Financial advisors are increasingly moving from a commission based model to fee based as a result of the financial crisis. However, both types are still readily available for consumers to decide which type is the best for your financial planning needs.
Fee based advisors usually charge clients based on a percentage of assets under management, while commission based financial advisors receive a commission for buying and selling investment products to clients. Naturally, a change from a transactional based compensation model to one based on assets-under-management has big implications for both Wall Street and investors.
Wall Street brokerages have encouraged their financial advisors to transition clients to a fee based relationship in order to reduce their dependence on transactional revenues and to retain clients in the fallout of the financial crisis. The latest Wall Street brokerage to encourage this change is Merrill Lynch, raising commissions from $50 to $75 for trades worth more than $300 in order to encourage a shift but given that most clients who are active traders probably use discount brokerage accounts already, the move probably won’t impact many clients.
Fee Based Financial Advisers: What Wall Street Wants You To Choose
However, fee based financial advisory will generally work to the benefit of investors as it removes the conflict of interest or incentive for financial advisors to “churn” (buy and sell) their client’s investments. Likewise, commission based incentives also mean that financial advisors are encouraged to put their clients in mutual fund and other investment products that come with high front-end commissions rather than no-load mutual funds or ETFs with low expense ratios or commissions.
ETFs are increasingly being chosen over managed mutual funds that pay brokers large commissions. Consequently, Wall Street brokers need to find another way to make money. A shift is developing towards fee based financial advisory services and it’s one Wall Street idea that actually works to the benefit of most investors.
A typical fee charged for fee based advisor services would average 1.5% per year as a percentage of your assets. So if your portfolio is worth $100,000, you will pay a fee of $1,500 per year but if the value of your portfolio rises to $125,000, you will pay $1,875 per year. However, should the value of your portfolio drop to $75,000, you will only pay $1,125. In other words, there is an incentive for your financial advisor not to lose your money or invest it in risky investment products that may not be suitable for your investment goals.
Likewise, fee based financial advisors can typically structure the advisory fee in other ways such as a flat fee for certain services and an hourly rate for other types of services with the later typically ranging from $150 to $300 an hour depending upon your needs. Just be sure to get everything in writing before opting for a fee based financial advisor.
Commission Based Financial Advisors
An investor with a small investment portfolio or one who rarely trades might still be better off using a commission based financial advisor and just pay the commission when they do trade. Likewise, an investor who is relatively sophisticated and understands how commission based financial advisors earn more money investing clients funds in mutual funds with front-end loads might find it better to just stay with the latter.
If you do decide to use commission based financial advisors, just be aware that if he or she puts your $100,000 into a mutual fund with a 3% front-end sales load, you will be paying $3,000 in commissions up front rather than the $1,500 per year you would have paid had you chosen a fee based financial advisor. However, if you own the mutual fund for five years before selling (and let’s assume there are no yearly expenses for owning the fund or a back-end load or sales commission to exit), you will likely have saved a considerable sum of money in yearly management fees.
Ultimately, an investor who is relatively sophisticated and can manage their own investments would probably be better off using a discount brokerage or making their own trades online rather than using a fee or commission based advisor working for a full service brokerage. However, if you are not comfortable investing on your own, then a fee based financial advisor rather than one motivated by transaction commissions will most likely be the best option.