How Financial Advisors Make Money

Understanding the different ways financial advisors get paid and the circumstances that fit best for each fee structure.

A recent article in the AARP magazine sparked this discussion, and I’ll include a link to that in the show notes. The article delves into the different types of financial advisors and the various fee models they use. It’s essential to understand that not all advisors get paid the same way, and knowing these differences can help you make better decisions about your financial future.

Three Main Ways Financial Advisors Get Paid

Let’s explore the three primary ways clients typically pay their financial advisors:

  1. Commissions
    • When an advisor sells you a product, they receive a commission from the company offering that product. Common examples include mutual funds, life insurance policies, and variable annuities. When you purchase these products, the advisor gets a commission, which is a one-time payment.
  2. Assets Under Management (AUM) Fees
    • This is an ongoing fee based on a percentage of the assets the advisor manages for you. If an advisor is providing you with continuous investment advice, you will likely pay a quarterly fee for this service. This fee model aligns the advisor’s interests with yours because their compensation increases as your investments grow.
  3. Financial Planning Fees
    • These fees can be charged hourly, as a flat fee per project, or as a subscription model. For instance, you might pay $4,000 for a comprehensive retirement plan or $300 per hour for advice. Some advisors offer ongoing financial planning services for a monthly fee, similar to a subscription. This model is more like consulting, where the advisor helps you plan but does not manage your investments directly.

Choosing the Right Fee Model

There’s no one-size-fits-all approach to paying for financial advice. The right model for you depends on your needs and preferences. If you need to purchase specific products like term insurance or mutual funds, paying a commission might be appropriate. If you want ongoing investment management, an AUM fee could be the best choice. And if you seek guidance without needing investment management, a financial planning fee model might suit you best.

The Importance of Transparency

When choosing a financial advisor, it’s crucial to understand how they get paid. Many people come into our office asking if we are fiduciaries, which is important, but they often forget to ask the critical question: “How do you get paid?” An advisor can be a fiduciary and still earn commissions, charge AUM fees, or collect financial planning fees.

Being transparent about fees helps build trust. If an advisor says, “You don’t pay me; the financial company pays me,” or if they fumble with their explanation, consider that a red flag. You should clearly understand how your advisor is compensated to avoid potential conflicts of interest.

Fee-Only vs. Fee-Based Advisors

There’s a common misconception about fee-only financial advisors. Many people believe fee-only means the advisor charges an hourly fee. However, fee-only can also mean charging a flat fee or an ongoing financial planning fee. If you specifically want an hourly advisor, consider the Garrett Planning Network, which specializes in hourly financial planning.

Most advisors are fee-based, meaning they can charge commissions, AUM fees, and financial planning fees. This hybrid model isn’t inherently bad, but it’s essential to know exactly how your advisor is compensated.

When interviewing potential advisors, be clear about your needs, ask how they get paid, and listen carefully to their explanations. Understanding these details can make a significant difference in your financial planning and retirement success.

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