People often wonder about the different ways financial advisors get paid. The issue is discussed not only by investors but also within the industry by professionals as compensation methods have been hotly debated over the past decade. I thought this would make an interesting post because I’m in touch with many different advisors and have a good knowledge of how they earn a living and what the average fee schedules look like. Let’s start with the first important breakdown: fees vs. commissions.
Back in the 1980′s and well into the 1990′s, the primary way financial advisors were compensated was through commissions. Many of those commissions were paid directly by investment companies on the sale of investment products. That commission amount could vary widely from 1% – 10% depending on the type of product sold. The amount of compensation is often tied to the liquidity of the product, so insurance products often pay more to advisors because they involve tying up funds often for long periods of time. Besides direct compensation from the sale of investment products, advisors who handle the purchase and sale of stocks can charge a commission each time a purchase or sale is placed. What they charge is often negotiated directly with the client but can be a flat dollar amount or a percentage of the trade amount. An industry standard which I’ve seen is 1% in, 1% out on stock trades. Obviously those fees are higher if you are working with a full-service brokerage firm versus a discount online broker.
It should be noted that while commission based financial advisors still exist, the business model has been shifting rapidly to fee based over the past decade. For many different reasons ranging from conflicts of interest to churning (excessive trading for the purpose of generating more commission), advisors and firms have been pulling away from the commission only business and moving towards fee based or fee only model, which we will discuss below.
Over the past 10 years and specifically over the past 5 years, the compensation model has really been moving towards fees, either a percentage of assets or a flat dollar amount. Advisors and clients often like this model as it appears to align the interests of both parties. For example, if an advisor charges 1% on a $500,000 account, he/she earns $5,000 per year. If that account grows to $600,000, that 1% fee is now worth $6,000. In theory, this correlation should cause the advisor to want to grow his/her accounts and take a best efforts approach to growing that account. Similarly, if the account loses value, that fee will be based on a lower account balance. This “percentage of assets” model is primarily how my firm works, with fees scaling down from 1.75% to 0.5% depending on the size of the account.
The realization has come over the past few decades that working on commission may incentivize advisors to always be looking for the next item of business, rather than focusing on the business they already have. While proper business practice would be to pay constant attention to each client’s account, if the advisor has already been compensated on the sale of an investment, it is reasonable to assume they will focus more on where to find the next commission than continuously monitoring an account which they may not earn further compensation on.
Some advisors charge flat dollar amounts (rather than a percentage of assets) for their advisory services. This can be one of the least expensive methods for clients, but it’s tough to find advisors who work this way because it’s hard to make a good living working on fees which aren’t connected to the management of assets. Some advisors charge $150 or $200 per hour to review client portfolios or a flat fee such as $500 or $1000 to generate a financial plan or review a portfolio. Many firms can actually be compensated as a percentage of assets or through flat fees.
The fee models work well because it removes many of the conflicts found with commissions payable on the sale of investment products. If an advisor is managing a brokerage account on a 1% annual fee, they can usually buy any financial product within that account and do so with a fully independent thought process as they don’t need to consider what the commission amounts paid by each investment product may be. This independent model has been gaining popularity over the years, especially as many advisors leave large wire house firms and create their own smaller firms with the goal of better servicing their clients. Here is what a typical % of assets fee schedule might look like for an advisory firm:
Up to $500,000 = 1.25%
$500,000 – 1M = 1%
1M – 2M = .75%
2M – 10M = .5%
Clients who pay these fees often receive planning services as part of that fee. The ‘advisory fee’ usually covers the management of investments, financial planning, and whatever other advisory services that firm may offer.
If you have any further questions about financial advisor compensation, please don’t hesitate to ask.
Premier Wealth Advisors, LLC
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *231
Securities offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Financial Planning offered through First Allied Advisory Services & Premier Wealth Advisors, Inc. Premier Wealth Advisors, Inc is a Registered Investment Advisor. First Allied Securities & Premier Wealth Advisors, Inc. are not affiliated entities.