How and Approximately How Much are Advisors Paid?
There are 6 ways your money guy can be paid
Here's a quick little chart I made for your reference. I'll explain more below.
In the end, almost every form of compensation works out to about even, with the exception of a bank advisor, but usually bank advisors, who are high-performers, will move their way up to a higher position. Most likely at the bank's brokerage house.
I would suggest that at the end of the day, your advisor is probably going to make about 0.60% - 0.80% off of your money. It's hard to know with 100% certainty, because this information isn't exactly shared very freely.
My problem with some of these forms of payment aren't that the advisor is getting paid, but that in some cases there are minor and major opportunities for clients to be sold products that aren't in their best interest, just because it will generate more income for the advisor.
The Best Way to Avoid That - Fee for Service Planners
Obviously there shouldn't be any conflicts of interest when you're paying for a financial plan, but the problem with that model is that not everyone can afford to pay for an advisor. In a lot of cases, people don't want to do that either.
There is also some value that comes with an advisor that is compensated because you have more money saved. I know that sounds bad, but in most cases it's true.
Bank advisors should be perfect as they are salaried employees who don't have a sales agenda, right???
Not exactly, because banks love to make money any way they can, so they pay the advisors a small salary and incentivize them with bonuses if they hit quotas. I hate when financial companies place quotas, because it means that their employees or advisors are being encouraged to sell things even if it's not in the best interest of the client.
Ideally, if I decide to grow K4 Financial, I will pay Certified Financial Planners a good salary to provide clients with written financial plans and ongoing advice that they feel is in the best interest of the client. No incentive will be given to those who excel in sales.
The common misconception that consumers often have is that the best advisor is the most successful one, but in my experience, that is far from the case. The most successful advisor is always the best salesman in the group, but that rarely makes that person actually good at financial planning.
Low or No-Load Mutual Funds
This is a stupid and misleading name, because there is nothing low or no about how much money you're being charged when you buy one of these funds. As I have said before, every mutual fund has an MER (Management Expense Ratio). This is the fee that is charged off of your returns every year. It's a fee that you never see, but it's always there and it's probably really high.
Advisors are paid a portion of this fee, in what is called a Trailer Fee. This is usually somewhere in the ballpark of 0.60% - 1.0%. I'm ok with that number if you're getting good advice, but am more concerned with the extra 1.20% - 2.40% that's going to support the giant corporation the advisor works for.
There is one major conflict of interest that can arise from this method. Some funds, especially ones that are on the more aggressive side, can and will pay a higher trailer fee, which means that Conservative investors may be "guided" towards purchasing funds that are riskier than they are comfortable with. As I suggested last week, I think that clients should try and increase their risk tolerance to try and improve returns, but that shouldn't be up to my discretion and especially not if I'm only saying it to make more money. There are also fund companies who may provide further incentive to reps who sell their fund over another, which may result in poorly diversified portfolios.
DSC Mutual Funds
I always hated DSC, but in this world, it was a necessary evil, because new advisors would never be able to survive without DSC and small clients would never get any advice without DSC.
There is a hybrid model I've heard about which I can agree with, but for now I will just talk about DSC. When a client buys a DSC mutual fund and locks that in for 7-years, this gives the corporation the security to know it can pay the advisor an upfront commission. This commission is usually around 3.50% to 4.0%. Then the advisor will be paid a smaller trailer-fee for the remainder of the DSC schedule. It generally evens out so that a no-load fund will pay a bit more by the time the DSC schedule is up, but who doesn't want money now?
You can only imagine the conflict of interest and issues that arose from DSC funds. This is the reason why they are soon going to be a thing of the past. This will be a bad thing for new investors who are just starting out, but I'll get into detail on that part next week. I will also talk about some of the ways that this method of generating commission was used to make a lot of advisors very rich at the cost of their clients. If you feel like you were misled in one of the ways I am going to suggest, you should fire your advisor and report the activity.
Fee per Trade
I have no idea how much brokers charge to do this, because I have never looked into it and I would never consider it to be an option. Personally, I believe that these are the types of accounts you hear about where clients lose an absolute boat-load of money at the discretion of their advisor.
If you have an advisor who is paid to just buy and sell your stocks and bonds and can do that at their own discretion, why wouldn't they just sit there and make trades all day, whether they're necessary or not? I would personally avoid this, but that's just me.
Percentage of Assets Under Management
I like this model as it seems quite upfront and fair as long as it's fully disclosed. This way there shouldn't be any conflicts of interest with regard to how the money is invested, as long as the client and the advisor have discussed and decided on a specific investment strategy. After wealth managers pay their firm, I believe they usually charge about 0.50% - 1.0% on their clients assets. They usually reduce their fee when clients reach specific portfolio values, which also makes sense.
I only ever have 2 issues with this model. First, it isn't available to everybody, which is too bad, because I like it, but it makes sense. If you're only going to make $60/year off of a client who has $10,000, I understand why most brokers won't give them the time of day.
I'm a bit of an idiot, so I charge every client exactly that amount and will deal with anyone that wants to be a little proactive. I have streamlined a few of the steps too, so it works out ok for me, but it was a risky move.
My next problem is that it's usually only focused on investments and nothing else. Financial planning is so much more and as I have said before, you now might just be paying some guy a bunch of money because he's telling you he knows how to beat the market, but chances are quite high that he doesn't have a clue how to do that and probably never does.
At the end of the day, just ask how much money they're making and how much other money is being charged and where that money is going. It's your money and you should know what the hell is going on with it
If it's more than you think they should earn, because you're not getting service and advice, then take your business elsewhere. I can assure you that there are plenty of advisors who would be more than happy to help you out.
Please share and if you want to receive a crazy-sweet newsletter once I figure out how to make a crazy-sweet newsletter, then sign up for that below as well.
Happy, almost Canada Day!!