A client reached out this week inquiring asking for help to decipher the various types of fees being charged by another financial advisor to a family member. I thought it was a great topic to cover as there can be lot of confusion (and not much clarity) on this topic.

While this may be a bit of an oversimplification, in general, there are two ways financial advisors get paid. They either sell advice or they sell products.

The former group (selling advice) is the one Windermere belongs to. Firms such as ours gets paid to provide advice. Our fees are based on the amount of assets a client has (and calculated based on a billing methodology and fee schedule that is disclosed and outlined in a client’s advisory agreement). Most advisors in this category (Windermere included) provide an invoice of their fees to show the calculation when fees are billed. Firms that sell advice do not earn anything above and beyond those fees – no commissions, no kick backs, and therefore no incentive to invest client money in any given investment and no reason to trade/not trade – other than to meet the client’s objectives and grow their wealth over time.

The other way financial advisors get paid is to sell products. In this group, there is no ongoing fee for advice based on asset values. However, the advisor still needs to get paid and does so via various commissions. The commission rate and structure will vary by product/investment.

With a mutual fund, the commission is known as a sales load and is disclosed by the mutual fund company (and should be noted by the advisor as well, although they may be hidden in the fine print in some cases), billed to the client, and then passed along to the client. This sales load is a percentage of the investment (varies by fund, usually 2-6%) and is deducted from the buy (or sell) transaction, depending on the exact structure of the sales load. As a result, many clients don’t “see” or understand that a fee is being charged. For instance, if a mutual fund with an upfront sales load of 5% is purchased in the amount of $10,000 for a client, the client actually buys $9,500 of that fund and the advisor collects $500 on day 1.

Other structured products sometimes used for investment purposes, like annuities or whole life insurance products for instance, also have a commission. It is required to be disclosed in the prospectus for the investment, but given the length and complexity of such disclosures, it can be hard to decipher. In addition, given the material nature of the commission paid by the issuer to the advisor, these products tend to also have surrender charges (ie: fees investor will pay if they sell the product in a given number of years) so that the issuer can recover the commission it paid out upfront, along with other fees associated with the issuance that are amortized over the life of the product.

If individual stocks and bonds are owned in a relationship with an advisor that is commission based, it can be a bit harder to determine the commission amount and structure. In some cases, there is a payment to the advisor for a given amount of trading volume, which could trigger more buying and selling of positions than would otherwise be warranted. There can also be incentive to buy/sell certain products if they are captive (ie: managed/underwritten by the firm that advisor works for). And in other cases, the advisor may be able earn a bit of fees on the bid/ask spread (the difference between what someone will sell security for and what another buys it for) if their firm is handling or directing the trades themselves.

As you can see, there are various ways that you will pay for financial advice and many times, investors I meet aren’t really sure which one applies to them and what they are actually paying. If you aren’t sure and you are working with an advisor already, I’d suggest asking the question. You have a right to know what you are paying and why. And if you decide to work with an advisor in the future, add a few questions related to fees to your interview list.

Financial advisors, like other professional service providers, undoubtedly should be paid for the services and expertise they provide. However, it’s up to you as the client and investor to ensure the fees are in line with your best interests and are commensurate with the value you are receiving.