How Do Financial Advisors Make Money?

Why it can pay to push products

The financial advisor industry is composed of brokerages and registered investment advisor (RIA) companies.

Brokers have historically made their money from sales commissions, and while the business has started moving away from commissions, it hasn’t abandoned them. Since payouts vary between different mutual funds, annuities and other products, brokers have incentives to steer you to more-lucrative options. It’s important to note that there are many highly ethical brokers who studiously ignore commission incentives. Nonetheless, the incentives exist.

RIAs, meanwhile, almost always charge what’s called an asset-based fee—often about 1% annually of the money they invest for clients. This removes the sales incentive. “The best opportunity for independent advice comes within the registered investment advisor category,” says Black.

A minority of RIAs will also offer just their planning services, usually for an hourly fee or a flat project-based fee. And a smaller percentage still of RIAs exclusively charge hourly rates or flat fees. These pure planners will create a financial plan, review and update an existing one, provide broad investment advice or help with specific financial questions. They usually won’t recommend particular investments and often won’t manage your investment portfolio.

Advisors vs. brokers

RIAs, who are regulated by the Securities and Exchange Commission (SEC), are held to what’s widely acknowledged to be a higher ethical standard than brokers, who are overseen by the Financial Industry Regulatory Authority, or Finra.

Confusing matters somewhat, RIAs and brokers can be “dual-registered,” which means they can switch hats. Wearing the RIA hat, they might manage the bulk of your assets on an asset-fee basis, but then don the broker hat to sell you an annuity on commission, for instance. To do so, they need only show that it’s in your “best interest,” which critics say is too subjective a standard. These advisors may describe their services as fee-based.

How to choose the best advisor type

The right type of advisor for you depends on the services you’re after. If you want a combination of financial planning and investment management, an RIA that’s not dually registered could be your best bet. Advisors at these firms will help ensure that your investment portfolio is aligned with the goals you want to fund, such as retirement. Most will recommend low-cost ETFs and index mutual funds to provide you with broad asset diversification, but a minority are passionate “stock pickers” who seek to beat, not match, the market.

If you’re a do-it-yourself investor, an hourly or fee-only advisor may be what you’re looking for. They can make sure you have a solid financial plan and the right insurance coverage, and that you’re saving enough for retirement. They can also review your investment portfolio and tell you whether you’re taking on too much risk, or too little, without pushing any particular investments. Many DIY investors highly value these reality checks.

Narrowing your search

Hourly financial planners are often solo practitioners without big marketing budgets, so you’ll need to seek them out. For online searches, use the specific terms “hourly planner,” and “flat-fee financial advisor.” Search tools on sites like XY Planning Network and Garrett Planning Network may help narrow your hunt. Look for strong professional designations such as Certified Financial Planner (CFP), and expect to pay $200 per hour and up.

And bear in mind that a “one-off meeting” might not be enough. “It may sometimes take three or more meetings to really get you on the right track,” says Daphne Jordan, the chair of the National Association of Personal Financial Advisors, a trade group of fee-only advisors. “Because if you’re working with someone who’s not in a sales role, they’re going to take the time to really understand your needs.”

To vet advisors, ask pointed questions

Financial advisors are required to make legal disclosures about how they do business. For RIAs, look for their Form ADV, which is publicly available through the SEC’s Investment Adviser Public Disclosure (IAPD) website or directly from the advisor. Information about brokers can be found on Finra’s BrokerCheck website.

But because the legalese in these disclosure documents can be hard to follow, be prepared to ask pointed questions when interviewing candidates. Tell them exactly what you want and ask if they’ll provide it, without any sales pressure.