6 Ways Financial Advisors Are Paid

Shawn: Ever wondered how financial advisors really get paid? Join us today as we discuss the six types and the potential conflicts of each. Let’s get some perspective. Welcome to another episode of Christian Financial Perspectives. My name is Shawn Peters and I’m joined as always by my co-host and father-in-law, Bob Barber. And today we have what I think will be a really fun episode. We’re going to be talking about these six ways that financial advisors are paid because believe it or not, there’s more than one. Bob: Yeah, that’s right. Shawn: So Bob, what made you want to do this episode today? Bob: I think because of mass confusion, Shawn, that’s why. People just don’t understand how advisors are paid. They don’t understand it can be six different ways. I know when somebody hears that, they’re thinking, you mean my advisor’s getting paid six different ways? No, your advisor’s probably getting paid one or two of these ways. Shawn: Not six all at once. Bob: Right, exactly. But these are the ways in which financial advisors are paid and they got to make a living, right? And so, I think it’s very good to be transparent about this and just be upfront. We have nothing to hide when it comes to how we’re paid. Shawn: And what we get paid is right there on our website. So we’re literally not hiding it. It’s publicly available. Bob: It is. It’s right there. Okay. So I came up with these six, and the first way was financial advisors are paid by the hour, like a fee, like you would pay a CPA. Shawn: Yeah, exactly. CPA ,attorney, something like that where it’s like, well, I’m probably going to need about three hours of work on that and this is my rate. Bob: And you’ll either pay the financial advisor directly or you’ll make the check to their company. Well, I’d say check, electronic check. Shawn: However you want, just depending on how they’re set up. Bob: But this is very upfront, very easy. Most of your financial advisors, depending on if they’re a CFP or not or their experience will do financial advice, do some financial planning for you. Probably starting at about the $150, $200 an hour all the way up to $400/500 per hour Shawn: $400 or $500. That’s right. So for our firm, as an example, this is one of the two ways that we get paid. And typically for us, obviously we don’t do a whole lot of business by the hour, but we have people that come to us sometimes and they don’t necessarily have a lot of money or they don’t have money they want us to manage it for them, but they want to make sure, hey, are we actually on the right path? And so maybe they do a couple hours of some one-on-one financial planning with one of our advisors and just kind of make sure they’re on the right path. Or we have maybe an existing client that we offer different levels of financial planning and the number of hours depending on assets under management with us. And maybe it’s someone who just needs extra time or extra hours that aren’t included already. So there’s just a couple of different ways that people might do that with us. And some people work only that way. Some advisors just work by the hour. They don’t do any kind of asset management or anything else. Bob: And Shawn, today with technology, it’s so efficient that I can do a tremendous amount of planning in just an hour to an hour and a half. It’s amazing. And we do this online and we have some past podcasts you could go back and listen to that. I don’t remember the exact titles of them, but we did one. Shawn: Well, this is only episode 180. Bob: Yeah. Shawn: Shame on you, Bob, for not remembering every single episode. Bob: It was one that we called, I think, interactive financial planning. Shawn: Yeah. Bob: Yeah, that’s right. So the second way that advisors are paid, financial advisors, and this is how we work around here, is through a ongoing monthly or quarterly asset fee for actively managing investment portfolios. Shawn: Right. So that is just a percentage of the assets under management that is billed, like you said, either monthly year or quarterly. For us, we bill quarterly. So whatever that annual fee is divided by four. Bob: Well, on our website we get paid, we say 1%. So it’s really 0.25% per quarter, which means if you wanted us to manage a $100,000, it’s $250 a quarter. That’s simple. Shawn: That’s it. Bob: And the thing about it also when a fee-based advisor is managing your money and it’s $250 for that quarter, there’s no surrender penalties or withdrawal penalties. So if you decide after just two weeks, I don’t want to do this anymore, you’ll be refunded part of that $250. Shawn: Depending on the advisor. So our firm, some firms bill in advance, which is what we do, we bill in advance and some bill in arrears, which is I guess a fancy way of saying in reverse, looking back. And so for us, since we bill in advance at the