Thursday, July 12, 2007

Compensation for Financial Advice

The idea of ‘you get what you pay for’ is as true today as it ever was. If you want objective advice, you’ll likely have to pay for it. How much you pay will vary according to the compensation method used by your financial professional. The value of this information will likely hinge to some extent upon the ‘fiduciary’ relationship; a fiduciary responsibility is one in which there is a requirement to place the needs of the client above that of the company/advisor. Many people assume this is always the case. There are, however, financial relationships where a fiduciary duty is not required.

It is important to understand [and be comfortable with] how your financial advisor gets paid. You need to make sure their compensation method is suited to your specific needs and situation. The International Association of Registered Financial Consultants provides a nice summary of these general compensation methods. Generally, financial advisors are compensated in one of four ways – solely by fees, a combination of fees and commissions, solely by commissions, or through a salary paid by an organization that receives fees. In some cases, you may be offered more than one payment option.

Fee Only.
Fee-only advisors charge an hourly rate (often $75 - $250/hour) for time spent in research, reviewing a plan with you, discussing implementation, etc. Some may charge a flat fee for a quoted service (such as developing a financial plan, drafting a will, etc.). More and more are moving into this category that don’t charge an hourly rate for services, but rather manage assets and charge a fee of 1% to 2% of total assets under management. They receive this classification because they make money from the management fee, not the sale/purchase of products. Obviously entirely different services, so categorizing them the same is confusing to many.

Fee & Asset Management.
Some financial advisors charge a planning fee and then will advise you on investments, insurance, and other financial vehicles; most will help with the implementation of recommendations using mutual funds and other investments. The fee for helping select and monitor these investments is usually a percentage of the assets assessed monthly or quarterly.

Fee + Commission.
Some advisors charge a fee for assessing your financial situation and making recommendations. The fee covers the data collection, analysis, recommendations and delivery of the plan. They may then help you implement their ideas by offering certain investment or insurance products. They typically earn a commission on the sale of those products. If so, that should be disclosed to you at that time. Commissions and other sales charges can vary dramatically from product to product. Don’t hesitate to ask your advisor for the amount of the commission and to explain how the commission will affect the return over the life of the investment.

Commission Only.
Some financial advisors charge no fee but rather are compensated solely by the commissions earned by selling investments and insurance plus services necessary to implement their recommendations. A commission-only advisor will develop recommendations for your situation and goals, review these with you and discuss ways to implement these recommendations. The only way they receive compensation is when you choose to buy the products and/or services being offered. The ultimate quality of any financial professional is independent of the method of compensation used. Competence and compensation are not necessarily correlated. No matter the method of compensation, the possibility of conflict of interest always exists. An advisor should be honest and straightforward about how they are compensated.

Helpful Resources.
- Checklist for interviewing a financial professional.
- Find a financial professional.
- Find a professional based on area of specialty.
- How a financial planner can help and choosing the right one.
- NAPFA – the National Association of Personal Financial Advisors – primary organization that represents fee-only financial planners. You can search for fee-only professionals in your area via their site.
- Your rights as a client.

No comments: