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Does your advisor make more off your
account than you do? We’ve been discussing how to protect
yourself when choosing a financial advisor. One of the
secrets to choosing an advisor that’s right for you is to
understand how they are compensated.
Financial advisors are generally compensated in two ways:
commission or fee-based. Commission-based advisors are
essentially ‘prepaid’ because you’re paying for service and
advice several years up front. The main disadvantage with a
commission-based advisor is that they have little incentive
to actively watch over your money.
Back in 1988 when I was a typical broker, I quickly learned
that I had to spend most of my time selling, not servicing
my existing clients. I was trained by the main office to
spend 90% of my time prospecting new clients. That doesn’t
leave much time for the current clients, does it?
This is why these brokers hold so dearly to the buy-and-hold
strategy. In a bull market environment that isn’t so bad.
But when the markets take a turn for the worse, this
strategy can leave you holding the bag. If they’re only
looking at your portfolio once or twice a year, then what
are you paying them for in the first place?
The commission system opens the door to a host of conflicts
of interest. Many firms operate on a grid, which means the
more commissions the broker generates for the firm, the
bigger the percentage they earn for themselves. Luxurious
trips are used as additional incentives. Your advisor might
be calling to recommend a certain product simply because
it’s the end of the month and they need to sell another
$100,000 in mutual funds to qualify for that trip to Hawaii.
The point is that with a commission-based advisor you can
never totally trust the reasons behind their
recommendations.
If commission-based advisors can be referred to as pre-paid,
then fee-based can be referred to as pay-as-you-go. Most
fee-based advisors have access to the entire array of
investment choices, not just those that pay a commission or
load. For instance, some of the best performing mutual funds
are no load funds and aren’t even offered by
commission-based advisors.
Because these advisors are paid a small ongoing percentage
based on the assets they manage for you, their motivation is
to service your account, not to sell you something. In fact,
they aren’t paid any more to put you in one product over
another. They get paid the same no matter what you’re
invested in or how long you’re in it. They know if you
aren’t happy with their performance, you can easily fire
them and take your account elsewhere.
Conflicts of interest are a lot less likely with a fee-based
advisor. They aren’t under the gun to bring in tons of new
money each month. They don’t have to switch existing clients
into new investments to generate additional commissions. For
independent advisors like myself, there are no big trips to
win, no pressure from the main office to use one investment
over another. The only pressure I face is the one to do the
best job I can for my clients.
Not all fee-based advisors are the same. Many traditional
advisors are making the switch to fee-based, mainly to
escape the constant pressure of bringing in new money each
month. However, they’re still managing money the way they
always have. They still set-it-and-forget-it and offer
little protection in a declining market.
An important thing to consider is that you won’t know if any
advisor is right for you until after the sale. If you choose
a commission-based advisor, it will be very costly to change
your mind should you be disappointed in their performance.
At least with a fee-based advisor, you can easily choose
someone else should you desire to do so.
So buyer beware. Remember that the recommendations of
commission-based advisors will always be colored by their
need to generate commissions. They won’t have much time to
service your account or carefully watch over your portfolio.
On the other hand, fee-based advisors have fewer conflicts
of interest and are motivated to maximize your return and
keep you satisfied.
If you’d like more information you can call me toll-free at
1-877-827-1463. I will be happy to help you in any way I
can.
Mr. Voudrie is a Certified Financial Planner and the
President of Legacy Planning Group, Inc., a private wealth
management firm in Johnson City, TN. For more information
call 1-877-827-1463 or email jeff@guardingyourwealth.com.
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