beginning of the quarter, in the case that you just said, Bob, if you were working with us and two weeks later you just said, this isn’t working out for me, for whatever reason, no hard feelings, we’ll pray for you. We’ll say best of luck to you. But we do a prorated to see, okay, well the two weeks is what percentage remaining of the quarter that we just billed for. And then those fees are refunded back. Bob: That’s correct. Shawn: Like you said, no surrender penalty. And we really like this in particular, which is part of why we work this way because if someone has been with us for five years, it wasn’t because they had to. They chose to stay over a five-year period, they weren’t locked in. Bob: I always say it’s like paying your tourist guide along the way instead of paying them all up front. You’re paying them along the way. He’s guiding you up the mountains. Shawn: Exactly. Bob: Okay. Now the third way is kind of the old fashioned way. And that is a upfront commission paid to a financial advisor from an annuity company, the old mutual funds that used to have a sales load to them or an alternative investment like a real estate investment trust paid by the company to the advisor for placing the client’s money in that product. Shawn: There’s different ways, obviously depending on the type of product, but typically the most common would be, for example, if you’re working with someone that is affiliated with a broker dealer, so they’re a registered representative, still a type of financial advisor, but if they put you in an annuity, let’s say it’s $100,000 you can invest in the annuity. They might get 5%, 10%, somewhere in between there, but let’s just say 5%. Well, they’re going to get that $5,000 commission upfront. And then typically the way the company protects themselves from you leaving early is there’s going to be a five year surrender penalty or surrender period where if you take your money out a year later, you’re only going to get the growth minus 4% of the original. So that original, what is that, $96,000. You’ll get $96,000 back of the original principal. Bob: If it was commission. That’s right. Shawn: Exactly. Bob: Right. Shawn: And then if there’s any growth, but that’s how they protect themselves because they don’t want to pay an advisor a 5% commission and then you take all your money out a year later and they’re left holding the bag. Bob: That’s right. And it usually goes down a little bit each year for four or five years. Shawn: Exactly. Well just to give you an example of a year later on a 5% commission. Bob: We’re going to go over some of those examples here later as well. Okay. So the fourth way out of our six ways is ongoing monthly, quarterly, or annual trail commissions. This is kind of like the ongoing quarterly asset management fee, but with some, it’s called a trail commission. And that’s usually going to be around 0.25% to 1% a year. Shawn: And a really common one for that one is if the advisor you’re working with places you in, say a C-class mutual fund, then those typically, the way they’re paid is instead of a upfront 5% commission, maybe it’s 1% per year. And again, that’s paid by the mutual fund company on an ongoing basis as part of the expense ratio. Bob: The client does not pay that. The mutual fund company does, but in a way the client does because the fee’s built in to the product. A lot of your annuities also have this same thing. And then we come across the fifth way. And the fifth way is what I refer to as a hybrid financial advisor. It’s a fee-based advisor and a commission-based advisor built into one. Now how does that work? Well, there may be a program like asset management that’s a fee-based program. And then maybe the advisor does sell annuities because they’re licensed to, or he sells life insurance and that’s commission based. So he’s getting the fee based and the commission. Shawn: And a common example of that would be an advisor who maybe they had been working only with a broker dealer and then maybe they decided to open up their own RIA, like our firm is. And they were doing some business under the RIA for the ongoing fee-based fee or management fee. But then they also, like you mentioned, they have some products like the annuity or insurance, something like that, that pays a commission that they run through the broker dealer. And so that’s how they’re able to operate in that hybrid environment and be both commissioned and fee-based. Bob: And always make sure as we’re going through this that you ask the advisor what they’re being paid. And this all should be disclosed to you do a prospectus. Alright. Shawn: And one thing I would suggest is don’t ask them how much are you paying them? Ask them how much are they being paid? I have heard that before. Bob: That’s true. Shawn: And actually it was just a few days ago as at the time of this