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How
Advisors Get Paid
Some costs may
not be obvious—leading some advisors to promote their services as
"free." Because almost nothing is free, it's prudent to always ask for
a detailed explanation. If you don't fully understand the compensation arrangement,
probe for more information until all the details are clear to you. A
reputable advisor will be completely open and forthright when discussing compensation. Always ask
what an advisor charges, what the fees are based on, and how much your
specific job is likely to cost. There's nothing indelicate about these
questions; no professional will blush at them. An advisor
that is a Registered Investment Advisor under the Securities Exchange
Commission is required to provide an ADV Part II Disclosure Statement prior
to commencing services for each client. Generally speaking, advisors are compensated through either fees or commissions. Commission-Only Advisors
earn their
income by selling financial products such as insurance or certain types of
mutual funds, or by executing securities trades. Fee-Only Advisors earn their income
through—as their name implies—fees (based, for example, on an hourly
rate, a flat annual or single-project amount, or an annual percentage of
assets). But some advisors may receive income from both commissions and fees. (Some of these advisors may therefore say their compensation arrangement is "fee-based," not to be confused with "fee-only" arrangements.) Other advisors will reduce their fees by the amount of investment commissions they receive on products you buy from them. Advisors may even be compensated through non-cash sales incentives, such as free vacation trips. Moreover, some compensation arrangements are subtle. Commissions on mutual fund purchases, for example, aren't always paid from a visible up-front sales charge (load). Instead, a fund may use a portion of operating expenses to pay commissions—which investors never see—to financial advisors. That's why you should review the expense ratio section of a fund's prospectus. There, the prospectus discloses whether the fund charges a 12b-1 fee, which it uses to recoup marketing and distribution costs, such as commission payments to advisors. In the case of insurance products, you typically won't
be told how much commission—also called a load—the agent or broker will
receive from the premium payments you make—you'll have to ask! There may be other types of expenses as well—commissions on the purchases and sales of stocks and bonds, for example, or legal fees for the drafting of documents in an estate plan. When you talk to potential advisors, therefore, ask about all the fees, sales charges, and other costs that you will have to pay, both directly and indirectly. Fee Arrangements Fee arrangements will differ depending on whether an advisor works with you for a short period on a specific aspect of your financial situation, or works with you on an ongoing basis.
One-Time
Fee A one-time fee can be useful for clients requiring a
specific need such as a retirement plan, estate plan, or an investment
review. An advisor can provide an analysis of your income and insurance
needs based on your financial goals for your financial plan. The costs of these analyses typically range from $500 to $7,500, although they could run higher or lower. (Such plans will have to be updated from time to time, especially if your circumstances change.)
Ongoing
Fees Advisors can also provide ongoing planning and
guidance, including managing money for you. Yearly fees, often based on a
percentage of assets under management, may be as low as 0.75% ($750 per
$100,000) or as high as 2% ($2,000 per $100,000) and may be based on a
sliding scale (the more assets managed, the lower the percentage charged). Keep the following points in mind as you evaluate advisor fees. Many advisors charge minimum fees, which may simply be too high when you consider the value of the assets you'll be asking the advisor to handle for you. Some advisors may even decline your business if your assets aren't high enough in value. And importantly, paying higher fees doesn't necessarily get you better service. A competent and trustworthy advisor whose fees are at the lower end of the scale may be as good as or better than a more expensive advisor. Commissions Versus Fees: Cautions Commissions inevitably come with potential conflicts of
interest. A commission-based advisor, for example, might be motivated to
earn income by:
Fees Versus Commissions: Advantages Fee-only advisors are almost always preferable to commission-based advisors. Don't be thrown off by charges that seem so visible, and perhaps appear high at first glance. The services of a fee-only advisor may actually be less expensive than "free" services when you compare the fees with the commissions you would pay on investments recommended by a commission-based advisor. A fee-only advisor's investment recommendations are not influenced by compensation arrangements. The advisor has no incentive to encourage frequent trading of securities, for example, or to favor load funds over no-load funds. Fee-only advisors typically provide clients with a wider variety of choices because recommendations aren't limited to firms offering attractive commissions on their investment products. A Closer Look At Certain Commissions As with fees, you should look closely at commissions charged for products you would purchase through the advisor. This is especially true for investments because their costs directly reduce returns that end up in your pocket. Because mutual funds are so widely held, we illustrate the point in the following examples of fund investments.
Up-Front
Commissions A typical initial sales charge for a load mutual fund
is about 5%, or $5,000 per $100,000 invested. This means, for example, that
only $95,000 of $100,000 earmarked for a load mutual fund would be put to
work for you. Many annuities pay the salesperson commissions up to 10%, or $10,000 per $100,000 invested. Before purchasing an annuity ask them what percent commission the insurance company pays.
12b-1
Fees All mutual funds have operating expenses, but the
expense ratios of some funds are higher than others—and one reason may be
that marketing (or 12b-1) fees are included in operating expenses. A portion
of these fees may be used to pay commissions to financial advisors. The
average expense ratio for funds that charge a 12b-1 fee is 1.21% (or $1,210
per $100,000), compared with 0.62% ($620 per $100,000) for funds without
these fees.
Different
Share Classes Because most investors hate to pay up-front sales
charges, many fund families now offer different classes of shares within a
fund. Investors can choose a class that carries an up-front sales charge
that reduces the amount initially invested. Or, investors can choose to
invest the full amount and pay a higher annual expense ratio that is
designed to provide commissions to the advisor year after year. Do your homework first. Many fund companies now offer
up to five different classes of funds (A, B, C, D, Y, etc.). Make sure the
advisor fully explains which class of fund they recommend and their reason. Of course, many advisors recommend no-load funds—such as Vanguard, Janus, Invesco, etc. that have low expense ratios. This choice allows you to keep more of a fund's returns. Indeed, the combined cost of the advisor's fee and a low-cost fund's operating expenses could quite easily be lower than the ongoing operating costs of the average mutual fund alone. So keep no-load and low-cost funds in mind as you discuss investment options with your advisor.
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1100 S. Townsend Ave., Montrose, Colorado 81401 Phone: 970-249-9900 Toll Free: 877-422-4770
Copyright (c) 1998-2008
ElderAdo Financial
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