When you work with a financial advisor, you’ll generally pay them via an advisory fee. This is often based on a percentage of your assets under management (AUM). Other common fee types are flat fees and hourly fees. Fee-only advisors make money solely from these advisory fees. Fee-based advisors, however, earn money in a variety of other ways in addition to the standard advisory fee. Make sure you know what fees you’ll pay and of any potential conflicts of interest your advisor may have. If you need help finding a financial advisor, consider using SmartAsset’s free financial advisor matching service.
How Fee-Based Financial Advisors Work
When you work with a fee-based financial advisor, you’ll likely agree to pay a fee in exchange for the services provided. This probably will be a percentage of your AUM. Some advisors charge a flat rate for all assets while others use a graduated scale in which the fee percentage decreases as your AUM increases. Some advisors may skip this altogether and instead opt for a flat or hourly rate. You may also pay a performance-based fee, a predetermined fee you’ll pay if your investments perform well.
In addition to earning money through one or more of these fee types, fee-based financial advisors also make money from other sources. In short, if your advisor earns money through anything besides a fee for the management of your portfolio, your advisor is fee-based rather than fee-only. Advisors won’t necessarily advertise their fee structures. Thus, it’s important to always ask any advisor you work with how they get paid.Methods of Compensation for Fee-Based Advisors
Revenue streams for fee-based advisors vary on an individual basis. In addition to advisory fees, some of the most common additional income sources for fee-based advisors include:
These are the most common additional sources of income for a fee-based financial advisor. However, any money earned from a source other than fees for portfolio management make an advisor fee-based instead of fee-only.Fee-Based Advisors and Conflicts of Interest
Fee-based advisors have a number of potential conflicts of interest. When advisors solely make money from managing a client’s assets, their only incentive is to maximize clients’ returns. Fee-based advisors, however, may have an incentive to make decisions that are not necessarily in clients’ best interests.
For instance, if an advisor receives a commission for every insurance product they sell, there’s an incentive to sell insurance to clients, even if they don’t need it. Furthermore, if an advisor makes a brokerage fee for every transaction they make, it would, in theory, behoove them to make more trades than they necessarily need to make. The same concept also applies to mutual fund commissions.
However, many advisors are bound by fiduciary duty to act in the best interest of their clients no matter what. Directly ask advisors whether they are bound by fiduciary duty. Even if your advisor is a fiduciary, make sure you know whether they have any potential conflicts of interest, especially if the advisor is fee-based. You always can opt not to buy the products your advisor earns a commission from if that makes you uncomfortable.The Bottom Line
Fee-based financial advisors earn money from sources beyond the fees their clients pay, such as through commissions and brokerage fees. This presents a potential conflict of interest. It would be in the advisor’s interest to make transactions from which they would earn extra money even if it isn’t necessarily in the client’s best interest.
Fee-only advisors earn money solely through the fees their clients pay, and thus inherently have fewer conflicts of interest. If you’d like the peace of mind of knowing your advisor can never make money from selling you something, look for a fee-only advisor. Make sure you know how your advisor earns money and whether they have any potential conflicts of interest. If they do, find out how they attempt to mitigate them.Financial Advisor Tips
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