If you choose to pay for advice, it is critical to understand how advisors are compensated. Many advisers try to eliminate conflicts of interest and act as fiduciaries by putting their client’s needs ahead of their own. According to The Free Dictionary, the word ”fiduciary” is from the Latin word fiducia, meaning "trust," and is a person who has the power and obligation to act for another under circumstances which require total trust, good faith and honesty. The good news is that the industry has been evolving towards a future with continued emphasis on putting the client first. John Bogle, founder of Vanguard once said, ‘The ultimate good is serving the consumer’ and that ‘I would call it being on the right side of history’.
According to The National Association of Personal Financial Advisors (NAPFA), there are three primary advisor compensation models:
Fee-Only Compensation – This model minimizes conflicts of interest.
It is the required form of compensation for members of NAPFA. A Fee-Only financial advisor charges the client directly for his or her advice and/or ongoing management. No other financial reward is provided by any institution—which means that the advisor does not receive commissions on the actions they take on the clients’ behalf. Compensation is based on an hourly rate, a percent of assets managed, a flat fee, or a retainer.
Fee-Based Compensation (fee and commission) – This form is often confused with Fee-Only, but it’s not the same.
Fee-based advisors charge clients a fee for the advice delivered, but they also sometimes receive payments for products they sell or recommend. In some cases, commissions are credited towards the fee, giving the appearance of a lower-priced option, but any outside compensation lessens the advisor’s ability to keep the client’s best interests first and foremost.
Commissions – Stockbrokers were initially needed to gain access to the market to buy and sell securities and charged a fee, called a commission, for each trade. NAPFA has always maintained that an advisor who is compensated through commissions is primarily a salesperson. A client working with a commissioned salesperson must always ask: Is this advice truly in my best interest, or is it the most profitable product for the advisor? Unfortunately, often the answer is the latter. In fact, a commissioned advisor could be putting the best interests of his employer ahead of the best interests of his client.
As you can see, it is essential to understand how your advisor is compensated for the advice you receive and if they face hidden conflicts of interest. Make sure you understand and ask questions of any advisor about how their fees are structured and what services you will receive.