In the world of financial planning, a variety of factors may affect the advice one receives from an advisor. I’ll tell you an obvious one: a company which sells their own products. Without volunteering names, you probably will if you haven’t already, bumped into this kind of business. Be aware when meeting with an advisor or broker that does so, that his/her advice may be slanted towards selling in-house products- which sometimes pay higher commissions to the selling broker. Even if current law requires this sort of incentive to be disclosed, good luck reading through and understanding financial disclosure documents.
On that note- I should point out that the best type of advisor to work with, in my opinion, is an independent advisor, preferably somebody with the CFP designation. Independent advisors tend to sell the products and services of tens if not hundreds of different financial services firms. Independent advisors have relationships with wholesalers from a variety of companies who visit the advisor firms with the intention of educating them on new product offerings which may be beneficial to their clients. It’s the job of a good advisor to match up the products and services which are most appropriate for a specific client’s risk tolerance and investment objectives.
Let me break down the commission system a bit further. Financial services companies are aware that many people don’t like to see up-front sales charges and commissions. They have used this awareness to devise different methods of paying advisors which are more marketable. Perhaps a fund will have higher internal expenses, part of which is used to pay commissions and expenses from within the fund’s total assets. This may be preferable for a client who wants to see their full initial investment deposited into the fund. This may be misleading however- as paying an up-front sales load will often be cheaper over the long run. In fact, if you qualify for breakpoints (lower commissions as your investment increases) up-front sales charges will nearly always come out cheaper.
The most ethical approach as I see it, and the way the financial planning industry has been swaying, is fee-based advising. Why? There is rarely an incentive for a specific product or service to be pushed in your direction. It is less likely you’ll encounter hidden sales charges, and often you can avoid transactions costs (such as trading stocks) as well. Fees are usually a percentage of the total portfolio amount. For example, 1.5% per year is a fairly common advisory fee. In this example, if a $100,000 account increases to $120,000, the advisor’s fee increases from $1,500 to $1,800. If the account dropped to $80,000, the advisory fee would drop down to $1,200.
The fee could also be hourly. Some people would like a one-time portfolio advice and will pay $150-$300/hour to get it. Then, they can implement the advice at their own speed and with their own methods. This could be a great option to take as well if you maintain even a little do-it-yourself attitude.
I think the logic behind the fee-based approach is fairly obvious and will eventually appeal to more and more people. Part of the problem is that the industry doesn’t ‘rush the process’ because they often make money from it. Those are my thoughts on the fees vs. commission debate. If you had an experience you’d like to share or have a different opinion, please feel free to share.
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