There are a variety of different compensation models that financial advisors can choose from. Which one is right for you? Let’s answer this question by looking at three basic compensation models: fee-only, commission-based, and fee-based. We will also discuss some of the pros and cons of each model.
Before we start
Determining your compensation model is one thing, but defining your business – setting up goals and strategies, and having a financial projection – is what makes and guides a successful financial advisor. By creating a business plan, you define your business path and help you and your stakeholders understand your business model.
Many firms use this model. Under a commission-based model, financial advisors receive rewards, commissions, or incentives for selling a financial and investment product. This product often includes a mutual fund, an insurance product, and an investment account.
A commission-based model can take many forms, but typically it is based on a percentage of the assets under management (AUM) or the sales of ﬁnancial products.
For example, an advisor may receive a commission of 0.25% on the AUM of their clients. This means that if you have $100 million in AUM, you will earn $250,000 in commissions.
This model may seem lucrative, especially if your firm gives additional incentives on certain types of products or amounts of AUM. But, it has some pros and cons that you should know.
Pros of Commission-Based Financial Advisor
- Attractive to Clients: For some commission-based financial advisors, this model presents an opportunity to attract more people to create retirement plans. Why? Because in the client’s point-of-view, the costs would be lower.
- Transparency: This would create a more transparent relationship. An informed investor can see and know exactly how much you are earning from each transaction.
- Great Motivator: On the plus side, commissions can be a great motivator for advisors to grow their business. The more assets they bring in, the more they earn.
Cons of Commission-based advisor
- Churning: To earn more money, a brokerage firm may practice churning, the unethical practice of excessively buying and selling securities in a client’s account. Churning keeps a portfolio constantly in ﬂux, with the primary purpose of lining the advisor’s pockets.
- Possible Conflicts of Interest: Most professional financial advisors are often independent contractors under a financial institution selling financial products. This setup creates an inherent conflict of interest, as the advisor may receive incentives to sell investment products that are not in the best interest of the client. Because you have to obtain some sort of quota or number of sold accounts, your interest in trying to earn more might conflict with the client’s interests.
So, is commission-based compensation right for you? Consider your strengths and weaknesses, as well as your goals and objectives, before making a decision. Ultimately, the decision of whether or not to use commission-based compensation structures for ﬁnancial advisors should be made on a case-by-case basis.
This personal financial advisor charges their clients both a flat fee and commissions on the sale of financial products such as mutual funds and insurance products.
Pros of Fee-Based
- Independence: These advisors are not obligated to sell a financial product or service. This means you can offer unbiased advice that is in the client’s best interests.
- Transparency: these advisors must disclose all fees upfront. This allows your clients to know exactly what they’re paying for and eliminates the potential for hidden commissions.
- Alignment of Interests: Because fee-based advisors are paid based on the advice you give, your interests are aligned with your client’s interests. Your goal is to see clients succeed ﬁnancially so that they’ll continue to use your financial planning services.
- Higher Potential Income: Because fee-based financial planners or advisors typically provide more comprehensive advice, you can charge higher fees. But this could be a disadvantage in some ways.
Cons of Fee-Based
- Less Attractive: Since you can charge higher fees, you might scare new clients. For them, paying higher or additional costs on top of their purchasing costs is less attractive from the client’s point of view.
- Potential conflicts of interest: While fee-based advisors are required to disclose all fees upfront, you may still have some conﬂicts of interest.
Fee-only Financial Advisors
As the name implies, fee-only financial advisors charge their clients a flat fee for their services. This fee can be charged hourly, annually, or as a percentage of assets managed. Referral fees are prohibited.
Pros of Fee-Only Advisor
- Aligned Interests: The main advantage of this model is that it aligns the interests of the advisor and the client. Since the advisor is not being paid commissions on the sale of financial products, you can provide unbiased advice that is in the best interest of the client.
- Fiduciary Responsibility: Fee-only advisors have a responsibility to follow the fiduciary standard in providing advisory services. This means that you are legally required to act in their best interest and put their needs ahead of your own.
- Limited Conflict of Interests: Because of the fiduciary duty, you will have limited conflict of interests.
Cons of Fee-only Financial Advisor
- Expensive for Clients: The downside of this model is that it can be more expensive for the client, as they are paying a flat fee for the services rendered by the advisor.
