15 Feb How Financial Advisors Get Paid
They’re in the business of helping you make money, but have you ever wondered how financial advisors get paid?
It’s a good question because the answer has the potential to affect your personal finances.
According to the Bureau of Labor Statistics, there were 275,200 financial advisors in the United States in 2020. BLS reports, “The median annual wage for personal financial advisors was $89,330 in May 2020. […] The lowest 10 percent earned less than $44,100, and the highest 10 percent earned more than $208,000.”
As you can see, the amount of money advisors make varies significantly.
While how well they perform certainly helps determine how much they make, the differences in how financial advisors get paid also play a part – specifically, how they are licensed and in what capacity they operate.
Financial advisors either charge a fee, earn commissions, or are on salary.
And how financial advisors get paid can affect what you pay for their services. For example, fees can add up quickly and cost you a lot in the long run.
Another consideration – if a financial advisor gets paid via commission, there is a big possibility they may sell you financial products that benefit their wallet instead of the financial products that are best for you.
Now, obviously, financial advisors should get paid for their work. The problem is that, more often than not, the people they advise are unaware of how their advisor is paid and how much it’s costing them personally.
Essentially, it is all about understanding what is in the contract you are signing.
But sometimes, the fine print is confusing to those who don’t speak the lingo, which is why we are explaining how financial advisors get paid in a way that is simple and easy to understand.
Watch the Video for a Full Explanation.
The Difference between a Fiduciary and a Suitability Advisor
Before we explain how financial advisors get paid, it’s important to understand the differences between types of advisors.
A fiduciary advisor is an investment adviser who works under the Fiduciary Standard, which means they must put their clients’ interests above their own and adhere to the Investment Advisers Act of 1940. They are also regulated by the SEC or state regulators.
In contrast, a suitability advisor does not operate as a fiduciary or adhere to the Fiduciary Standard. This type of advisor is not regulated by the SEC or state regulators OR required to protect clients’ best interests.
Instead, they are only required to give advice that is suitable for a client based on his or her financial needs and objectives.
The type of advisor also plays a role in how they get paid.
A fiduciary advisor must disclose – and in clear terms – how they are compensated.
Fiduciaries either charge a flat fee or receive a fee for the percentage of assets. This puts them on the same side of the table as you.
However, suitability advisors often get paid commissions. If an advisor receives a commission, he or she only has to find a product that’s suitable for you.
This may create a conflict of interest because the advisor may be inclined to choose a suitable product that offers a higher commission.
Watch Why Working with a Fiduciary Is CRITICAL to Your Financial Future.
How Financial Advisors Get Paid
Now that you know the difference between the types of advisors, it’s time to break down how they get paid AND why it matters.
Keep in mind that your advisor should tell you how he or she is getting paid (and fiduciary advisors are required to do so). So it is a red flag if they aren’t willing to tell you.
Go ahead and ask.
If advisor charge fees, they will usually fall into these categories:
- AUM – Assets Under Management – One type of fee an advisor may charge is called an AUM Fee, which stands for Assets Under Management. We see this type of fee quite often. A common fee here is 1% annually of the assets that are being managed. These fees are normally paid every quarter. Sometimes these fees may have a graded scale, which means fees are reduced once higher amounts of assets are being managed. For example, you’ll pay 1% for up to $500,000 in assets, 0.75% for assets from $500k to $1 million, and 0.50% for assets over $1 million.
- Fixed-Rate or Hourly – This type of fee is usually found with advisors that don’t charge for AUM. They may charge you a flat fee, like $500 per year, to call in for financial advice throughout the year, or they may charge you an hourly rate like $250 per hour for every hour they work for you.
- Financial Planning – It’s common for advisers to charge a declared fee for financial planning. This fee could range from $100 to several thousand dollars, depending on the complexity of your financial plan. Note: Some advisors could charge both a financial planning fee and an AUM fee.
Advisors who receive commissions can receive them in multiple ways.
- Insurance products – The advisor may be paid a commission for selling you an annuity or other insurance products like life insurance and long-term care insurance.
- Mutual Funds – Advisors who sell most mutual funds can be paid a commission on them. The amount they will be paid depends on the mutual fund class sold to you. For example:
- Class A mutual funds are front-end loaded, meaning you will pay the fee upfront. So, a $1000 investment into these may charge up to 5.75% of your investment or $57.50 in this example. The remaining amount, $942.50, will be invested into the fund and not the full $1,000. These funds also have lower ongoing fees, like 12b-1 fees and annual expenses. (Note: 12b-1 fees are mutual fund (or ETF) fees that cover the expense of marketing/selling of the funds.)
- Class B mutual funds do NOT have an upfront fee. Instead, they have a back-end sales load, which is referred to as a contingent deferred sales charge (CDSC). You don’t pay this unless you sell your shares before a specified time, which could be up to seven years. Note – They have higher 12b-1 fees than Class A mutual funds.
- Class C mutual funds usually do NOT have an upfront fee. For this reason, they look good upfront, but you pay for it on the backside. They have the highest ongoing fees (sometimes up to 4 times as much) and annual expenses.
Look for your mutual fund class type to see how financial advisors get paid.
If you’re not sure what you are paying, check out FINRA’s mutual fund analyzer. If you type in your information in the analyzer, it’ll tell you about your upfront fees and ongoing fees.
It’s important to recognize that commissions often cloud people’s judgments – this includes financial advisors.
For example, suppose a financial advisor will receive a higher commission from selling a particular type of mutual fund. In that case, he or she may push this fund on you rather than searching for the best option for your financial needs.
Some advisors will receive a salary and possibly a bonus based on the products being sold.
You may see these advisors working for a big brokerage firm or your local bank.
Traditionally, banks sell financial products under the FDIC. You may have even seen FDIC plaques displayed on their desks.
The thing is that some banks sell financial products that the FDIC does not approve, such as annuities.
I knew someone who worked in a bank and took down his FDIC plaque whenever he worked with clients buying annuities.
He was allowed to do so because banks want to sell annuities because they provide the biggest payday to the bank…and its sales force. So, he switched from FDIC approved to a salesman whenever someone came into the bank to purchase an annuity.
It’s Your Money – Work With Someone You Trust
When it comes to your financial future, you want to work with a financial advisor who is focused on what is best for you – not his or her wallet.
This is the big difference between a fiduciary advisor and a suitability advisor. And the difference in how they get paid directly affects your financial future.
If the contract and terms don’t look good or you are not getting clear answers, walk away. Better yet, run!