Most advisors are paid either through commissions earned on investment transactions or through fees. Some advisors are compensated by a combination of the two.
: Fees do not vary by product. Fees can be hourly, a flat annual retainer or based on net worth or assets managed. Net worth or asset management fees typically vary from 2% to less than 1% (depending on the service) per year. Fees are typically debited from the investment accounts. There may be separate fees for investment advice (or commission) and financial planning services.
Advice: Ask for a clear explanation of fees and carefully review disclosure documents.
: Commissions are usually transaction based. The commission percentage varies by product. Commissions typically come off the top" of the investment amount. Mutual funds are a common example. Mutual funds can be load (commission) or no-load funds. A no-load mutual fund is commission free. A load fund includes a commission charge - typically up front, but may occur on the "back end" (at sale). In some cases, the advisor receives a "trail" (ongoing commission paid from the fund's annual expense ratio).
Advice: Ask for a clear explanation of all charges and carefully review disclosure documents.
Expense Ratio: Mutual funds also contain a "hidden" charge called an expense ratio. This expense covers the fund's cost of doing business. Although disclosed in the prospectus, many investors are unaware of the cost. This charge can range as low as 1/10th of one percent to over 2% each year. The higher the expense ratio, the greater the drag on performance.
Some advisors are affiliated with large brokerage firms while others are independent. Fee-only firms are usually independent. They are regulated by the Securities and Exchange Commission (SEC) or an individual state. Commission-based advisors are sometimes independent. Independence allows the advisor to practice with no particular affiliation to a family of products.
Charles Schwab’s take on the benefits of an Independent Registered Investment Advisor.