How Financial Advisors Get Paid
The goal of getting paid in the financial services industry is to generate commissions through transactions that lock in commissions annually. This is known as annuitizing. These days, financial advisors are usually required to generate at least $500,000 in sales annually. The firm the financial advisor works for will typically keep 60% to 70% of the sales revenue.
In the past, transaction based trading, one-time sales charges for buying financial products was the way financial advisors made their money. The business model has changed and more and more firms are encouraging them to annuitize their business. This is why financial advisors like to put you in C share mutual funds or wrap accounts so revenue is recurring and less transaction based trading occurs (lessening lawsuits). C share mutual funds and wrap accounts are discussed in further detail in the financial services products section. Additionally, if the financial advisor retires or leaves the firm, the business model he used to structure each portfolio remains in tact. If a financial advisor has $50 million of assets under management, all in C share mutual funds or a wrap account managed by a third party and he is getting paid 1%, his annual sales are $500,000 and he is not even managing the assets.
There are also fee only financial planners that will charge you by the hour to develop comprehensive financial plans. After the plan is developed they may direct you to a financial advisor who will sell you life insurance, mutual funds or an annuity. The good news is they do not make money by selling products they have a quota for. The bad news is you do not know their relationship with the financial advisor they are recommending you to (for a possible kick back). Financial planners that work for broker dealers or insurance companies may offer free advice so long as you invest with them, i.e., waive the $1,000 consultation so they can get $4,000 in commissions for selling you a life insurance policy.
Financial Advisors
I was talking to a friend of mine the other day who just inherited some investments from his recently deceased mother. In a previous life I was a financial advisor, so my friend asked me to take a look at the account. The account was unsuitable for the client, had many risky illiquid funds, was subject to high sales charges, high annual recurring fees and experienced a decline in value of close to 50% in the past three years. The financial advisor had worked with the family for decades. No one in the family had ever mentioned that the financial advisor’s recommendations were not in line with the family’s goals, nor did anyone discuss the large commissions he was making on this ill-advised account.
I have seen this story many times over; it even happened to me before I got into the financial services industry. Financial advisors, life insurance salesman, annuities salesman and many financial planners are highly pressured commissioned sales people with quotas who are paid for selling you a product. Unlike other industries, financial advisors hide sales charges from the buyer. If you invest $10,000 in a mutual fund, your statement will not show that the salesman got paid $500 and he certainly will not tell you that. However, if called on it he will refer you to the fine print in the prospectus that he should have sent to you before you bought the fund.