August 31, 2009, 5:00 am

A Response To Financial Nuts – Knowing How Your Advisor Is Compensated

by: The Financial Blogger    Category: Financial Planning,Personal Finance
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financial-nutsI recently read an article by Financial Nuts where he got pushed by a financial advisor to buy life insurance. During their very first meeting, the advisor kept coming back to his need to buy life insurance while the client clearly stated he was not interested.

Unfortunately, I must admit that we hear this kind of story too often about pushy financial advisors. Times are rough for several of them and they try to make a few extra bucks by any means possible. Many are straying far from their valuable mission: to provide high quality financial advice!

However, I am also aware that we (financial advisors) can be insistent when we really see there is a weakness in our client’s financial situation. This is why we try (sometimes lacking in tact & sensitivity) to convince our client that he is making an important mistake by ignoring our advice. Some people think they know and master their personal finances and this is where they get it wrong and are too embarrassed to admit it; they just know enough about finance to hang themselves ;-)

When you meet with a financial advisor, the first question you should ask is how he is compensated. This way, you will be in a better position to know if he is pushy because he wants to make a sale or because it is really important for you to follow his sound financial advice personalized to your current situation.


Fee Based advisors

Technically, if you are looking for non-biased financial advice, these are the go-to-guys. Fee based advisors are usually certified financial planners with great experience. They set a first meeting where they will ask several questions about the 7 fields of financial planning.

Then, they will write a full financial plan with their observations regarding your actual financial situation and their recommendations attached. They won’t sell any products as their recommendations are formulated as solutions to potential financial weaknesses they have observed. You have no obligation to buy anything or to follow their recommendations.

Where is the catch? There is none… but you must be prepared to pay for the service, at the very least $1,000 for a financial plan. Depending on your personal situation (i.e. if you have more needs towards estate planning with the creation of family trusts or if you have a company), the bill can exceed several thousand. I guess this is the price to pay to get non-biased financial advice!

Beware: some of them will provide you with a complete financial plan and will also include products amongst their recommendations. Since most people were not ready to pay more than 1K for a financial plan, fee-based financial planners started to lower their fees and increase the amount of products within the proposed plan. It doesn’t mean you have to purchase from them as you paid for the plan and you can leave the office with it. Just be careful with their recommendations.

Commission Based advisors

You will find most brokers in this category. They are usually pros in one field (insurance, investments, or mortgages) but they offer all products as a global financial service. The life for young commission based advisors is pretty tough as they don’t eat if they don’t sell. This is why the average income of a new advisor is 25K in Canada (before expenses) and the turnover during the first year is 80%. They live according to one rule: the survival of the fittest.

This is why you are hear of so many pushy advisors; they want a pay check at the end of the month! Unfortunately, those are the ones responsible for the bad reputation financial advisors field in general. They think about their own good instead of managing their clients’ assets ethically.

Having said that, I know a lot of commission based advisors who put their clients first and provide high quality financial advice. Since it is the highest paying structure for a financial advisor, you will also find the cream of the crop. Since a top performer in a bank will barely reach 6 figures, a top performer on a commission structure can make more than 500K per year. No wonder young advisors dream ;-). However, top financial advisors have built their business on strong relationships through sound financial advice for their clients!

Somewhere in between based advisors ;-)

You will find these advisors working for banks and other financial institutions (investment firms, insurance companies, etc.). This is actually my personal situation: I am an employee with a base salary. The bank gave me a book of their clients (they are not mine as opposed to commission based advisors) and my goal is to grow the business in the book. We get a bonus depending on the net growth of “our” book at the end of the year.

The base salary is big enough so one can live with it without any bonuses. This way, we should be less pushy. On the one hand, we offer our company products exclusively (which is not necessarily a bad thing, since most financial institutions have similar products!). On the other hand, I have seen many other advisors sitting on their base salary and become reactive to their clients instead of being proactive…

As you can see, there is no perfect and transparent compensation system. Each of them has its strengths and weaknesses and may lead to biased financial advice. However, by knowing upfront how your financial advisor is compensated, you will be in a better position to understand why he is insisting on one solution / product or not… we hope.

image source: Law_keven’s photostream

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Comments

As you suggested, there is no one perfect model for financial advisors or clients. Unfortunately, many insurance reps will push life insurance as an investment vehicle and many fee based advisors will shun it, even when necessary, because they don’t get paid for it.

The best model is to interview several advisors, and follow one (whether insurance, commission or fee based) who takes your whole financial picture into account and will advise you on all aspects, no matter what their firm affiliation.

[...] The Financial Blogger: Knowing How Your Advisor Is Compensated [...]

[...] The Financial Blogger says you should know how your advisor is compensated. [...]

Financial planners are a great idea but you do have to be careful of their motives and that they have your best interests at heart rather than just being a salesman for the products that will gross them the biggest commissions.