When it comes to working with a financial consultant, there are typically two ways they can be compensated: commission-based or fee-based. Commission-based advisors earn their income by selling financial products, such as insurance or mutual funds, and receive a commission from the vendor. Fee-based advisors, on the other hand, charge a fee for their services, as a flat or hourly fee or based on a percentage of the assets they manage.
Conflicts of Interest May Arise
Because commission-based advisors receive a commission for each sale, their income is tied to the products they sell, which can create a conflict of interest. For example, a commission-based advisor may be incentivized to recommend a certain investment product, even if it's not the best choice for their client, simply because it pays a higher commission.
Fee-based advisors charge fee for their services, often based on a percentage of the assets they manage. This means that their income is not tied to the products they recommend, which can help to eliminate that conflict of interest. But another conflict arises - their income is tied to the amount of your assets they manage. So, is the flat or hourly fee the best approach? Not so fast - now there's an incentive to bill the client for complexity and more hours. The fact of the matter is there's almost always a conflict of interests between a consumer and a service-provider or sales person - regardless of the profession.
Aren't Commission-Based Products More Expensive?
One common misconception is that the expenses of fee-based products are always lower than commission-based products. However, this is not always the case. For example, some fee-based investment accounts charge ongoing management fees that can add up over time. If the advisor provides ongoing advice and active investment management, the client may see great value in that ongoing management fee.
Commission-based products, on the other hand, may have a one-time commission that is built into the cost of the product. While this commission may be higher up front, it can be less expensive over the long run. If the client only desires advice on a single transaction, why would they pay an ongoing fee that ends up being more expensive than a commission? Of course, the cost of a financial product is just one factor to consider when choosing an investment. Other factors, such as the features, risk level, and potential return, are also important to consider.
Why Compensation Differences Are Often Irrelevant
While there are some key differences between commission-based and fee-based compensation for financial advisors, they are often irrelevant when it comes to choosing an advisor. Both commission-based and fee-based advisors can provide valuable services to their clients. For example, a commission-based advisor may have expertise in a certain type of investment product, such as annuities, that a fee-based advisor may not have. Similarly, a fee-based advisor may be able to provide comprehensive planning services, including retirement planning and estate planning, that a commission-based advisor may not offer.
Be weary of advisors that claim one compensation method or the other is what's best for the client. In the end, what matters most is finding an advisor who has the knowledge, experience, and desire to truly help you achieve your financial goals - regardless of how they get paid.