When shopping for financial planner or financial advisor, one question you should ask is "How is this person compensated?" You should also ask this question if you already have a financial planner or financial advisor but are not completely sure how that person is compensated. Not all financial professionals get paid the same way. The compensation method of a financial professional can affect how that person serves you, so you should have some knowledge regarding the different methods when selecting a financial planner or financial advisor. The terms financial planner, financial advisor, and financial professional can be used interchangeably for the purposes of this discussion.
The three most common compensation arrangements are commission-based, fee-based, and fee-only. The primary difference is source of the compensation. Commission-based advisors get paid by companies when they sell those companies' products to you. Fee-based advisors get paid a fee from you while also getting paid by companies when they sell those companies' products to you. Fee-only advisors get paid from you only and receive no compensation from selling companies' products.
When financial professionals receive compensation from parties other than their clients, their compensation can be difficult to trace. Clients may not know how much or how often their advisors get paid. Also, when financial professionals are hired to serve their clients but get paid from other companies, conflicts of interest can arise. Some financial advisors might be motivated to act in the interest of the company who pays them. Most financial professionals who receive commissions are ethical and act in their clients' best interest, but their motivation still has to be questioned whenever they receive commissions from products they sell.
The advantages of the fee-only method are transparency of compensation and elimination of conflicts of interest. Because fee-only advisors are paid by their clients only, clients can see exactly how much and how often their advisors get paid. Clients can also feel confident their advisors are motivated to act in the best interest of their clients. Because fee-only professionals do not receive commissions from other companies, they have no motivation to act in the interest of other companies. These advantages have made the fee-only compensation method a popular trend in the financial services industry.
When shopping for a financial planner or financial advisor, make sure to ask how he or she is compensated. You should never feel anxious or embarrassed about asking your financial advisor about how he or she is compensated, and your financial advisor should never be reluctant to provide you this information. As for my opinion, I believe the fee-only method of compensation agrees best with financial professionals who seek the fiduciary role with their clients. I suggest you evaluate all compensation methods and select a financial professional who is compensated in a way that agrees most with your personal preferences.
