Fee-Based Financial Advisor vs Commission Based

“Is it better to invest with a financial advisor that charges a fixed-annual fee that I can lock in now or one that earns commission from investments? If they aren’t earning commissions on investments, will they still be motivated to max performance? On the other hand, how do I know commission-based advice won’t be biased?”

If your goal is just to get the highest returns you can, a commissioned broker can help you build an aggressive investment portfolio. Just remember that no advisor, regardless of how they’re paid, can guarantee results—and besides, “performance is fleeting,” says Dana Rhodes, the head of advisory services with Ann Arbor, Mich.-based financial services company Axtella.

Rhodes and other experts agreed that you might want to broaden your focus from beating the market to ensuring your long-term prosperity. That would mean seeking out an advisor who cannot just recommend investments, but help you set goals, minimize taxes and use insurance to manage risks to your wealth.

These so-called holistic advisors predominate today, having largely supplanted the old-school stock jockeys. “The role of an advisor has really evolved,” says Tampa, Fla.-based advisor coach Liz Lenz.

Sizing up different payment models

You’re right that professional investment advice can be biased. While the bad actors are in the minority, no advisor is immune to temptation. Commissioned brokers are often singled out as working in a conflicted business model. “The way to get the least-biased advice is to absolutely not work with [that] a sales model in the first place,” says Pamela Krueger, the CEO of Osterville, Mass.-based Wealthramp, which connects customers with vetted financial advisors. But other kinds of advisors are subject to conflicts as well.

Commissioned brokers

Brokers and their firms are often paid through trading commissions. A hypothetical purchase of 100 shares of a stock trading at $50 per share might come with a $100 commission, for example. It’s tempting for brokers to earn more by, for instance, recommending more frequent trading. And different investment products pay different sized commissions, which can influence brokers’ recommendations.

But brokers will want to keep you as a client, especially if you’ve got a bigger account, and that incentivizes them to try to achieve good after-fee results on your behalf. And while the brokerage industry has pivoted over the years from picking stocks and bonds to emphasizing financial planning and advice, many brokers tout their roots as stock pickers.

Note that many insurance companies also employ financial advisors, who offer planning and investment-management services. While these advisors may work under a brokerage model or an asset-based model, they may also be incentivized to recommend in-house insurance and annuity products.

Asset-based advisors

Registered investment advisors, or RIAs, and their personnel operate under a somewhat stricter regulatory framework. They’re considered fiduciaries, which means they’re legally required to put clients’ financial interests before their own.

Most charge clients a percentage of their assets under management, or AUM, each a year. For example, if your advisor manages $1 million for you and charges a 1% AUM fee—which is pretty typical—you’ll pay $10,000 a year.

That doesn’t mean RIAs are immune from conflicts. RIAs want to keep your account growing so their fees grow as well. Say you want to withdraw $700,000 from your investment account to buy your next house: Your RIA might be tempted to recommend using a mortgage instead.

When RIAs talk about clients’ long-term financial success, they often emphasize financial planning as much as or more than investments. But this category of advisors certainly includes proud stock pickers—often veterans of the Wall Street brokerage firms.

Fixed-fee advisors

A small minority of advisors offer fixed-fee arrangements. These range from a fixed-annual fee of $1,000 or so for smaller clients to five- or six-figure annual retainer arrangements for wealthier ones with complex needs. Fixed-fee advisors, who are usually RIAs, are often interested in your whole financial picture, not just investments. So if you’re only focusing on investments, you might find yourself paying for more than what you want. Also, these advisors often give priority to financial planning over investing.

Keep in mind: Some advisors may both charge you a fee—either fixed or asset based—and accept commissions. Advisors who don’t accept commissions generally describe their services as fee only.

What’s the best way to pay for investment advice?

If you’re purely focused on investments, it may be most economical to use a commissioned broker. That way, you’re not paying for extraneous planning advice. If you plan to buy and hold your investments for several years, your costs in the long run would likely be lower in this scenario than several years of AUM fees.

As for avoiding conflicted or pushy advisors: Unfortunately, the ethical ones don’t wear white hats, and the unethical ones don’t wear black hats. That means you’re going to have to meet with candidates and ask tough questions.

It’s always best to interview several advisors before hiring one. Ask for recommendations from friends, family and associates who are happy with their investment returns. Tell each candidate exactly what you’re after and ask for proof of past performance—remembering that good results are often fleeting.

As you narrow your list, ask candidates how they’re paid. Ask them exactly what conflicts of interest they’re subject to and press them on how you’ll get your money’s worth. The right candidate won’t get defensive, talk over your head or begin spouting sales jargon.

And don’t forget to check regulatory records for client disputes or other black marks. For RIAs, use the Investment Adviser Public Disclosure database. For brokers, refer to the BrokerCheck search tool provided by the Financial Industry Regulatory Authority. Both databases are free to use.

Again, remember that financial success isn’t just about beating the market. A good advisor can use tax-planning strategies to help you keep more of what you earn, for instance. They can help you determine whether giving priority to debt repayment over investments will get you further in the long run. And they can objectively review your insurance—especially if they’re not employed by an insurance company—to make sure you’re adequately protected against the financial ruin that might follow a car wreck or a slip-and-fall on your property.

As Lenz says, “One financial planning mistake can negate all the investment outperformance that you have.”