By Financial planning is an indispensable service that helps people and families navigate the complex world of investments, retirement, taxes, and everything else. But how do these professionals get paid? It’s something many people have wondered about-an easy question but one that doesn’t always have an equally straightforward answer. This post intends to provide insight into the various compensation models that exist for financial planners and promote empowerment by facilitating informed decisions regarding professional assistance.
Understanding the Landscape: Why Does the Form of Compensation Matter?
Before moving into specifics, it is helpful to understand why understanding a planner’s form of compensation is salient. It’s so because it bears on their objectivity-as well as the possibility of conflicts of interest. If planners’ compensation were entirely commission-based, they could be tempted to recommend products that payout the most, regardless of whether these are an appropriate fit for your particular circumstances. Fee-only planners, those who charge for their services directly, are viewed as generally having more alignment with the interests of their clients.
The Three Major Compensation Models
The compensation of financial planners is mainly built upon three major different models:
Commission-Based:
The traditional model where planners earn commissions from the sale of financial products, such as mutual funds, insurance policies, and annuities.
A commission is calculated when the client buys the product suggested by the planner: A percentage of the sale is paid to the planner. This percentage shall vary according to the product and the company concerned.
PROS:
There might be no fee charged upfront by the client.
Those with very limited capital may find it easier to obtain planning assistance.
CONS:
There exists potential conflict of interest: Planners may favor selling high commission products over what is best for the client.
There may be lack of transparency: Clients may not have a clear understanding of the commission structure or costs involved in getting the product.
The advice tends to be more product oriented, while the comprehensive planning may not be.
Fee-Only:
Such a model emphasizes transparency in services rendered and objectivity in decision-making. Fee-only planners charge clients for their services; this arrangement leaves no room for any conflict of interest arising from product sales.
How it works: Planners may charge by the hour in which case a set price is charged for time worked; Flat fee: The planning fee will be determined in advance, for example, the creation of a financial plan.
Assets under management (AUM): Fee-only planners charge a percentage of any assets of theirs that they manage.
Pros:
– Objective advice: The planners here are not paid for selling any products.
– Transparent: Clients know from the start what they will have to pay for the services provided.
FIDUCIARY DUTY EXISTS: Most fee-only planners are fiduciaries and have a legal obligation to act in their clients’ best interests.
Cons:
– By virtue of its design, the fee-for-service planning may, from the client’s viewpoint, cost more in fees up front.
– Due to an increase in value, the AUM fees can be considerable.
Considerations: Not always accessible because their asset amount is often not that high.
Fee-Based:
This means their hybrid nature reflects the functional aspects of both best-fee and commission-based models.
How it works: Fee-based planners may charge fees for planning services and earn commissions from product sales.
Pros:
Flexibility: Clients have the option of choosing a fee-based-service and commission-service combination.
Potentially lower upfront costs than pure fee-only.
Cons:
Raises the potential for a conflict of interest: The commission part can nonetheless exert an influence on the recommendation of a product.
Less transparent compared to fee-only: clients must have a careful understanding of the fee-and-commission structure.
Discerning the objectivity of the advice given by the planner can be challenging.