I had a conversation with a friend who recently retired and he told me how he has been through several financial advisors over the years. Several of these advisors steered him to invest in areas he was not familiar with but he felt those advisors were the pros. So he followed their advice and the results were less than stellar. In fact in almost every situation he would have been better off investing in index funds.
I asked him how these financial advisors were compensated and he admitted that he was not sure. He felt that since they were working for established firms he could rely on their advice. I wonder how many people know how their advisors are compensated.
Compensation of financial advisors ranges from hourly fees to commission only. When selecting an advisor one of the first questions to ask is how he/she is compensated because their priority may be to make money for themselves or their firms instead of you. An advisor should also be asked if they have either a personal or professional stake in any entity or corporation they are recommending for investment.
I suggest that no matter how an advisor is paid try to understand what your total annual costs will be (even if it is only an estimate). If you are retired or approaching retirement this may be even more important for your financial well being. Financial advisor compensation can be structured as follows:
Basically you pay an advisor for their time. It is a good idea to have well formulated questions when using an advisor who bills on an hourly basis. If you walk in unprepared it may be a very costly option.
Is a set fee for a particular service. At least you will know up front how much that service will cost. This may be a good option assuming your advisor is reliable, reasonable and can provide you with the response you are looking for.
This fee is a management fee and is either based on a percentage of assets managed or some net worth calculation. This option provides the advisor with some incentive to increase the value of your assets.
Extra caution should be taken if your advisor is compensated with one of the following options:
Salary and bonus:
This compensation package provides an advisor with a base salary and a bonus based on sales to his/her clients. This may incentivize the advisor to push particular services or products.
Commission and fees:
This hybrid type of compensation appears to be a combination of the good and bad. The fee is for a particular service while the commission is for products that an advisor may sell you that may be related to the fee based service. Again the advisor may be pushing only particular services that increase his/her commissions.
Probably the worst scenario for most clients is the commission only advisor because he/she may only provide services or products that yield the highest commissions.
So if you have not paid attention to how your advisor is compensated it may be time to ask some questions.