June 2021: How do Financial Advisors make money?
If you are considering investing money with a Financial Advisor (advisor) or analyzing your current investment account(s) with an advisor, it is important to understand the fees involved with your investment and the service the advisor is really providing. In our newsletter this month, we will review the fee structure for the most popular products and services advisors provide their clients.
How do Financial Advisors make money? Typically, an advisor has three ways of billing for their services: transactional, fee-based, and fee-only. How an advisor bills for their services, is typically related to the types of products or services they offer and provide their clients.
1. Transactional: Advisors that are transaction orientated will primarily broker and sell products to clients. They will typically focus on products that have a commission at the time of the transaction. Each of the products they sell will have its own commission payment and structure. Transactional advisors primarily focus on advising clients on a particular transaction, rather than provide continued advice like financial planning.
2. Fee-Only: Fee-only advisors are advisors that only charge a fee. Their fee will be administered via one of the following ways: a percentage of the assets under management, an hourly rate, flat fee, or a combination of these fees. The specific fee structure will vary by the advisor and the type of service(s) they provide to a particular client. Depending on the fee structure a client is being charged, the advice can vary from continued financial advice and planning, to a one-time consultation.
3. Fee-Based: An advisor that is fee-based is similar to a fee-only advisor in that they predominantly bill via some sort of fee schedule. They are also licensed to sell commission products and may also charge a commission in some cases. The advice you receive will vary based upon the product or service you are using or being offered.
Depending on the products or services offered, a Financial Advisor may have some control over the fees that a client ultimately pays). Below are the most common fees that a client may encounter:
1. Trading Commissions: The fee paid to a brokerage firm to execute a trade. In the past, this fee was a more significant factor. However, in recent years this fee has been drastically reduced, sometimes to zero.
2. Management Fee: A management fee is an on-going fee that is charged by an investment manager for managing the assets in an investor’s individual portfolio. This fee is usually a percentage of the assets being managed for the client. An advisor may have a range of fees they can apply to an account, so in some aspects the advisor may have discretion over the management fee they charge.
3. Front-End/Back-End Loads: The word “Load” is another word for sales commission typically used with mutual funds. In order to compensate the advisor for selling shares of their fund, Mutual Fund companies will compensate an advisor via the load. Mutual Fund companies will typically offer multiple types of share classes that an advisor may select to offer their clients. At the advisor’s discretion, depending upon the share class they sell to their client, the (Load) commission can be different and charged on the front end of the transaction when a client buys into the investment or the back end when a client sells their position.
4. Expense Ratios: This is a recurring fee typically found within Mutual Funds and Exchanged Traded Funds (ETFs) to support the general operations of the fund company and the marketing of the investment fund(s). The fee will vary based upon a number of variables, like share class, type of fund, and even the fund company. Although the expense ratio is levied by the fund company, in some cases an advisor will have the power to select what fund they offer clients. Funds that offer different share classes will sometimes have a different expense ratio for each respective share class. In these cases, an advisor does have some discretion over the expense ratio a client pays.
If you follow this link, there is a chart that lists the most popular products and services that advisors typically provide. The chart lists the product/service, describes the product/service, explains what fee(s) are involved, and who receives that fee.