Compensation changes people’s behavior. Before choosing a financial advisor, it is very important for you to fully understand how they are compensated to ensure that your advisor’s interests are aligned with yours. There are three key parties in a financial planning relationship. You, the advisor, and the product company. The financial advisor can be compensated in one of the three ways. Commission only, fee based, or fee only.

Commission only financial advisors, just like the name implies, they get paid every time they make a sale. It works like this: The advisor provides you a recommendation. You follow the recommendation and buy the product from the product company. And the product company pays the advisor a commission for the sale. Of course, more sales lead to higher commission, and certain products pay higher commission than others.

Fee-based financial advisors can choose whether they want to get paid through commissions, fees, or both. And you don’t necessarily know how they get paid when they give you a recommendation. They are not required to disclose the information to you. For instance, they can charge you a fixed percentage of fee to manage your portfolio, but they can also make a commission when they convince you to take money out of that portfolio to purchase one of their annuities. Fee-based financial advisors can also receive additional compensation from product companies for keeping your assets with them.

Fee-only financial advisors receive no compensation from the product company. They only receive a fee from you for providing advice and managing your portfolio. Therefore, they have no incentive to recommend you one product over the other. It is the only compensation structure that’s truly free from any conflict of interest.

Because fee-only compensation structure is preferred by more and more clients, many fee- based financial advisors like to represent themselves as fee only. Wall Street Journal columnist Jason Zweck had an article on this. The article is titled, Fee Only Financial Advisors Who Don’t Charge Fees Alone. In this article, he discusses certified financial planners who falsely market themselves as fee- only when they actually receive compensation from product companies.

A good way to make sure that your financial advisor is a true fee-only advisor is to visit NAPFA.org, because only true fee-only certified financial planners can be a NAPFA registered advisor. Of course, compensation structure is only one of the many factors you should consider before choosing a financial advisor. But it is with no doubt. one of the most important.

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