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Reputable advisors will be completely open with you on this topic because they want you to fully understand how they're paid and by whom. Still, compensation methods can be complex, and making an apples-to-apples comparison isn't easy.
Compensation methods
Financial advisors are typically paid for their advice through commissions, fees or a combination of both.
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Commission-based advisors
receive a percentage of the sales amount on the financial products they recommend such as mutual funds, stocks, bonds and insurance.
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Fee-based advisors are paid a flat fee. Their fees can be billed by the hour or project, as a flat annual amount, or as an annual percentage of assets under management.
When you interview financial professionals, be sure to ask them to disclose all the costs you'll pay—directly and indirectly.
About commissions
Commissions are also called loads or sales charges. A mutual fund sales charge may be assessed when you buy shares or when you sell, depending on the share class. With stocks and bonds, a commission may be assessed in the form of a transaction fee both when you buy and when you sell.
Mutual fund share classes. Mutual funds offer the flexibility of choosing from among a variety of payment options, designated by alphabetical share classes. Although Class A, B and C shares are the most common, they aren't identical from fund to fund, so you'll need to read prospectuses and ask your advisor to explain anything you don't understand.
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Front-end loads, also called "A shares," are paid just once, as a percentage of your purchase price. They can be an attractive choice for long-term investors.
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Back-end loads, also called "B shares," are paid when you sell your shares rather than when you buy them. The amount of this charge declines over time, typically disappearing altogether after 6 or 7 years.
- Level loads are also called "C shares." Ours have no front-end charge when shares are purchased, but a small back-end charge is applied if shares are sold within 12 months of purchase. Because of their higher ongoing fund expenses, C shares are more attractive for short-term investors.
- Many funds charge 12b-1 fees to cover promotion and distribution (including marketing expenses) of the fund. This fee is typically less than 1% and is explained fully in a fund's prospectus.
If you purchase Class B or C shares, you'll pay higher ongoing fund expenses (used to compensate your financial advisor). Depending on the amount of money you're investing or intend to invest in a fund, you may be eligible for a breakpoint discount that would reduce or possibly eliminate front-end sales charges.
It's important to have your advisor calculate charges for the share class that makes the best sense for you. This determination will take into account the amount you're investing, how long you plan to hold the shares and other factors.
About fees
The services of a fee-only advisor may appear to carry higher costs than those of a commission-only advisor, although this is not always the case. As with any purchase, you'll want to compare all the costs, not just the most visible ones.
Types of fees. Fee arrangements vary depending on what services your advisor provides.
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One-time fees make sense if you're looking for an estate plan, an investment plan, a calculation to determine your retirement income needs or other one-time analysis.
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Ongoing fees
are often based on a percentage of the assets in your portfolio, possibly featuring a sliding scale—the larger your portfolio, the lower the percentage charged.
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