As a financial advisor for two decades, I have seen a lot – both with clients and with other financial advisors. I have come to believe that most advisors end up in the financial advice profession because they want to help people in a practical way. However, as in every profession, there are the bad apples. Like the cardiologists who send every patient to the cardiac catherization lab because it is significantly more profitable than an office visit, there are financial advisors who are simply looking to “make a sale”. These bad apples often get bad outcomes for their clients that then make others fearful to get the professional help they need. The core issue often boils down to compensation – something that many clients of financial advisors really do not understand. Therefore, it is wise to understand the different ways advisors might get paid so that you don’t get taken advantage of and know what to be on the lookout for.
There are basically two forms of compensation for advisors: fee and commission. Some advisors choose one or the other, but many get paid both ways. The licensing for giving advice for a fee is different than earning a commission on the sale of a product. Why is that important? Because an advisor’s licensing can give you a clue about how they are paid.
Generally, an advisor who charges a fee for advice has a Series 65 or Series 66 license. The difference is beyond the scope of this discussion, but both licenses allow an advisor to earn fees in exchange for the value they provide. In contrast, advisors who get commissions on the sale of financial or insurance products generally have one of the following licenses: Series 6, Series 7 and / or a state issued insurance license. This list is not exhaustive, but these are the most common licenses.
I am not necessarily advocating one approach over the other as I know good advisors who charge both ways. However, I personally have chosen to only charge a fee for advice as I believe it removes a potential conflict of interest and more importantly, I think both clients and prospective clients understand how paying a fee works. When properly disclosed, commissions are a valid form of compensation. However, often clients do not understand that they are paying a commission and can justifiably question the objectivity of an advisor who is promoting certain products for a commission. Additionally, commissions on the sale of financial and insurance products are generally at least several times more than the initial annual fee that would be charged.
If you are shopping advisors, one important question to ask a prospective advisor is: “What securities or insurance licenses do you have?” That information alone will give you some insight.
There is an important distinction in what you have just read. A fee is paid by the client for advice and commissions are paid from the company sponsoring the product on the sale of their product. Perhaps it goes without saying, those advisors who do not charge a fee get paid by commissions – unless they work for free! I can’t tell you how many prospective clients I have met with who did not think they were paying their advisor. A telltale sign that you may need a second opinion is if your advisor equates financial planning with insurance and investment products.
Sometimes products are necessary to implement your financial plan, but financial planning is much more than just investment and insurance products. Other components of financial planning include developing a plan for things like turning investments into cash-flow, income-tax minimization, when to start social security, how best to do charitable giving, estate distribution to heirs, asset protection and of course risk management and having a proper investment strategy. The holy grail is to find an advisor who doesn’t just plan for these items but who can also offer wisdom and perspective as you consider amongst various alternatives. This is the secret sauce that you are really looking for.
The argument for advisors who get commissions is that it may cost less over the long run than paying a fee. Of course, this assumes you keep that same product and don’t replace it down the road as circumstances change. The argument against advisors who get commissions is that the commission creates a conflict-of-interest as the compensation is normally much greater and that the advisor may not have incentive to continue to provide service and ongoing financial planning advice.
On the flip side, the argument against an advisor who charges a fee is that it could cost you more over time. Whereas the argument in favor of an advisor who charges an ongoing fee is that it is a pay-as-you-go approach and gives the advisor incentive to continue to help you with your planning and investments. Further, I believe this approach aligns the interests of the advisor and their clients – if investments perform better the advisor also does better and if they do poorly, so does the advisor.
I know advisors with integrity who work both ways. However, the marketplace of your peers has spoken quite loudly in favor of working with a true financial planner who provides advice on all areas of their financial life for a fee. The preference is for a Fiduciary advisor who puts client’s interests first by their commitment to transparency & the ideal of removing conflicts of interest (as much as possible). And while there are plenty of good advisors who get commissions, if I got hit by a bus tomorrow, I would want my wife to go to a fee-only fiduciary advisor to get ongoing advice and counsel.
And in case you are wondering, most fee-only fiduciary advisors who do not accept commissions will help their clients shop for financial products that may be needed. Ironically, the insurance industry is recognizing this trend and increasingly developing products that do not have a commission built in and are therefore more competitive for clients.
I do not think morality can be legislated. And there is no such thing as a conflict free arrangement. Think about it, you have a conflict with your local grocer as they promote higher profit and less healthy foods! But when it comes to your life’s savings, I think transparency and adherence to the highest available standards of conduct from your financial professional should be the starting point and that you should not settle for anything less!