3 types of financial advisors and how to choose one

What type of financial advisor do you have?

There are three main types that can exist: traditional or commission financial advisor, fee-based financial advisor, and fee-only financial advisor. Understanding these different types of financial advisors is vital if you want to make better decisions with your money.

Traditional financial advisors

A traditional advisor is paid based on the money invested in products that they sell. How much you pay depends on which products you buy, since each product has a sales commission attached to it.

These fees are often not visible to you because they come out of the return on your investment.

Fee-based financial advisors

A fee-based advisor charges a flat percentage depending how much money you have under management, but not necessarily on the products you buy.

The assets or money that you invest are still important for this type of advice. How much you have under management matters, and the bigger your portfolio is, the better your financial advisor does. This provides some incentive to grow your wealth.

Fee-only financial advisors

A fee-only financial planner is charging a flat dollar amount as opposed to a percentage. A pure fee-only advisor does not make commission on products that are sold and it will not matter how much money is invested. The fee for the advice is based on the work performed or the time spent to provide the advice. The best way to think of this type of planner is how a consultant bills for their time.

How will the financial advice differ?

The actual type of advice provided in all three cases is very similar and any variances are often determined by the personality of the advisor, their ability to listen, how they account for your whole situation and how well they serve your specific needs. The main differences among the types of financial advisors are cost, transparency, and access to products. Questions can be asked to determine how to uncover these differences.

Issues to consider when choosing financial advisors

If the advisor does not want to disclose fees, this is a red flag. If the advisor tells you that calculating fees is complicated, give them a specific example. “If I had $100,000 to invest, what would the total fees amount to in dollars? Please include all of the fees within the product and for the advice, trading, administration and referral to other companies.”

Have the amount shown to you in dollars, so you can relate it to everyday expenditures. Run multiple scenarios with different dollar amounts so you can see what happens when your account size gets larger or smaller. If they are charging fees based on a percentage of assets, the fees will grow or shrink with the account size. The actual fee will depend on what products they suggest to you in the case of the traditional advisor, but not for the fee-based or fee-only advisor.

Are there any referral fees from other companies, and how does it work? Referral fees are exactly what they sound like – getting paid for referring someone’s product or company. If a bank employee is selling you a competitor’s mutual funds, there is likely a relationship between the two companies. Traditional and fee-based advisors may or may not have these arrangements but fee-only advisors typically do not.

Ask the advisor what products they have access to, and keep in mind who they are working for. Some clues that they are giving you a good selection are access to GICs, all brands of mutual funds, exchange traded funds (ETFs), and other securities like individual stocks. You may not need all of these options, but it may disclose if your choices are limited because of the advisors’ employer.

Their products may be what you need, but the possible conflict of interest between you the customer and the advisor will be made more apparent. This question is applicable in the traditional and fee-based advisor scenarios. For the fee-only advisor, access to products depends on the type of account you have, except those that have a very high minimum initial investment or restrictions due to complexity, like hedge funds or futures trading accounts. A self-directed account is the most accessible type of account.

If you are being sold something that you do not want, this is another red flag. There may be a reason for this product choice, but if you are not comfortable with what someone is selling, and there are no other options given to you, this may be an indicator of a commission motivating the sale. Most of the higher commissions come from products that are complicated and involve equities, derivatives, or both.

Being “out of the market” means buying GICs or cash. If someone is willing to recommend staying out of the market for a period of time, this is usually a sign that fees are not an issue and are not a motivating factor.

The type of financial advisor you have can play a big role in what results you achieve, choose carefully.