Defining the 3 major models of compensation for advisors
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The difference between a good and bad advisor can be worth $100,000s over your lifetime. A good advisor is your one point-of-contact for any financial problem you have, all the way to being your sounding board in making rational decisions (if you don’t feel confident in how best to manage your money).
The issue is, there’s a lot of middlemen and third-parties involved with managing money for people. As you might imagine, more middlemen = (usually) more broken incentives. After working in the industry for a few years, I wanted to break down how different types of advisors get paid and what they have to offer.
There’s 3 major types of “advisors” you can work with - (a) commission-based, (b) fee-based, and (c) “free”.
Commission-based typically includes:
- Insurance agents
- Mutual fund representatives
- Real estate brokers
- Commission investment managers
These advisors make their money by getting you to buy a product. They fit their advice into a one-time purchase - “buy this mutual fund because it’ll make you a lot of money!” Since they have a sales-centric model, they will not recommend investments to you in the context of your larger financial picture.
Fee-based typically includes:
- Full-service advisors (like us)
- Discretionary investment managers
This group earns their fee as a percentage of your investable assets, between ~0.5% to ~1.5%, giving you advice that fits into your picture since their earnings are tied to how much your portfolio actually grows. Full-service advisors will give you advice on all parts of your financial life holistically.
“Free” advisors typically includes:
- Wealthsimple
- Robo-advisors
- Any other party that tells you they won’t charge you upfront
What’s the catch? There’s no such thing as a free lunch. These parties will either (1) take their fee out of your returns (e.g. if your portfolio returns 9%, you only get 7.5% in your bank account), (2), they’ll charge extra on currency conversion, or (3) they’ll get payment for order flow (PFOF) - robo-advisors, specifically, will receive money from their execution brokers when they give them trades to make. It’s similar to them earning commission; every dollar they can convince you to use on their platform to trade will put more money in their pocket. This also happens to be why they spend so much on marketing and focus on making “investing so easy” for the average person - introducing people with no knowledge to financial products that they probably shouldn’t be using on their own - crypto, options, alternative investments, etc. If you’re not paying for it, you’re not the customer - you’re the product!
Some other considerations you should think about when you select an advisor:
- They’re part of an independent advisory firm (e.g. not banks) where they do not have their own products to sell to you, and they give you access to products from all major firms to get you the best ones
- Their expert-team is well-qualified (e.g. Advisor or Portfolio Manager should have a CFA, Planner should have a CFP, Accountant has 10+ years of experience, Trust, Estate and Insurance planner should have a TEP, CLU, and CFP)
- They build your financial plan around your full life and not just your investments
- Their team of experts is in-house is accessible (e.g. Planner, Accountant, Portfolio Manager, Estate, Trust and Insurance Specialists, etc.) that you should be allowed to tap into when you have questions (free-of-charge, of course)
- Similar in age (and potentially career background) to you so you don’t age out of each other, and your advisor has a strong understanding of your trajectory