How Are Advisors Compensated?

How are advisors compensated?

Ah, very good question! Let’s talk about the ways an investment advisor or financial planner can be compensated.

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Hourly Fee.

This is the easiest to understand. You get together and pay the advisor for their time. I guess the advantage of this is you control the cost. You know exactly what you are paying. The disadvantage is that even though you may need help, you may be reluctant to pick up the phone or ask for help, knowing that the clock is ticking. Also, what you think may only take an hour could easily swell into two, three, or more hours.

Flat Dollar Fee.

Instead of charging by the hour, some advisors will charge a flat project fee – for example, if they are going to create a financial plan for you – or a flat monthly or quarterly fee. Flat fees can be good because you know what you’re on the hook for going in, and you don’t have to worry about tracking the minutes.

Commissions.

What are commissions? It’s basically a fee someone gets for buying or selling something for you, like if you need life insurance. An advisor can help you get a policy. For his efforts, he may get a commission, or a fee, when you buy it. Or maybe you want to sell 100 shares of McDonald’s stock. Your advisor will sell these for you but may get a commission, or again, a fee, for doing so. When you think of a commission, think in terms of a transaction. Something happened. Something was bought or sold. Commissions can be a flat amount, or often, they are a percentage of whatever it is you are buying or selling. For example, if you sell your house, you may pay your real estate agent a commission. This could be 5% of the value of your house if they sell it for you. So if your house is sold for $100,000, then the real estate agent’s commission would be $5,000. If your house was sold for $200,000, then 5% of this would be a commission or fee of $10,000.

Assets Under Management Fee.

This is a common way advisors are compensated. If you really want to sound cool, you can say “AUM.” This fee is not based on hours or transactions, but instead, it is a flat percentage of the assets your advisor is managing for you. Huh? Okay, let’s break it down because it’s actually much easier to understand than you think. Let’s say you work with an investment advisor, and that advisor says she is going to charge you 1% AUM. What does that mean? It means that whatever assets she is managing for you, she gets a 1% per year fee. If you have an investment account with $100,000 in it, she would get a fee of $1,000 per year. Because an assets under management fee is so common, let’s dig a bit deeper so you really understand it.

The first question you might have is, “What do you mean by ‘assets under management’?”

Does that include your house? Your Ford Fiesta? Your baseball card collection? The answer would be no. The assets we’re talking about with this fee are investment assets. Not your house, personal items, or even your bank accounts. We’re just talking about investments.

Okay, but what does it mean “under management”? Does your advisor supervise, have control over, or provide advice on the assets? For example, maybe you have two investment accounts, but your advisor only buys and sells investments in one of them. Well, that one would be the one “under management,” meaning it is under her watchful eye and she is managing, or buying and selling, for you. The other investment account would not be under management and her fee would not apply to that account.

Those are the most common types of fee arrangements you will see.

Keep in mind, though, that sometimes you get what you pay for and sometimes you don’t. Meaning, just because you are paying high fees doesn’t mean you are getting any better service or advice. In fact, if the fees you are paying are too high, it can make it difficult to make money as an investor.

Assume you will pay some fees. Find an advisor and a fee arrangement that you understand and that you are most comfortable with.

The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.