Advisor Compensation

  • Julie Wielehowski, CFP® ChFC®

Nearly anyone can call themselves an “Advisor”. So what do all the fee disclosures mean? Here we explore different compensation models that investors come across. This is meant to apply to investment management, not necessarily financial planning engagements.

Compensation Declarations

I get a lot of phone calls from people saying “I know I want to find a fee-based advisor; I don’t want to pay commissions”. This concerns me and here is why: Fee-based is not the same as fee-only, and it is a confusing moniker that has become very popular over the last five years or so. I also hear occasionally from planning clients that they don’t pay anything for their current arrangement. This concerns me also! I have yet to find anyone managing investments for free, but who can blame investors for thinking that when the fees are sometimes so buried in statements, or not showing up as a fee at all, but buried in the spread or on a trade confirmation or a mutual fund expense?

So what are the differences? Let’s explore the more common compensation arrangements.

Commission: This can be simple or complex, depending on the arrangement. If you have an account managed this way, I encourage you to take a look at the commissions schedule from your provider. Some are a flat fee plus a percent, some are capped, some vary based on the size of the transaction. Some are charged on both the sale and the purchase ends of a transaction. Some have different schedules for stocks and ETF, mutual funds, and fixed income.

Another type of sales charge shows up in mutual funds. Funds can have something called a sales load, which is an initial charge based on the size of the investment. It is not uncommon to have a load as large as 4 or 5%. The ongoing fees in the mutual fund tend to be lower, such as 1 %. Some mutual funds have no up-front charge, but have an ongoing expense in the 2% range, a portion of which often makes its way back to the firm that is managing your investments.

Depending on how much activity goes on in your account, and what you are holding in your account (is it a diversified, buy and hold stock portfolio, or a high cost mutual fund?), this structure may be a good deal for you. You might want to do the math though, and make sure.

Fee Only: Fee only asset management is often a percentage of something. Sometimes its assets directly under management, sometimes its net worth, sometimes its an equation of net worth and income. Sometimes it is a fixed retainer. There could be other models as well. The point is, the fee paid from the client to the advisor is the only compensation. There is often a commission charge to the account on transactions, but it goes to the custodian/ broker-dealer, not the advisor, and it is typically fixed in the range of $0-$50. Additionally, mutual fund fees do not typically find their way to the advisor, so you usually won’t see mutual funds with sales loads or high 12-1b fees in a fee-only arrangement. But don’t think that the fees here are small. On a million dollar investment account this might run around 0.75-1.5% (for a human advisor, less for a robo).

Fee-Based: This one is usually a combination of the two. Commissions, for example from a mutual fund load or up-front sales charge, and an ongoing fee, often based on the account value, are compensation for the advisor and/or firm.

I have yet to actually validate that someone is having their assets managed by someone else for free. Managing investments is a valuable service. It takes education, discipline, confidentiality, regulatory awareness, and hopefully is built on a foundation of ethical practices. There is always a cost for this kind of service.