How is your advisor paid?

Advisors guide you through the complicated realms of finance and investments.

They’re responsible for management of your assets and your financial plans — both of which are critical for your future.

But do you know how your advisor is compensated?

Advisors can be paid in many different ways. The two most popular are commission or fee-based, but many advisors use hybrids unique to their firms.

About commission

While you’re probably familiar with the term commission, it has different connotations in the investments industry; and refers to the many different fees that can be charged based on products an advisor sells.

One of those is a sales commission on mutual fund purchases. These are called loads, and there are different types. For instance, there’s a one-time front-end load that’s paid at the time you purchase a mutual fund (it’s generally a percentage of the amount you invest). This money is paid to the investment firm, and your advisor also receives a commission.

Meanwhile, a back-end load is a fee you’re charged when you sell a fund. The percentage of this fee declines each year you hold the fund, and for some funds can zero out if you hold onto them long enough.

Another type of load is called a surrender fee on an annuity. When you purchase an annuity, or certain funds with an annuity component, the product dealer pays your advisor a commission. But if you sell the product before the prearranged maturity date, the company may not have earned enough money to pay off the commission. So the dealer charges surrender fees to recover that cost.

About fee-only

When your advisor uses a fee-only structure, direct payments from clients are her only source of compensation.

Charging a fee based on an annual percentage of your assets under management (AUM) is one type of fee-only compensation. It can range from 0.5% on the low end to 3% on the high end. The more services offered, generally, the higher the fee. If your advisor provides financial planning along with financial management, the fee will be higher.

Or, your advisor might charge an hourly rate, similar to a lawyer or accountant. Advisors with more experience often charge higher rates. This structure can be a good option if you’re paying only for advice, while implementing the actual transactions related to the financial plan on your own.

If your advisor has been hired for a specific project, like creating a retirement plan, she might charge you a flat fee for the duration. Or, if the investment is ongoing, like stock options, she might charge a quarterly or annual fee to manage those funds.

About fee plus commission structures

Advisors can also charge a combination of commission and fee-only. In these cases, the advisor could receive fees from you in addition to commission from a product dealer.

Some argue there’s greater objectivity in fee-only compensation, since your advisor won’t receive incentives from dealers for selling their products.

However, investors with smaller portfolios may not be able to afford fee-only; commission is generally a one-time charge, while fees are ongoing each year.