recording, but I had a client call in and they were calling in on behalf of one of their kids and they had talked to someone when they asked, well, how much am I paying you? They said, oh, well you’re not paying anything. This is just part of it. But what she should have asked was, how much are you getting paid? Because it was one of those things where there was a fee built in. So technically she wasn’t going to be paying the advisor, but the advisor’s being paid by the company and the investment product that she was going into. It was like, I feel like, come on, you know what she was asking. So ask, how much are you getting paid? Don’t ask, how much am I paying you to kind of hopefully sift through that a little bit. Bob: Folks, you got to admit there is no free lunch. So that’s built in there somewhere. And then the last one is a salaried financial advisory. A lot of times you’ll see these kinds of advisors working for a very large company or a large mutual fund company, and they’re paid from the fees that are generated in those proprietary funds that they may manage or the trades of stocks on buy sell side. Not a commission, but just, well there is that, but it’s just a small amount. Shawn: It’s almost more like kind of a bonus if you will, if they hit their sales target, something like that. Because again, you’re not technically paying, in this case, you’re not paying that advisor directly because they’re on salary. Again, it’s more of, well, depending on how well the company has done and because they’re putting you in maybe funds that the company owns or runs, they’re still getting paid. Like you said, there’s no free lunch. So they’re still getting paid. It’s just a little different. Bob: Okay. So that’s the six ways. And I just want to share one last thing I want you to think about, and this has to do with a little bit about commissions. Often commissions are not paid upfront by client, like we mentioned, but they’re backloaded as withdrawal penalties for a certain number of years in a financial product. Example, there’s a 7% to 10% penalty for getting your money back in one year. The commission is probably around that same amount paid upfront to a financial advisor. Shawn: Which at 7% for our firm to make that same amount, would take about seven years. Bob: So here you go. So as an example, you invest $100,000, then you want your money back in one year, but you may only be able to get – an example of a 10% commission – $90,000. Shawn: Plus the interest or returns made. Bob: That’s correct. Exactly. Here’s where the potential, and it’s very tough on some advisors when they think about it, that advisor is, I could get paid $250 upfront to manage this person’s money for a fee, or I could make a $10,000 commission. Shawn: $250 ongoing each quarter. Yeah. Bob: Ongoing. Shawn: Versus $10,000 upfront. Bob: Okay, so you think about that, I get $10,000 now or $250 now. That’s where the temptation, a great temptation, can come in and it’s very tempting for a financial advisor, especially when they’re just getting started in the business. And Shawn, I thought, as we are Christian Financial Perspectives. I think a good scripture to go with this is from Philippians 2:3-4. You ready? Because you’re my reader? You go for it. Shawn: I like this one. “Do nothing out of selfish ambition or vain conceit, rather in humility, value others above yourselves, not looking to your own interest, but each of you to the interest of the others.” Bob: There you go. Shawn: That’s a good scripture. Bob: It is a good scripture and it’s a good scripture for the reason you need to look for a fiduciary, fee-based financial advisor. Look for it in that order. Shawn: That’s right. And as always, if you have any questions, feel free to reach out to us. You can visit our website, www.ChristianFinancialAdvisors.com. You can also call or text us during normal business hours at 830-609-6986. Or if you’re really fun and tech savvy, you can always comment on the video if you’re watching the video, and we try to respond to all those. So God bless and thank you for joining us. [DISCLOSURES] * Investment advisory services offered through Christian Investment Advisors Inc dba Christian Financial Advisors®, a registered investment advisor registered with the SEC. Registration as an investment advisor does not imply a certain level of skill or training. Comments from today’s show are for informational purposes only and not to be considered investment advice or recommendations to buy or sell any company that may have been mentioned or discussed. The opinions expressed are solely those of the hosts, Bob Barber and Shawn Peters, and their guests. Bob and Shawn do not provide tax advice and encourage you to seek guidance from a tax professional. While Christian Financial Advisors® believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability.