Published on October 18th, 2012 | by Jack Waymire
The Compensation Methods of Financial Advisors Matter a Lot!
Savvy investors do not buy investment products from sales representatives (reps). They select “real” financial advisors who have the specialized expertise and services they need to help them achieve their financial goals. This is a far cry from reps who want to sell mutual fund products that pay 5% commissions. Regardless of what reps say in their sales pitches, astute investors should know reps, who are paid at the time of the sale, have no economic incentive to help them achieve their financial goals.
If you are a savvy investor you should pay fees to a financial advisor for his knowledge, advice, and services. If you become dissatisfied with the advisor’s results you can terminate the relationship and the advisor’s compensation stops. This is a powerful incentive that motivates advisors to help you achieve your goals.
The compensation methods of reps and advisors have another major impact on you. A rep is paid a 5% commission to sell you an investment product. The 5% commission may be deducted from your assets (front-end load) or paid by the product company (back-end load). A back-end load sounds attractive until you read the fine print. You cannot sell the product without incurring a declining 7% sales charge for seven years. In other words you just bought an illiquid product unless you are willing to pay the sales charge to sell it.
Compare the 1% fee that is charged by most advisors to the 5% commission that may or may not be deducted from your assets. It will take five years for the fee advisor to make as much as the commission sales rep and that is if he meets your expectation for value. You can stop his compensation at any time. There are no big deductions from your assets and you are not forced to pay big penalties if you are dissatisfied.
How does the sales rep justify being paid five years in advance compared to fee advisors? The justification is contained in a sales pitch that is designed to confuse you. Sales reps claim their commission is a one-time expense and fees go on forever. What they conveniently neglect to say is the fees can stop anytime you are dissatisfied with your results. So the only reason fees go on “forever” is because you are satisfied with the results of the advisor. And, there is no penalty to terminate a financial advisor. You send them a letter or email and the relationship is over.