Decoding Financial Advisor Compensation Models
Many people ask us the difference between fee-only and fee-based compensation models for financial advisors. They also want to know how project fees, asset-based fees, and hourly fees work. For the average investor, the compensation models of financial advisors can feel downright confusing.
Few other industries have so much variation when it comes to paying a professional. When you hire an auto mechanic, you pay for parts and hours of labor. When you hire a piano teacher, you pay per lesson or for a set amount of time. All these methods are straightforward and easy to understand.
Unfortunately, the financial advisory world is a different ballgame. Payment models vary from firm to firm and, sometimes, from client to client (depending on client needs, services rendered, net worth, etc.).
Since payment models for financial advisors are sometimes complicated, misinformation abounds. Consumers might fall for “special offers” or “guaranteed returns.” Or they might believe they are entitled to free financial planning because large brokerage terms do this for “free.” However, there’s no such thing as a free lunch—those big firms are making their dollars somehow. Many of these large brokerage firms use 10-20 questions to be analyzed by a robo-advisor, which is NOT financial planning. Genuine financial planning is comprehensive, multi-layered, and involved. For most people, quality financial planning is worth the price tag.
But how can clients determine if a pricing model is fair? And how will they know if a particular pricing model is right for them? To clarify the confusion, let’s talk about different ways a financial advisor could be compensated AND which methods make sense for certain types of investors.
Two Compensation Models to Avoid
There are several legitimate, ethical compensation models for financial advisors. However, before discussing those, I want to touch briefly upon two models to avoid: commission-based and fee-based.