Can you quickly answer how your financial advisor gets paid?
If you're like the vast majority of people, the answer is no.
Many of us think that we're actually not paying anything substantial, and this is how things work - after all, they reached out to us during vet school / internship / residency / etc and said they'd work with you for free! They even set you up with some insurance and took care of your investing accounts.
Sweet deal! You didn't pay anything, and you're now set with a solid financial plan. Chances are you even got free food out the whole thing.
Does this sound too good to be true? It does to me. And it also sounded great back in the day.
Until I hit the brakes hard. There was something fishy about the whole working for free. And the push to quickly take care of paperwork "and get you all set up".
And notice how I didn't say anything about compensation. They didn't either - other than: "we'll work with you for free, there's nothing to worry about!".
Everyone must get paid somehow
There just no other way around it. We all have bills to pay. The grocery store won't let you take any food just because you love animals or any other reason.
Financial professionals are not different. The problem is when you have no clue how that happens, and which conflicts of interest are present.
On top of that, the financial industry as a whole wants to make money. There's nothing better than medical professionals that have higher incomes than the general population and basically no financial training.
Overall, this industry invests strongly in sales training, and barely anything goes into educating these advisors. Some of them only have in-house training, let alone any meaningful certifications! See this post for more information: Your financial advisor: friend or foe?
No one works for free. It's just not doable. You simply don't know how your paying for the "advice" you're getting. Figure it out ASAP!
Types of compensation
Fee-Only
This is the compensation model you want to see. Better, find an independent, fee-only advisor. Independent means they can offer multiple investment options, regardless of who issues those products.
There are different types of compensation: flat annual fee/retainer, hourly fee, and assets under management (AUM).
While the first two are self-explanatory, AUM means you'll be paying your an annual percentage of your assets.
And while this is the model that offers less conflicts of interest, these are still present. For example, you might be advised not to pay your student loans, and instead use those funds for investing. This would increase the AUM, therefore increasing the fee to be paid. If the fee is fair, AUM is still much better than the following models.
Fee-based
Not the same as above! Commissions are being paid in this model!
Commission based
Stay away! They only get paid if they sell you products/investments. The vast majority of training is in sales, not in topics that could help you in the long run. And even if there are advanced certifications involved (see here), there's an unacceptable conflict of interest.
Higher commissions are offered in the worse investments/products. This happens so that there's a big incentive to sell these products, despite the fact they're not good. The in-house sales training makes sure the financial advisors/salesman truly believe in what they're trying to sell - it's a win-win situation for the company and their employee. There's nothing remotely close to a win for you though.
In essence, many "financial advisors" are commission based salespersons. The ultimate goal is to sell products, not necessarily give you good advice.
Finally, a quick reminder on what being a fiduciary means: they have an ethical and legal duty to act solely in your best interest. This is also of utmost importance!
[…] It's not uncommon to see actively managed funds with expense ratios of >1%. I don't know about you, but I really don't like throwing money away… Especially when some of those investments recommendations might have been made by your financial advisor. Check out this post: Financial advisor compensation – how do they get paid? […]