Compensation and Conflict with Your Financial Advisor

Financial advisors are paid in several different ways, depending on the terms of their agreement with their clients. Sometimes conflicts of interest are present in the compensation scheme an advisor takes on. It is important for prospective customers to be aware of this potential for conflict so that they can choose an appropriate compensation method that makes the most sense based on the kind of help they are getting from the advisor. Following are the primary means of compensation for financial advisors, and a brief discussion of potential conflicts of interest that can accompany each of these payment methods.

Hourly Rate

When a financial advisor is paid by the hour, he or she may have a bias toward offering more advice or services than what may really be needed in order to increase the billable hours. In this scenario, actual financial products offered are usually kept to a minimum in lieu of very specialized advice. This sort of setup is very rare except in rare circumstances where it is the most appropriate and beneficial billing method for both parties. Items like business law, special taxation questions, and things of this nature may be treated on an hourly basis and are appropriate when choosing a financial advisor for such a business.

Flat Rate

The potential conflict of interest with the fee only or flat rate system is that an advisor may be tempted to offer as little as possible to shorten the meeting and get out as quickly as possible. The advisor thus may resort to canned advice not at all customized to that particular client's specific situation. Generic advice like this is easier to get through and less likely to lead to extended discussion or specific questions.

Percent of Assets under Management

This compensation system is common for advisors who work with clients with sizable portfolios. In theory, the reasoning behind it is that if an advisor makes money, it means the client is also making money, and vice versa. So the advisor ought to be motivated to spend time doing the research and legwork necessary to produce a positive result. However, the tendency of advisors in this scenario may be to simply keep as much as possible under management whether it is performing or not, and whether or not other options for use of some investment capital (i.e. paying down debt, etc.,) might be more advisable. In this compensation structure, the financial advisor may also be tempted to advise riskier investments in an attempt to rake in higher commissions.

Commissions on Sales

Commissions on sales can lead to a rather obvious possible bias on the part of the advisor to close sales on products paying a commission and avoid those that do not. Advisors may find themselves offering advice geared more towards making choices to buy more of these commission paying products and doing what is good for the advisor rather than basing advice on what the advisor believes is good for the client. Advisors in this scenario are much less likely to raise concerns about portfolio deficiencies that call for products the advisors will not receive a commission on.

It must be noted that a good and helpful financial advisor will do her best to minimize the bias introduced by whatever method of payment is in use, and will work for the client's betterment and not her own. None of these issues raised in this piece are impossible to overcome. They should simply be kept in mind and possibly discussed openly as you and your advisor discuss compensation mechanisms. The best financial advisor is the one who focuses solely on the client's interest.

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