There are two ways to pay financial advisors for their services: fees and commissions. You pay fees to financial advisors that are usually deducted from your investment accounts. Third parties, such as broker/dealers and mutual fund families, pay commissions to sales representatives. You pay fees for financial knowledge, advice, and services. Third parties pay commissions for the sale of their investment and insurance products.
Who do sales representatives work for if third parties pay them?
Selecting the right advisor is one of the most important decisions you will make for your financial future. Method of compensation is a distinguishing characteristic that makes it easy to determine the type of person who wants to influence or control your financial decisions.
1. Financial Advisors versus Sales Representatives
This is the number one reason why you should pay fees. Only financial advisors have Registered Investment Advisor (RIA) or Independent Advisor Representative (IAR) registrations that permit them to be compensated with fees. Sales representatives, who hold Series 6 and Series 7 securities licenses, only method of compensation is commissions. Their licensing does not permit them to charge or accept fees.
The choice is yours and it is a dramatic one. You can select a financial advisor (fees) or a sales representative (commissions) to help you invest your assets.
2. Financial Fiduciaries
Only RIAs and IARs are financial fiduciaries who are held to the highest ethical standards in the financial services industry. They are required to always put your financial interests ahead of their own. Non-RIA/IARs are held too much lower ethical standards. The higher standard protects you from potential conflicts of interest that undermine your ability to achieve your financial goals.
3. Paid for What?
Let’s assume you have $300,000 of assets that are available for investment. A 5% commission sales rep will be paid $15,000 for selling you mutual funds, hedge funds, and annuities. You may want to ask yourself, What did the rep do to earn that amount of income? Yes, he recommended particular products to you. But, those products came from his broker/dealer’s approved list. The bottom-line, there is no relationship between compensation and service when reps are paid commissions.
4. Paid In Advance
Sales reps are also paid the 5% commission within 30 days of the sale. This is their incentive to sell the product. Most of the time, this represents 100% of their compensation. So they are paid in advance for selling you products, but they have no vested interest in the results of their recommendations because there is no compensation. You would have to be pretty naïve to believe reps are going to provide ongoing services for years for no compensation.
Contrast that to financial advisors who are paid 1% per year for their advice and services. It will take them five years to earn the 5% that was paid to their commission counterparts.
5. Advisor Accountability
Not only will it take 5 years to earn 5%, but all compensation stops if the advisors do not meet your performance expectations. This means financial advisors who are paid fees are more accountable for results than their commission counterparts. Results can include investment performance, risk management, and expenses.
If you want an accountable professional who is paid for results, your only choice is a registered financial advisor who is compensated with fees.