Comparison Table: Different Compensation Models
|Advisor as Title||Yes||Yes||Yes|
|Fiduciary Duty||Not required||Optional||Required|
|Eligibility for National Association of Personal Financial Advisors (NAPFA)||Not eligible||Not eligible||Eligible|
|Basic Ways of Compensation||Commissions paid by financial firm||Commission by company;Fixed Annual Fees Paid by Client||Clients Pay Fixed Annual Fee|
Tips for Choosing the Best Compensation Model
As a ﬁnancial advisor, one of the most important decisions you will make is choosing the right compensation model. The compensation method you choose will determine how you are paid, and ultimately, how successful you are as an advisor. Here are some tips that include some questions for you to answer and help you choose:
Objectives and Skills
Review your goals and objectives. What are you trying to achieve as an advisor? Are you looking to retire early? Or are you more interested in building a long-term, sustainable business? With your goals clearly defined, you know which one of the compensation models will lead you to achieve these at the fastest possible time.
Assess your skills and experience. What kind of advisor are you? Are you more of a salesperson or a strategist?
Personality and Credentials
Consider your personality. What kind of person are you? Are you more risk-averse or risk-taking?
Reflect on your lifestyle. How do you want to live your life? Do you want to work hard now so that you can enjoy a more relaxed lifestyle later? Or do you want to work hard now and enjoy the fruits of your labor now?
Evaluate your credentials. Do you have a CFP® designation? Or are you working towards one? Your credentials will help you get more clients. They signify to others that you’re serious about helping others achieve their financial goals in life.
Consider your work experience. Are you a new ﬁnancial advisor or have you been in the business for years?
Analyze your clientele or target market. Who are your ideal clients? What do they value most in an advisor? If you’re targeting high-net-worth individuals, for example, you’ll likely want a compensation model that allows you to charge higher fees.
Assess your local market. What is the standard rate for ﬁnancial advisors in your area? If you’re in a high-cost area, you’ll likely need to charge higher fees to be competitive.
Look at your ﬁrm’s culture. What is the culture of your ﬁrm like? Are they more traditional or are they open to new ideas? Your ﬁrm’s culture will guide you in choosing the right model.
Other Questions People Ask
What is the difference between a registered investment advisor and a certified financial planner?
There are a few key differences between registered investment advisors (RIAs) and certified financial planners (CFPs). For one, RIAs are regulated by the Securities and Exchange Commission (SEC), while CFPs are certified by the Certified Financial Planner Board of Standards. This means that RIAs must adhere to a higher standard of fiduciary duty, meaning they must always put their clients’ best interests first. Additionally, RIAs are typically fee-based, while CFPs may be either fee-based or commission-based. Finally, RIAs typically have more experience and education than CFPs.
What are the services of personal financial advisors?
A financial advisor helps individuals and businesses manage their finances. This can include budgeting, tax planning, investment planning, retirement planning and preparation, and estate planning. Financial advisors can guide clients on debt, risk, and wealth management.
What is fiduciary duty?
First, let’s define the fiduciary. Fiduciary refers to a person or a company who manages someone else’s property or assets. The most common fiduciaries are financial advisors. The obligation that arises from this fiduciary-beneficiary relationship is what you refer to as fiduciary duty. It has 3 types: Duty of Care, Duty of Loyalty, and Duty to Act Lawfully.
What is the best compensation structure for fiduciaries in the financial industry?
The most common fiduciaries in this industry are investment advisors, financial planners, broker-dealers, and insurance agents. These professionals use different compensation models. Broker-dealers and insurance agents often receive compensation using commission-based methods. On the other hand, investment advisors and financial planners either use fee-based or fee-only methods.
How much money can a financial advisor make?
With experience and success, a financial advisor can make a very good living. However, salaries can vary widely depending on factors such as location, education, and the type of firm where an advisor works. For example, financial advisors working for large firms may earn more than those who work for smaller ones. So, while it’s possible to make a lot of money as a financial advisor, there’s no guarantee that you’ll become a millionaire. But if you’re smart and hardworking, you just might.
Which model is best for you?
So, which compensation model is right for you? That depends on your individual circumstances and the type of services that you offer. If you are just starting as a financial advisor, you may want to consider the fee-only model. If you are planning to change your current payment structure, you should weigh the pros and cons of each model before making a decision.