When choosing a financial advisor or investment manager, don't make the decision lightly. We are talking about your financial future here. When it is all said and done, there are financial and non-financial considerations to consider. Non-financial considerations include communication skills and overall comfort level that you feel with your advisor. This is fairly straight forward and is a VERY important part of the puzzle. Being comfortable enough to share your thoughts, ideas, questions and expectations is vital to getting the most out of your client/investment manager relationship.
Regarding the financial factors, there are several ways that an advisor can be compensated, each providing different incentives for an advisor/manager.
Commission – Most in the financial service industry are paid this way. Commissions can be earned each time a trade is made in the account and by putting your money in various forms of funds that pay a trailing commission as long as you own them. This type of relationship can create a divide between doing what is best for the client and what is best for the advisor. Most of the financial products that pay the highest trailing commissions are products that are not necessarily best for the client. Bottom line, high fees can kill returns and prove costly for clients over the long term. This commission relationship is also suspect because of the fact that most investors have no idea how much of a commission they are paying their advisor. Clients do not write a seperate check for these commissions, and therefore, they assume the cost is nothing. Truth be told, the commissions are being paid by the client's investments, quietly, discreetly and many times at a very high cost to your financial future.
Fee-Only – Swinging to the opposite side of the chasm, you will find fee-only advisors. Fee-only investment managers are typically compensated on a percentage of assets under management, period. There are no trading commissions to be made from churning accounts or conflicts of interest to sort through between various financial products or funds. Frankly, this enables the advisor to look at ALL available financial options, without regard to how that might affect his/her own revenue stream. Most fee-only advisors also have a fiduciary (legal) responsibility to put the clients interest above his/her own (commissioned brokers do not have this requirement). Fee-only advisors financially succeed when the client succeeds, and this enables clients and advisors to be on the "same side of the table" with interests aligned. The psychological barrier that many clients new to this arrangement struggle with, is the fact that they can now "see" that they are paying their advisor, when it appeared to be "free" before. The truth is that this arrangement more easily creates a financial situation where the client and advisor are rooting for the same goal...portfolio growth.
Fee-Based – This is a hybrid of the two preceding forms of compensation. Advisors compensated this way may accept both a management fee as well as commissions. To what degree each source of compensation is used can vary greatly between advisors under this model, so make sure you understand the blend used before you dive in.
The Bottom Line
Great advisors can be found in all three categories of compensation arrangements. The fundamental differences between each is significant and should at least be acknowledged by clients, so that they understand the incentives and motives behind financial advise they receive. Knowing HOW you receive investment management services will at least allow you to know what kind of field you are playing on. Invest well!