The services of a good financial advisor certainly aren’t free, but do you know how your advisor gets paid? After all, they have to make their money somewhere. Financial advisors can be paid in a variety of complex ways, and we’ve broken them down for you here.
When you buy mutual funds, you can either get them actively or passively managed. There’s a huge difference between these two options in terms of your costs.
When you invest in actively managed funds, you’re paying a team of expensive financial advisors to manage your funds and determine what and when to buy and sell. Naturally, because these are actively managed by real people, you’re going to be paying more because these professionals need to get paid for their services.
On the other hand, if you invest in passive index funds, they’ll be managed by computers—the software will automatically maintain the right weightings in order to match index performance. In the case of passive index funds, you’re not actually hiring people to do the work, so your costs will be reduced.
Your Advisor’s Compensation
Though financial advisors can get paid in a wide variety of ways, the most typical compensation method we see is a monthly deduction from your account. However, the deduction taken from your account is based on a percentage of its balance, so if you make more money, your advisor makes more money from the account. But if your balance lowers when you lose money, your advisor ends up getting less compensation from their percentage deduction as well.
How big of a percentage will your financial advisor take from your account, you might ask? Well, it depends on the size of the account. But generally, advisors will take a 1% fee from a $1 million dollar account. Portfolios with less than $1 million in assets will generally get charged a larger percentage.
Mutual Fund Trails
Beware of financial advisors that collect mutual fund trails on top of their usual compensation. This is a big red flag because it indicates a conflict of interest. An advisor who collects these trails probably isn’t working in your best interest. They have an incentive to sell you a fund because they’ll get paid for it, so you’ll typically end up overpaying.
There are many different types of financial advisors. Those who collect mutual fund trails are usually brokers who are in the game for their own interests. Fiduciaries, on the other hand, are legally bound to serve your best interests and are prohibited from receiving compensation from mutual fund trails.
Why Should You Care?
Your financial advisor will get paid one way or another. But the way they get paid for their services should matter to you. The more money your advisor takes as compensation, the less you have in your account, so it behooves you to know what percentage is being taken out and if any additional fees are being charged. And if your advisor is paid in ways that are less than transparent, like collecting mutual fund trails, then you should find a better advisor that has your best interests at heart.
The better you understand how financial advisors get paid, the better chance you have of making informed decisions that will benefit you and your investments in the end. Don’t work with an advisor who isn’t willing to be transparent about their fees—in writing. Shop around for advisors and ask for compensation details, so you can save money. Also, don’t forget to ask what you get for these fees, like a written summary of the services provided, so that you can get the best value.