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Article Archives: 04/14/2004

The Secrets To Choosing An Advisor -- Part III

Does your advisor make more off your account than you do? We’ve been discussing how to protect yourself when choosing a financial advisor. One of the secrets to choosing an advisor that’s right for you is to understand how they are compensated.

Financial advisors are generally compensated in two ways: commission or fee-based. Commission-based advisors are essentially ‘prepaid’ because you’re paying for service and advice several years up front. The main disadvantage with a commission-based advisor is that they have little incentive to actively watch over your money.

Back in 1988 when I was a typical broker, I quickly learned that I had to spend most of my time selling, not servicing my existing clients. I was trained by the main office to spend 90% of my time prospecting new clients. That doesn’t leave much time for the current clients, does it?

This is why these brokers hold so dearly to the buy-and-hold strategy. In a bull market environment that isn’t so bad. But when the markets take a turn for the worse, this strategy can leave you holding the bag. If they’re only looking at your portfolio once or twice a year, then what are you paying them for in the first place?

The commission system opens the door to a host of conflicts of interest. Many firms operate on a grid, which means the more commissions the broker generates for the firm, the bigger the percentage they earn for themselves. Luxurious trips are used as additional incentives. Your advisor might be calling to recommend a certain product simply because it’s the end of the month and they need to sell another $100,000 in mutual funds to qualify for that trip to Hawaii. The point is that with a commission-based advisor you can never totally trust the reasons behind their recommendations.

If commission-based advisors can be referred to as pre-paid, then fee-based can be referred to as pay-as-you-go. Most fee-based advisors have access to the entire array of investment choices, not just those that pay a commission or load. For instance, some of the best performing mutual funds are no load funds and aren’t even offered by commission-based advisors.

Because these advisors are paid a small ongoing percentage based on the assets they manage for you, their motivation is to service your account, not to sell you something. In fact, they aren’t paid any more to put you in one product over another. They get paid the same no matter what you’re invested in or how long you’re in it. They know if you aren’t happy with their performance, you can easily fire them and take your account elsewhere.

Conflicts of interest are a lot less likely with a fee-based advisor. They aren’t under the gun to bring in tons of new money each month. They don’t have to switch existing clients into new investments to generate additional commissions. For independent advisors like myself, there are no big trips to win, no pressure from the main office to use one investment over another. The only pressure I face is the one to do the best job I can for my clients.

Not all fee-based advisors are the same. Many traditional advisors are making the switch to fee-based, mainly to escape the constant pressure of bringing in new money each month. However, they’re still managing money the way they always have. They still set-it-and-forget-it and offer little protection in a declining market.

An important thing to consider is that you won’t know if any advisor is right for you until after the sale. If you choose a commission-based advisor, it will be very costly to change your mind should you be disappointed in their performance. At least with a fee-based advisor, you can easily choose someone else should you desire to do so.

So buyer beware. Remember that the recommendations of commission-based advisors will always be colored by their need to generate commissions. They won’t have much time to service your account or carefully watch over your portfolio. On the other hand, fee-based advisors have fewer conflicts of interest and are motivated to maximize your return and keep you satisfied.

If you’d like more information you can call me toll-free at 1-877-827-1463. I will be happy to help you in any way I can.

Mr. Voudrie is a Certified Financial Planner™ Professional and the President of Legacy Planning Group, Inc., a private wealth management firm in Johnson City, TN. For more information call 1-877-827-1463 or email jeff@guardingyourwealth.com.

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