As I discussed in part one of this two-part series, people often turn to financial advisers when they dont have the time, energy or talent to manage a complex financial life.
If you think the services of a professional sound like something you could use, the next question becomes which type of adviser do you pick.
Generally, who can classify financial advisers two ways:
- How they are compensated
- Professional designations
How they are CompensatedThere are three basic ways you compensate financial advisers for their work. Each of the three methods has some good points and some weaknesses. In the end, you should choose the adviser you feel will do the best job for you and worry less about the method of compensation. The compensation methods are:
Fee OnlyThe fee-only adviser develops a comprehensive plan that lays out how you can reach your financial goals. However, it leaves the actual execution of the plan to you. The adviser doesnt sell any products or services other than the plan itself.
The strong points of fee-only financial advisers are:
- Comprehensive plan Fee-only advisers usually produce the most comprehensive plan since this is their sole product.
- Objective recommendations Since the fee-only advisers make no money off sales of any products, their recommendations are not driven by potential commissions.
- Customer interaction Fee-only advisers are more likely to spend time educating customers on various aspects of the plan since it will be up to the customer to execute the plan.
- Cost Fee-only advisers charge more than other types of advisers since they do not take any other form of compensation.
- Execution Some customers find they are not much better off with a plan in their hand if they have to perform the execution also.
- Updating As things change, the plan needs updating, which may involve additional costs.
Fee and Commission or Percentage of AssetsThe second method of compensation of financial advisers includes a fee and commissions. The fee, which is usually substantially less than what a fee-only adviser would charge covers the cost of building the plan and commissions cover the cost of execution.
A variation on this compensation plan involves an annual fee based on a percentage of assets in your accounts. The fee compensates the adviser for monitoring your investments and making recommendations.
The strong points of fee plus commission advisers are:
- Plan development The fee plus adviser develops a plan for the customer that lays out suggested strategies for reaching the customers goals.
- Execution Because the fee plus adviser receives compensation from executing the plan, the adviser is there to execute the plan.
- Multiple products The fee plus adviser often sells or has access to multiple products such as insurance in addition to investments, so much of they can do much of execution.
- Objectivity There is always the question of how objective the advice will be when it results in a commission for the financial adviser.
- House products Fee plus advisers may push house products (certain mutual funds or life insurance products, for example), which may not be the best choice for your particular situation.
- High-price products There is a danger the fee-plus adviser will pick products for your plan that pay higher commissions over other equally good, but lower commissioned products.
Commission OnlyThe third method of compensation is commission only. The financial adviser receives their only compensation from products they sell you.
I think you can see the inherent problem with this arrangement it is in the adviser best interest to sell you something. A person who works on a commission only basis is a salesperson.
However, this is not to say that you cant work with someone on this basis. It will depend on the individual and your relationship.