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July 6, 2020
Each payment method has advantages and disadvantages based on what services you require from a financial planner. What is important is that you clearly understand your financial planner’s compensation structure and the pros and cons of their method.
Commission-based advisors earn their money by selling stocks, bonds, mutual funds, life insurance, annuities, and other investments. Most retirement financial planners working under this model act in an ethical manner and will try to keep your best interests in mind. However, they may be influenced by the rate of commissions that they’ll earn by selling you one product versus another. It’s possible they may lean toward selling you products that may not be in your best interest simply because they will result in them earning more money.
In a commissionoonly setting, you risk that the advisor is selling you something that is good for them (based on how much money they’ll earn) and is not exactly the best for you. However, the advantage of using a commission-based advisor is that the advice itself is free. And the majority of the time, you can assume the advice will be in your best interest.
Always ask your financial advisor if they are being compensated with commissions and how they justify one financial product over another.
A fee-only financial planner is compensated entirely by fees.
The fees might come in the form of flat fees or an hourly rate.
If the advisor is compensated with a flat fee, then you pay a predetermined amount for a specific deliverable. Rates vary tremendously. A basic overall retirement plan might cost anywhere from $1000 to $2500. Advice on how to allocate your 401(k) retirement account might range from $500 to $2,500.
If the advisor is charging an hourly rate, then you are paying for the exact amount of time they spend helping you. A Certified Financial Planner (CFP) may charge a median fee of about $100 to $250 per hour.
Many people prefer a fee-based financial advisor because this fee structure reduces the likeliness of conflicts of interest arising. The advisor is not earning a commission from the products they sell you. As a result, you can be sure that they are recommending the products and services that best meet your goals and risk tolerance.
Another advantage of using a fee-only planner is that you are usually paying for a clear set of well-defined deliverables.
Assets under management (AUM) is also sometimes referred to as Funds Under Management (FUM). These financial advising fees are based on a percentage of the value of the client’s assets that a financial institution is managing.
This fee structure is typically used when you are hiring a financial advisor to actively manage your money on an ongoing basis. (Sometimes the advisor will also provide some general financial planning guidance. Clarify with the advisor whether or not they will do this for you.)
The advantage of paying your advisor a fee based on the amount of money they are managing for you is that they have the proper incentives to grow your wealth. Afterall, the more the financial advisor grows your assets, the more they are paid. They also would not want you to lose any money.
Depending on the amount of money you have, advisors typically will charge you a fee representing 1% to 2% of your assets each year.
It’s important to keep in mind that there is a significant distinction between a fee-based financial planner and a fee-only financial planner.
A fee-based financial planner charges flat or hourly fees or a fee based on AUM, plus they also earn a commission for the financial products you buy.
Some financial advisor fees are charged in the form of a retainer. A retainer fee is an upfront cost for a service. This is considered an alternative to a fee structure based on AUM.
The advantage is that you know how much you will be paying for a specific service.
Each type of financial advisor fee has specific advantages and disadvantages.
Whichever type of fee structure your financial advisor uses, you should be sure to understand all of their incentives. It is important to ask your financial advisor if they might have any conflicts of interest. It is also in your best interest to ask if they earn bonuses or other awards in return for their recommendations.
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