Financial Advisor Compensation: What You Need to Know

Guest Blog post by Kenneth Klabunde

Ever wonder how a financial advisor is compensated? You’re not alone.

Whether you currently have a financial advisor or are thinking about hiring one, asking how your financial advisor is compensated is an important conversation to have. You see, how a financial advisor is compensated can tell you a lot about whether or not he or she has your best interests in mind.

Know if your financial advisor is held to a fiduciary standard.

Before we dig into the different compensation models, let’s first cover an important detail that helps to distinguish them in the first place.  A fiduciary standard requires that a financial adviser act solely in the client’s best interest when offering personalized financial advice. (CFP Board)

This means that under federal law, financial advisors who are sworn to a fiduciary standard must provide unbiased financial services to their clients. CERTIFIED FINANCIAL PLANNERTM professionals take this oath.

Why it’s important.

Knowing whether or not your financial advisor is held to the fiduciary standard will immediately signal any potential conflicts of interest in the financial services your financial advisor recommends. This important question will not only help you better understand the value a financial advisor can offer, but it’s also a filter by which you can choose the right financial advisor that must care for your best interests.  

So, how are financial advisors compensated?

There are two basic methods of compensation for financial advisors that are worth noting:  

1.  Commission-Based Advisors

A commission-based financial advisor is paid for the financial products he sells.

This is a compensation model very plainly means that a financial advisor is only paid when they sell "commissionable" products to you. There is a conflict of interest and these financial professionals are typically not your more traditional financial advisor professionals. Commission-based advisors tend to be investment advisors who work for major broker firms.

2.  Fee-Only Compensation

Fee-only financial advisors are independent of the major broker firms and, in theory, should provide you conflict-free advice because they are paid in fees, not commission.

Fee-only advisors charge a flat hourly rate for services, a flat fee for a service – like financial planning, or tiered fees that adjust depending on how much assets you have him or her manage. This type of compensation means that a financial advisor will be able to provide more objective financial advice and look at all possible financial solutions that can meet your specific financial needs without being motivated or persuaded by compensation.

Last Thing

Knowing how a financial advisor is compensated at least allows you to better understand what type of financial service you will receive and what may be influencing financial recommendations.

Kenneth Klabunde, MS, CFP® is the principal at Precedent Asset Management, a fee-only wealth management firm located in Indianapolis, Indiana. Kenneth specializes in providing comprehensive planning and investment services for clients looking to build, manage and preserve their wealth. 

Kenneth and I became friends after meeting at a conference and I asked him to share some thoughts as a guest for this site.