How do Financial Advisors get paid?
First it’s important to understand that the term “financial advisor” and “financial planner” are unregulated and ambiguous terms. Almost anyone in the financial services industry can refer to themselves by these titles. You can also forget the designations after an advisor’s name. They don’t tell you anything meaningful about the advisor’s experience, knowledge or compensation methods.
What you really want to know about the person you are considering hiring is what licenses they hold.
The licenses are what legally control how an advisor behaves.
A. An insurance license means the person can receive commissions from the sale of annuities and life insurance.
B. A Series 6 or 7 license means the person can receive a commission from the sale of stocks, bonds and mutual funds.
C. A Series 65 or 66 license means the person can receive fees from investment management or financial planning services.
D. If the person…
- has no licenses, they legally shouldn’t be giving any advice or selling any products.
- has multiple licenses, ask them how much of the total compensation is from commissions versus fees. If the majority of their personal compensation is from commissions, then they are essentially salespeople.
- receives fees, ask them if they can provide advice for accounts their firm doesn’t manage. Most can’t. This is important if you’re looking for a comprehensive planner versus an investment manager for a particular account.
You can and should investigate any person you are interviewing by typing them and their firm’s name in FINRA’s Brokercheck. You’ll learn if they have any strikes against them. But you’ll also learn what licenses they have and how they can be compensated.
Because of the lack of transparency in this industry and the ambiguity, your best bet is to seek out advisors who only have a Series 65 or 66 license. These are advisors who can receive fees.
Again, many advisors who receive fees are not able to provide comprehensive advice. This is why a NAPFA registered financial advisor is a good place to start your search.
The most common types of fees an advisor can receive include Assets Under Management, Hourly and Fixed.
- As the name implies, with an hourly fee, the advisor is compensated for the time he/she spends.
- Fixed fees are ones that are agreed to beforehand and not dependent on time or size of the account.
- But by far, the most common fee charged by investment advisors is the Assets Under Management fee (or AUM). The AUM fee is calculated as a percentage of the value of accounts under management on a particular date. AUM fees can be calculated daily, monthly or quarterly. Advisors working with the general public generally bill on a quarterly basis.
As an example of how AUM fees work, let’s assume your account is valued at $100,000 on the last day of the quarter. Let’s also assume your AUM fee percentage is 1% on an annual basis, which is common.
The fee calculation is to take the $100,000 account value and multiply it times 0.01 (1% in decimal form). The result is $1,000. Then divide this figure by 4 to get the quarterly fee: $250. This quarterly fee is often deducted from the account(s) under management. This fee calculation is then repeated every quarter.