Types of Financial and Investment Advisory Firms
In general, there are three types of financial advisory firms based on the three different compensation models listed below:
Commission-based advisory firms
At the onset of the financial advisory industry, most advisors operated on a commission-based structure. This is a structure where an advisor is compensated by commission earned from products sold.
Image Source: Types of Financial and Investment Advisory Firms
Today, the financial advisory and investment industry as a whole is very slowly moving away from a commission-based structure toward a fee-only structure. With a commission-based fee structure, there is an extremely high level of conflict of interest involved.
Commissions can either be paid by mutual fund companies, insurance companies, and other large financial institutions that sell financial products. Commission-based advisors are only paid if a client buys a product; as such, there is an incentive to conduct transactions that may not necessarily be in the client’s best interest.
This conflict of interest is due to the high reward that an investment manager earns by steering his or her clients toward financial products or advice that earns the most commission. In a lot of cases, the client’s interest is not the main concern for the advisor; rather the biggest factor is how much money can be made off the client.
Fee-based advisory firms
Many consumers confuse fee-based with fee-only advisors, and that is unfortunate because there is a huge difference.
Fee-based investment managers receive some of their compensation directly from their clients, but they are also free to accept commissions from the companies whose financial products they sell.
These types of advisors and investment management firms sell products and accept commissions for selling these products. In addition, such advisors offer some specific services that are based on a fee-only structure.
Basically, their fee structure is fee-only plus commission-based.
Oftentimes, details that the advisor earns commissions are not readily provided to the client or made apparent in the client’s statement.
Like the commission-based model, a fee-based compensation model creates potential conflicts of interest because the investment manager’s income is affected by the number of transactions conducted and by which products are selected.
Fee-only advisory firms
Finally you have the fee-only compensation model. Of the three compensation methods, fee-only is the only model that is not based on commission. The only fees received by fee-only advisors are the fees paid directly by clients. Such advisors will not accept commissions or other incentives from companies whose products they recommend.
A fee-only structure ensures a high level of objectivity in the advice provided by such advisors.
Whether they charge an hourly fee, a flat fee, or a percentage of assets under management, fee-only advisors have made a pledge to their clients not to accept compensation from outside sources.
Although all Registered Investment Advisors are required to act as fiduciaries with respect to their clients, the fee-only model is the only method of the three that really encourages advisors to follow that standard by eliminating the conflicts of interest inherent in the other two methods.
Here, at AdvisoryHQ, our methodology is focused on identifying, ranking, and presenting top rated, fee-only wealth advisors and investment managers. However, we do acknowledge that there are honest, good-intentioned wealth advisors who chose to work under different compensation structures, but, too often, their clients are unaware of the conflicts of interest that exist in some of these models.
As long as full disclosure is made, and as long as that disclosure is easy to understand, there is room in the world for all types of financial advisors, investment managers, and wealth management firms.
AdvisoryHQ (AHQ) Disclaimer:
Reasonable efforts have been made by AdvisoryHQ to present accurate information, however all info is presented without warranty. Review AdvisoryHQ’s Terms for details. Also review each firm’s site for the most updated data, rates and info.
Note: Firms and products, including the one(s) reviewed above, may be AdvisoryHQ's affiliates. Click to view AdvisoryHQ's advertiser disclosures.