By Craig Lemoine, Ph.D., CFP®, Director of Consumer Investment Research
Financial advisors provide financial planning or investment guidance to clients. They may meet in person, remotely or provide advice within a larger firm setting. Financial advisors may work for themselves, with small firms or large organizations. They generally provide advice to help their clients pursue their financial goals.
But, not all financial advisors are paid the same way.
How Financial Advisors Get Paid
Financial advisors’ business models usually fall into one of the following five categories. Each business model makes money differently, and in turn pays financial advisors differently:
- Investment advisor representatives of a larger investment advisory firm
- Registered representatives of a broker/dealer firm
- Agents of an insurance company
- Salaried professionals representing a financial service company
- Some combination of the above roles
Let’s break each one of these down and discuss their pay models.
Investment Advisor Representatives
Also known as IARs, these advisors must affiliate with a state or federally regulated investment advisory firm. They charge fees for services, and these fees can take a variety of forms. Most common is charging a percentage of assets managed on behalf of a client. This model is called AUM (assets under management). An AUM fee is charged to a client – for example, 1% annually – by the investment advisory firm. A portion of the fee is then paid to the financial advisor. Fees range based on the level of management, platform, firm and the types of assets held in client accounts.
IARs can also charge different types of fees. They may charge flat consulting or financial planning fees. These fees cover consultative financial advising and are often used when working with businesses. Hourly and monthly subscription fee models are also used by investment advisory representatives. With any of these fee models the consumer pays a direct fee to the underlying investment advisory firm, and a portion of that fee is then paid to the financial advisor. Financial advisors charging fees are required to act as fiduciaries and put their client’s best interest before their own.
Registered Representatives of a Broker/Dealer Firm or Agents of an Insurance Company
Financial advisors who are registered representatives of a broker/dealer or agents of an insurance company are paid differently. They are paid a commission by their underlying broker/dealer or insurance company when a customer purchases a product, such as a mutual fund, annuity or life insurance policy.
The commission is not paid directly by the consumer. Instead, it is built into the price of the product. The amount of the commission varies greatly by type of products – life insurance policies tend to pay higher first-year commission rates than mutual funds. Commissions arrangements also vary within industries, with some companies paying higher or more frequent commissions to agents for the sale of a product than others. In order to recommend a product, financial advisors earning a commission must believe that the product is in their customers’ best interests.
Salaried Financial Advisors
These financial advisors are paid a salary – and often a bonus – by a financial service company. These business models often have central planning or call centers and are becoming more popular when investment frms, insurance companies or robo-advisors offer direct-to-consumer financial planning services.
Salaried jobs generally come with employee benefit arrangements. Financial advisors in internal, leadership or operational roles are often paid salaries, even within broker/dealer or investment advisory companies.
Dual Registered Advisors
Those who are both IARs and registered representatives of a broker-dealer and/or agent of an insurance company are called dual registered advisors. These financial advisors can offer products that pay a commission, provide fee-based services, or a combination of both. Financial advisors who only charge fees might categorize themselves as “fee-only.” Advisors who are dual registered often use the term “fee-based.”
AUM Fee Model vs. Commission Model
The following examples illustrate how two financial advisors are paid from different compensation models.*
Meet Ruben. Ruben (64) is a recent retiree looking for help with his financial and retirement plans. Ruben is wondering when to take his Social Security benefit and has questions surrounding his housing, lifestyle and making gifts to his children. Ruben has $1,000,000 in an IRA (individual retirement account) at his local bank as well as other assets. Ruben is talking to two financial advisors, Ana and Michael, and is curious how both would be paid.
Ana is a financial advisor and investment advisor representative. She charges assets under management (AUM) fees to manage client assets and also charges annual financial planning fees to prepare a comprehensive financial plan.
Ana would charge Ruben a one-time $2,500 financial planning fee to work on his financial plan, and an annual 1% AUM fee on his account. In total, Ruben would pay Ana’s investment advisory firm $12,500 this year ($2,500 flat fee and $10,000 annually to manage his investments). Ana will receive a portion of these fees in accordance with her contract with her investment advisory firm, generally 70–90% of the fees. Ana will get paid between $8,750 and $11,250 to advise Ruben over the next year and manage his retirement assets.
Michael is a financial advisor and a registered representative of a broker/dealer. He does not charge any fees but provides retirement planning advice and works with annuity products. Michael recommends Ruben purchase a variable annuity contract with a $1,000,000 premium. Michael shares the product could grow and later provide Ruben with income.
Michael’s broker/dealer will receive a commission from the annuity company, in this example 6% of the initial purchase, and pay a portion of that to Michael based on his contract with his broker/dealer, generally 60–90% of the commission. Michael will be paid between $36,000 and $54,000 as an agent selling the product to Ruben.
Which Financial Advisor Compensation Model Is Best for You?
As our example illustrates, financial advisor compensation ranges and is tied to the underlying advisor business model. Asking the following questions can help empower you and create a level playing field when evaluating a financial professional:
- How will you be paid?
- Do you charge fees? If so, what type of fees do you charge? What services and time periods do they cover?
- Will you receive a commission if I purchase a financial product? If so, how is the commission calculated and paid?
Financial advisors come from a wide range of backgrounds. Every compensation model has pros and cons. Understanding how your financial advisor is paid can help set the stage for a meaningful and long-term relationship.
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Craig Lemoine is not affiliated or registered with Cetera Advisor Networks LLC. Any information provided by Craig Lemoine is in no way related to Cetera Advisor Networks LLC or its registered representatives.
*These examples are hypothetical only, and do not represent the actual performance of any particular investments. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and when sold or redeemed, you may receive more or less than originally invested.
There is a surrender charge imposed generally during the first 5 to 7 years that you own the contract. Withdrawals prior to age 59 ½ may result in a 10% IRS tax penalty, in addition to any ordinary income tax. The guarantee of the annuity is backed by the financial strength of the underlying insurance company. Investment sub-account values will fluctuate with changes in market conditions.
An investment in a variable annuity involves investment risk, including possible loss of principal. Variable annuities are designed for long-term investing. The contract, when redeemed, may be worth more or less than the total amount invested. Variable annuities are subject to insurance related charges including mortality and expense charges, administrative fees, and the expenses associated with the underlying subaccounts. Investors should consider the investment objectives, risks and charges and expenses of the variable annuity carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained directly from the company or from your financial professional. The prospectus should be read carefully before investing or sending money.