If you have ever been involved in a financial transaction with a broker, adviser, or planner, the following questions may have crossed your mind...

"Is this product in my best interest, or in their best interest?"

"How will my adviser be compensated in this transaction?"

"Is there anything that might be influencing their recommendation toward this particular product or service?"

If so, you are not alone. The financial services industry and its compensation system is not as clearly understood as other industries. By knowing the “hows” and” whys” underneath the products and services offered, you may be in a better position to make smart choices with your money.

It goes without saying that each adviser deserves to be compensated in some way for the service and products that they provide consumers. Very few of us are naive enough to believe that they work on a pro-bono basis.

Understanding how advisers and agents are compensated can give you, the consumer, a better basis for understanding what may be right for you, or what could be a product recommended in self-interest.

Types of Compensation

Compensation in the financial services world can mostly be reduced to fees or commissions.

Fees are generally paid by the client directly to the adviser and Commissions are generally paid by a product company to the adviser.

As a general rule (but not necessarily always the case) commissions are paid up front to the adviser at the time of the sale, whereas fees can be paid on a one time or recurring basis.

Which is Better, Fees or Commissions?

The age old question among both agents and consumers is whether it is better for your adviser to get paid commissions from the sale and recommendation of financial products, or based on the fees paid directly by the client.

Although this issue is not the focus of this article, I will highlight where conflicts of interest can occur with either model.

Conflicts of Interest

A conflict of interest occurs when what is in the adviser's best financial interest is not what is necessarily in the client's best financial interest.

Unfortunately, conflicts of interest in the financial services industry are common, regardless of the compensation model.

Let's look at a couple of common examples:

Property and Casualty Insurance: The commission that property and casualty insurance agents generate (such as auto and home owners insurance agents) is normally based on the amount of premium that the client pays. By definition, if an agents commission is based on premium dollars, an inherent conflict of interest arises if their goal is to reduce your premiums and save you money.

Life Insurance: Compensation for life insurance sold is first based on the type of life insurance sold. Permanent life insurance can offer agents a higher level of compensation than term life insurance. If permanent life insurance is a better product and always a better choice for consumers, then there is not an inherent conflict of interest.

Some would argue that permanent life insurance is not a superior product for most families. If that is true, the agent now has a conflict of interest in which type of life insurance he or she sells.

Even if term insurance is being used, the compensation is based on the total annual premiums. That does not remove a potential conflict of interest to help clients save money, if the agent will be compensated less for this act.

Investments: There are a multitude of investment products as well. Some of these products are commission based. The structure of many commissionable investment products can have inherent conflicts of interest for the agent and consumer as well.

Some categories of investment products pay a larger up front commission, with little after the first year. This has the potential to disincentivize an adviser to update the investments after the initial sale is made.

Other categories of investment products offer a modest commission, but require the client to maintain a specific holding period before a back end load is eliminated. This can also disincentivize an adviser to update investments if the client will incur a penalty to move the investment.

This is not to say that fee-based investment advice is without conflicts of interest either.

Fee-based investment advice normally compensates the adviser on a recurring basis, tied to the current balance of the investments under management. For a fee-based adviser, the loss of investment assets equals the loss of income. So the recommendation to use investments to pay off a mortgage or invest in a business may be met with greater resistance from a fee-based adviser, versus a commission-based adviser who has already received a bulk of their compensation

So How Can I Find a Financial Advisor I Can Trust?

Finding an advisor that you can trust doesn't necessarily mean that they have to be fee-based or commission based. They should, however, be open and honest about how they are compensated and how this system could present conflicts of interest in the advice that they give.

Make sure to ask these direct questions whenever interviewing a potential adviser. If you have never discussed the issue with your current adviser, take the time to explore it with them to ensure you are comfortable with their answers.


By Derrik Hubbard, CFP
Read our Christian Financial Planning Blog