While many financial service professionals refer to themselves as “financial advisors”, the financial advisor designation is actually a very broad category. Within the field of personal financial advising there are three main subsects, each with their own method of compensation and, subsequently, their own planning methods.
1. Registered Investment Advisors: The first category of financial advisors, RIAs, manage a client’s portfolio in order to optimize returns and profits. They are also, notably, the only type of financial advisor with a fiduciary responsibility to their clients. This means that they are the only type of advisor that has to put the client’s financial needs before their own. If they are Fee-Only advisors it is a constant, legal obligation.
2. Stock Brokers: Stock brokers, sometimes called “broker dealers”, are similar to RIAs but have no fiduciary responsibility. This means that, when choosing between two products for their client, they may choose the product that gives them a higher commission rather than the one that is better for their client.
3. Insurance Agents: The third type of financial advisor, insurance agents, take a much less holistic approach to financial planning. They focus on the insurance aspect of personal finances, and are very commission-driven. While this does not necessarily mean that they will sell a client suboptimal products, their decisions may be influenced by what offers them a higher commission.
Method of planner compensation should be a major factor in determining which type of financial advisor is best for you. While no method of compensation is inherently better or worse for the client, certain types of compensation may encourage advisors to make decisions for personal gain, rather than the sake of the client’s best interests.
Fee-Only: A Fee-Only compensation plan works exactly as it sounds. The advisor is compensated with an initial or periodic fees, and receives no other forms of fees or commissions. This fee is usually paid prior to services rendered, to ensure truly impartial advice is given.
Fee-Based: While they may sound similar, and both receive initial fees from the client, Fee-Only and Fee-Based compensation schedules have one stark difference. While Fee-Only advisors maintain their status as a fiduciary at all times, Fee-Based advisors can “pick and choose” when they must put the client’s interests ahead of their own. This means that a Fee-Based advisor can collect their fee from a client, and later make a decision based on what allows them to collect a higher commission.
Commission: A commission plan, where an advisor receives payments from companies and organizations for selling their products to clients, is the form of compensation most often used by Stock Brokers and Insurance Agents. If you have ever gotten the feeling that a financial representative was trying to sell you something, it is likely that they are paid on commission. While this doesn’t necessarily mean that the product is low quality, it does encourage these advisors to sell clients the product which offers them the higher commission, rather than the best product for the client’s unique situation.