What qualities do you look for in your financial adviser?
When asking a few clients recently, the most common answers mentioned were: integrity, honesty and accountability. It is no surprise that clients are inclined to choose an honest adviser. After all, there have been many scandals in the financial industry from Bernie Madoff to Earl Jones that have made many investors think twice when choosing an adviser.
You work hard for your money. You deserve someone who will be looking out for your best interest. What the average investor doesn’t know is that many financial advisers are confined to compensation structures that may make this hard to do!
Let’s explore some of the different adviser compensation models and their differences.
Salary and Bonus
Advisers are typically given a reasonable base salary and are responsible for meeting sales targets in varying product categories the institution has to offer in order to receive a bonus based on annual performance. The targets range from number of credit cards to mutual fund volumes of in house products as banks aspire towards gathering all of their clients’ financial dealings at one institution.
Compensation Style #1: Bob is a financial adviser at a big bank and makes a $60,000 salary along with an annual bonus that is determined by how well he reaches his objectives along with a portion of the bonus tied to the bank’s overall profitability. His targets range from selling $1,500,000 worth of mutual funds, to $3,500,000 worth of references to his lending staff.
The commission model is one adopted by the majority of independent brokers and advisers. Through this structure, advisers are typically paid very little start up income and are heavily dependent on growing their client base to generate transaction based income. This “transaction based income” typically comes from selling a multitude of different products ranging from life insurance policies to mutual funds.
For mutual funds there are varying fee structures, from paying an upfront fee which goes towards paying the advisers, to a differed sales charge (DSC), to no fee at all (no load fund). The DSC is a fee that is charged as a percentage of the invested funds when they are sold. The fee declines over time towards 0%, but this takes an average of 5 to 7 years and is put in place as an incentive to maintain the amount invested in the mutual fund. Regardless of the fee on the transaction, the investment usually pays a “trailer fee”, which is essentially an annual commission based on the investment to compensate the adviser for the ongoing services they provide their clients.
Compensation Style #2: Ted is an independent broker, he recently found a new client looking to invest $50,000. With this money he invests into a few diversified mutual funds which compensates him 0.70% upfront along with 0.30% for every year the assets remain invested. This transaction provides Ted with $350 of instant income and $150 per year as long as the amount remains invested in the mutual funds.
Fee Based (“Asset Under Management”)
The Fee based compensation structure is common for advisers dealing with high net worth clients. The adviser typically charges the client a fixed percentage of the assets held in the portfolio. In most cases the percentage is tiered to benefit higher net worth individuals. The annual fee typically covers all of the transactions that take place during the year and incorporates any trading commissions and management costs associated with the investor’s portfolio. There is usually a high level of disclosure around the amount charged.
Compensation Style #3: Julie works for a firm that tailors financial advice to high net worth clients. She recently met Jerry, a Doctor that is looking for someone to manage his portfolio of assets totaling $3.5M. The negotiated annual fee is set at 1.00% of the portfolio’s value, thus Julie would generate $35,000 of revenue from Jerry’s portfolio which would help pay for compensation, commissions and administrative fees.
Fee for service (also known as “Fee Only”)
The fee for service model is an emerging business model that is slowly growing in popularity and availability in the marketplace. Astrolabe Financial Group has this model in place. With a fee for service adviser, the client typically pays a flat hourly rate or a fixed amount per plan, which essentially makes the adviser completely objective when recommending a suitable solution.
Nathan and Micheline, clients at Astrolabe Financial Group, expressed that with the fee for service model being used the adviser did not have a financial interest in the decision being made. They expressed that “Astrolabe did not get a commission for steering business towards any particular company. Astrolabe was, in a few words, working for us.”
Compensation Style #4: Stevan, a fee for service adviser was contacted by Rachel to help her put together a basic investment plan. Stevan prepares a comprehensive strategy for Rachel which takes him 5 hours to complete, his total income from this plan totals $750.00 at his hourly rate of $150/hour.
Many countries have begun to embrace the fee only model as the preferred method of offering financial advice. In the past year, The Future of Financial Advice Act (FOFA) went into effect in Australia. This act focuses on improving the quality of financial advice. Eventually, the Australian government wants trailing fee commissions and product based commissions completely removed. The main goal is to change the way advice is offered.
Transparency is Key: How is your adviser being compensated?
Of course adviser compensation models may not be limited to those mentioned, as there are many hybrids that have been adopted. Whatever the case may be, your financial adviser should always be in the position to disclose his compensation structure to ensure complete transparency and to enable you to judge the impartiality of his recommendations.
Now that you know how most financial professionals are compensated, you will be able to make a much more informed choice when choosing an adviser. Make sure your financial wellbeing is always the number one priority!