When it comes to investing, there are typically two types of investors. The ones who do it themselves and the ones who need professional help. In the information era, information is abundant and free. The internet has made it more possible than ever to invest on your own. I’m not saying it is easy to do it on your own but certainly it can be done.
In order to invest on your own you must possess three key traits – the desire, the time and the knowledge to be able to do it all yourself. If you lack one or all of these traits, chances are you will have to get some help. But where do you go to find that help?
Finding the right advisor can be just as daunting as finding the right investment. As you seek help, it is important to know how financial advisors get paid. Let’s look at four ways advisors can get paid
Commission based advisors
The majority of financial advisors earn a living from commissions. They get paid when you buy mutual funds, stocks, GICs, life insurance or other financial products. The biggest concern for investors is the potential conflict of interest – Are certain products recommended because they are in your interest or are they being sold because of compensation issues? Commission based advisors have often been criticized for too much focus on products instead of providing good sound financial advice.
Regulatory rules force advisors to disclose how they get paid and how much. As a result, you should always ask how much an advisor gets paid when they sell you a product. Good advisors rarely have any problem justifying how they get paid and how much.
Fixed fee advisors
Fixed Fee advisors get paid a fixed percentage of your total investment portfolio. For example, they might buy and sell stocks, funds or other securities without charging any transaction fees or commissions. Instead, they charge a flat fee (like 1.5% for example) on the total portfolio. In this case, the fees are fully disclosed and totally transparent. This method of compensation takes some of the potential conflict of interest out of the equation because the compensation is fixed. Buying and selling investments does not trigger commission. Instead it’s all about increasing portfolio values which means the goals of the advisor are more aligned with the clients.
In some cases, advisors are paid a fixed salary instead of commissions. This also minimizes that potential conflict of interest that can exist in a commission based arrangement. In many cases, when you are dealing with salaried employees, you are often working with employees that work with big companies like the banks for example. As a result, investors might question whether salaried advisors are working in their best interest or whether they are working for their employer. In many cases, salaried employees only use products from their employer as solutions instead of shopping the market for the best products.
Time based advisors
Time based advisor get paid for their time. Usually they charge an hourly or a flat fee for the work they do. They don’t typically sell products. Many investors balk at paying fees for time when it appears that they can get free advice from commission based advisors. The bottom line is time based advisors will usually give the most objective form of advice because you are simply paying for expertise and time. Once investors start to realize how much money they are paying in fees through other arrangements, paying a fee for time can start to look really attractive.
As you can see, there are pros and cons to every methodology. In my travels, I am continuously surprised at how many investors have no idea how they are paying their financial advisors for their services. It’s time to talk openly about compensation and how you will pay for financial advice. If you need help, make sure you ask about how you are paying for advice and how much.