Some Wanderings Through The Land Of Advisor Compensation
I joined the financial services industry in the spring of 2016 feeling excited about my upcoming career as a financial advisor. Like many youngsters, I joined a large insurance company. I had interviewed with a few and felt best with the one I chose. I didn’t know much about the industry. I didn’t actually know much about financial planning. But the company was willing to take me, so I jumped on board.
I was informed that I needed to gather 200 names of people that I knew and that I was close to. After some preliminary training we hit the phones and attempted to schedule meetings with these individuals. We had scripted and specific language that we were told to use in order to get people to say “yes” to a meeting, and how to “overcome their objections” if at first they didn’t say yes.
In time I realized that my lack of technical training wasn’t going to be good long term, and the conflicted nature of our compensation model wasn’t good for clients. I later left to a fee only financial planning firm, and eventually left that company to start my own firm based on a flat fee only pricing structure.
I’ve given a lot of thought to advisor compensation. I hope you find my wanderings valuable as you consider how you are currently paying your advisor, or how you might do so in the future.
Traditional Advisor Compensation: Assets Under Management
There are two traditional methods in advisor compensation: fees and commissions.
When your advisor is paid based on a percentage of assets under management, they are generally extracting a fee based on the investment assets that you choose to let them hold. For example, if you have a $100,000 account and the financial advisor charges 1.5%, you’re going to pay $1,500 per year for service. As your account grows, so do the fees.
In practice, it’s generally accepted that traditional asset under management, or “AUM” fees, are going to be somewhere around 1% on your first $1,000,000. Paying $10,000 per year is notably different than $1,500, but because these fees come directly from client investment accounts (and not from clients’ bank accounts) clients generally seem to be okay with this. Or at least they don’t make as much of a fuss as they might were they to write a $2,500 check every quarter to their financial advisor.
Because of technology and evolving viewpoints regarding investment strategies, financial advisors have had to rebrand themselves from strictly asset managers to also become financial planners. However, the AUM model of compensation from investments has persisted. Financial advisors under this model will tell you that they provide holistic financial planning, but that their compensation is derived from your investments that you hold with them.
A sad consequence of this model is that even if you’re willing to pay for the financial planning advice, if you don’t have the assets to manage, you might be politely shown the door and told to come back when you have money to invest.
New age style fees on a percentage basis include basing financial planning and investment advice on a percentage of your income or even based off of a percentage of your net worth. It remains to be seen if these compensation arrangements will last. More interesting, in my opinion is the movement of many advisors to break out their financial planning and asset management fees into two. In other words, advisors are recognizing that their value proposition is the financial planning component rather than investment management. So they charge a smaller AUM fee and separate (often flat) financial planning fees as a monthly subscription fee, quarterly fee, etc. It’s not the compensation model that I’ve adopted, but still an intriguing one, and one that I feel has merit.
One of the positive aspects of the AUM (or similar) models is that financial advisors are generally more and better trained than their financial salesmen counterparts--more on that later. They often hold industry credentials, including the CFP® or ChFC®, or are working towards one or both of those.
If you’re asking me (which you are if you keep reading), financial advisors are often paid too much or too little under the AUM model. For example, if your investment assets are smaller, you might be paying just $750 ($50,000 at 1.5%) per year for financial planning advice. That’s a steal of a deal. Alternatively, if you have a $2,000,000 portfolio being charged 1%, well...you do the math.
Traditional Advisor Compensation: Commissions From Product Sales
The client-advisor dynamic changes in some dramatic ways when your advisor is compensated based on commissions from the sale of an insurance or investment product.
When advisors are paid on commission the advice they give must ultimately lead to the sale of a product. Why? Because if it doesn’t, the advisor won’t have income to take care of themselves and their family. This method of advisor compensation has gotten a lot of bad press over the years because so many people have been sold products that turned out to be something other than what they expected.
Remember, if a financial advisor is paid on commission, it’s likely that they have sales quotas that they need to hit. If they don’t hit these quotas, they can be fined by their company, or even lose their contract as an agent with the company. These incentives make it difficult for commission compensated financial advisors to take an objective look at a client’s overall financial situation.
How Should Financial Advisors Get Paid?
The industry continues to evolve. I believe that the financial advisory profession can be a noble one. At its best, we help people deal with their humanity. Money is hard to manage. There are countless great financial advisors out there who are helping people create more meaning in their lives, protect and care for their loved ones, and use their money in ways that help them and their families achieve a greater degree of peace and satisfaction.
I believe that financial advisors should be paid what they’re worth. I don’t believe that their compensation should be based off of commissions from the sale of a product, nor do I believe that it should be based on how wealthy you are or how much you choose to invest with them. Similar to respected professionals in tax and law fields, financial advisors should be paid based on their time, professional ability, and service. That certainly leaves a wide range of pricing models, and that’s okay. The advisor who charges transparent and flat fees while working with young families won’t be able to charge the same amount as the advisor who specializes with corporate executives.
I believe that flat, transparent fees are the compensation model of the future for financial advisors. As with other movements, I believe this one will come once the public demands it. So long as companies can charge high commissions and advisory fees without protest, not much will change.
These are my opinions, unless I’ve specifically cited other material. The information and ideas I’ve presented should be referred to for information purposes only. Before you implement anything, make sure you have a thorough discussion with a qualified professional who understands your situation.