It is an undeniable truth that the financial world has more than a few dirty secrets. These secrets are often overlooked and can ruin the hope of many new investors. Beginners want to get unbiased financial advices in their best interest. But the fact is, some financial advisors are also involved in these unfavourable situations. Some deliberately try to charge more money than necessary.
For this reason, it is important for investors to understand common compensation models for financial helps. Three common models are fee-only, fee-based and commission-based.
• Commission-based:
These advisors may offer multiple commission-paying products like loaded mutual funds, annuities and insurance. In fact, these financial advisors may not disclose to us the amount of commission they earn.
They facilitate the transactions and sometimes, we don’t hear anything from them again because they have obtained their commissions. Advisors who work based on commission could cause conflicts of interest, because they prefer things that benefit them financially. Due to specific financial incentives, they may prioritize clients that can give them the biggest commission. Some commission-based advisors are honest and ethical, but many could cause conflicts of interest.
• Fee-based:
Fee-based advisors take fees for their services, but they could still get commissions from investment products and insurance that they sell to us. They could charge us fees based on the amount of assets they manage on our behalf. They still take commission income as the icing on the cake. This allows them to potentially earn much more.
• Fee-only:
This is probably the most unbiased and the most appropriate kind of advisor. They are honest enough to take only fees for services they offer. They may earn fees from hourly compensations, percentage of assets that they manage on our behalf and the size of project financial planning.
We should make sure that all fees must be written clearly in the contract. When choosing fee-only advisors, we should be sure that their services won’t cause any kind of conflicts of interest. By understanding how advisors work, we should be able to avoid conflicts of interests.
We need to be wary if advisors offer us insurance programs and other financial projects. These offers will require us to spend some amount of money and advisors will get compensations for that. Advisors who practice full disclosure are also able to provide the most ethical, honest and unbiased advices.
Many commission-based and fee-based financial advisors are unwilling to practice full disclosure and this is something that we need to avoid. It means, if they sell annuities; they will show the amount of compensation they get.
These advisors could also encourage us to confirm with the annuities provider about the amount of commission they receive. Dishonest advisors may act more like marketers and they try to convince that life insurance policies they offer is the real solution to our problems. Recognizing honest advisors take practice, but we should be able to spot them quite easily.