How do you pay for your financial advice?
Written By: Peter J. Merrick, BA, FMA, CFP, FCSI
One of the most important things I have learned by being actively involved in the financial industry for over a decade is when you hire your financial advisor, you should be as clear as possible about how you are paying that advisor. Whether you are investing millions or just dabbling in the TSX, it matters how one pays for that financial advice.
Perhaps the financial advice you are getting is free. It may be from reading The Globe and Mail, The Toronto Star or a mutual fund company's promotional investing material. It may be from watching television shows on ROBTV, attending a workshop hosted by your bank or talking to your dentist. However, if you are led astray by the advice you get without paying for it, "free" could turn out to be very expensive.
Although it is an uncomfortable area for many people, compensation is one of the most basic things you must understand when you enter into any professional relationship that involves your money. Whether you are starting a new relationship or reevaluating a continuing one, you could have more options than you realize. And the choice you make could matter more than you realize.
The three basic forms of compensation in Canada:
First, your financial advisor can be paid on commissions generated when you make transactions. One example is the stockbroker, who earns a commission every time you buy or sell a stock or a bond or some other product purchased through the broker.
Second, your financial advisor may be paid according to the growth or shrinkage of your assets. For example, some advisors' fees are a percentage of your portfolio, say one per cent every calendar year. If your portfolio appreciates, so does your advisor's fee (and vice versa).
Third, in a "fee-only" arrangement, you may pay the advisor strictly by the hour. Here, you are buying only the advisor's experience and expertise - and of course his or her time.
Each one of these forms of compensation gives the advisor some sort of incentive.
A financial advisor whose compensation depends on transactions has a financial incentive to generate transactions in your account. A commission based financial advisor might determine that the most appropriate investment for you is T-Bills. But he or she cannot afford to tell you that, because there's no commission involved. A mutual fund salesperson whose compensation includes commissions has more incentive to persuade you to invest in a fund with a six per cent backend load than one with a three per cent load.
A financial advisor whose pay is based on the size of your assets has an incentive to see those assets grow - and of course to persuade you to place a higher percentage of your assets under his or her management. If you pay the financial advisor a straight percentage on assets, then you and the advisor both want to achieve exactly the same thing: profits. Just make sure this doesn't lead you to take too much risk as you pursue high profits.
A fee-only financial advisor has a financial incentive to take as much time as necessary to do the work you need - but no incentive to steer you to any particular product. Some investors balk at paying an hourly fee for something they think they can get free. But in the case of investment advice, doing that can be "penny wise and pound foolish."
Whatever arrangement you prefer, any top-notch financial advisor will be glad to discuss this topic with you quite candidly. Seek an advisor who is willing to be open with you. Remember, advisors are in business to make money, not to take pity on you and do charity work. If your financial advisor dodges this topic or gives vague answers, it is time for you to look elsewhere.
Peter J. Merrick, BA, FMA, CFP, FCSI is a college instructor at George Brown College for both the Department of Financial Services and the Centre for Continuous Learning. He is currently designing the Certified Employment Benefit Specialist program offered in Toronto by Dalhousie University. Peter is also the President of Merrick Wealth Management, a boutique fee-for-service only employee and executive benefit consulting firm. He can be contacted at peter@merrickwealth.com or www.merrickwealth.com or (416) 854-1776.
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