies. So, there are an abundance of products that could be considered suitable in any given situation. But just because an investment is suitable, does not guarantee that it is in the client’s best interest, especially when fees and loads are taken into consideration.
Fee-based advisors charge their clients a fee for their advisory services. But that’s not the only way they get paid. Fee-based advisors also receive compensation through the sale of various financial products they recommend to their clients.
Fee-based advisors do not have a fiduciary responsibility to act in their clients’ best interests. Instead, they are only required to offer “suitable” recommendations. That’s where the potential conflicts of interest come into play. Like with brokers, the prospect of additional compensation can be hard to resist and can lead to recommendations that have a higher cost to the client.
A fee-only financial advisor is different. Rather than earning their income from commissions, they charge either a flat fee or a percentage of assets under management. Registered investment advisors [RIA]s, are fee-only advisors with a fiduciary responsibility to act in their clients’ best interests. That means they do not accept any compensation from third parties — namely the companies that sell the financial products they recommend.
The fee-only model removes any potential conflicts of interest. So, a fee-only advisor is not motivated to sell you a particular product because of the money they stand to make off that sale. Instead, fee-only advisors get paid based on a flat fee, an hourly rate, or a percentage of assets under management — which means their only motivation is to ensure they provide you with sound financial advice. That way, you become a happy customer who turns into a longtime and wealthy client. When that happens, everyone wins.
When you’re choosing a financial advisor, one of the most important questions you can ask is how they get paid. RIAs are required to disclose their compensation in detail, so do your due diligence and ask. A well-informed investor is a better investor — every single time.
Fiduciary Advice for Every Client
At DreamWork Financial Group, we believe that trust is the most important aspect of an advisory relationship. That’s why we are structured as a fee-only RIA. So, when you invest with DreamWork, you can rest assured that all of our recommendations are in your best interest.
Additionally, we believe that all clients should have access to individualized, fiduciary advice. In keeping with that belief, we have no investment minimum to participate in our unique wealth management program Investing Gameplan™. With Investing Gameplan™ from DreamWork Financial Group, You Don’t Have to be Wealthy to Have Wealth Management®.
To learn more, or speak to one of our fiduciary advisors, contact us today.