Nothing in life is free, including professional financial advice. As you consider various financial advisors, one of the important questions to ask is “How are you compensated for your services?”
The Cost of Financial Advice
Understanding various compensation models can help you evaluate and compare the costs of working with different financial advisors. That knowledge can also help you be on alert for potential conflict of interests that can sometimes come into play.
While compensation models for financial advisors vary, the following are three of the most common:
- Fee-only – A fee-only financial advisor charges you directly for his or her advice and/or ongoing management. The advisor doesn’t receive commissions on the actions taken on your behalf. Compensation is based on an hourly rate, a percent of assets managed, a flat fee, or a retainer.
- Fee-based – Fee-based advisors charge a fee for their advice, but may also receive payments for products they sell or recommend. In some cases, commissions are credited towards the fee.
- Commission-based – Commission-based advisors don’t charge you for financial advice. Instead, they earn income through salaries, commissions, or retrocessions paid by their employers and/or third parties.
Advisory and Brokerage Relationships
Each compensation model has advantages and disadvantages. Whether you work with an advisor in an “advisory” relationship or “brokerage” relationship can make a difference.
In an advisory relationship, the advisor is registered with the Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. He or she has a fiduciary responsibility to his or her advisory clients. That means the advisor is obligated to act in your best interests and make full and fair disclosure of all material conflicts of interest.
Services are provided for a fee. You’ll receive a Form ADV disclosure brochure that contains important information about your advisor, the advisory services to be provided, the fees for such services, and material conflicts of interest.
In a brokerage relationship, you typically pay a commission on each transaction in your account. The amount of the commission in a brokerage relationship varies depending on the security or investment product. When an advisor makes a recommendation about a security in this relationship, he or she only needs to determine if that recommendation is suitable at the time based on your investment objective, risk tolerance, and other information you provide.
Note: LPL Financial is a registered investment advisor and a broker/dealer, which means that an LPL advisor can offer you both investment advisory and brokerage services. In a brokerage relationship, clients typically pay a commission to LPL on each transaction in the account. Clients don’t pay commissions in an advisory relationship. The amount of the commission in a brokerage relationship varies depending on the security or investment product selected by the client. For more details, read: Working with an LPL Financial Advisor – The Choice Between Advisory Services and Brokerage Services.
What’s Best for You
As you consider various financial advisors, make sure to include the compensation question in your research. Each compensation model has its pros and cons. What’s important is that the advisor you choose to work with employs a compensation model that you understand – and that you feel you’re getting the service and value you need.
If you haven’t compiled a list of prospective financial advisors to consider, use LPL’s Find an Advisor tool to get started.