When Advisor Commissions Are Better Than Annual Fees

Fee-only isn’t the only way to go.

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Commissions have become a dirty word in the advisory world, but I’m not sure they are as evil as everyone makes them out to be. There are several ways financial advisors can charge for the advice they give or the recommendations they make.

One method is to charge an investor a fee based on the percentage of assets under management. This fee can and should be adjusted up or down depending on the services that the advisor provides. The benefit to an investor is that as his or her assets grow, the advisor makes more money. If the account goes down in value, the advisor makes less money. There is obviously an incentive for the advisor to grow the assets under management and minimize losses.

This is a pretty good deal for everyone, and a lot of investors and advisors prefer this fee structure.

[See 4 Ways Your Financial Advisor Should Help You.]

Another common compensation method is the commission model, which is generally clear-cut. Advisors are compensated by collecting a fee (commission) from the client to conduct a transaction. When an investor decides to buy or sell a security, the advisor receives a commission regardless of whether the client profits or not. This is a good deal when you are planning to buy and hold an investment for a long time.

Different assets can be best served by different types of advisors. For example, a lot of advisors like to recommend investment strategies that include a municipal bond portfolio. This is fine, except when it is not. However, for wealthy individual investors, I don’t think it’s ever appropriate to hire a bond manager and pay them (and the advisor) a fee to manage something that should be bought and held to maturity.

If an investor’s financial plan calls for a portfolio of municipal bonds, it makes sense to pay an advisor a commission to build a portfolio of municipal bonds. It costs less to buy a complete portfolio of laddered bonds and replace them as they mature through a commission structure than to pay a manager an annual fee to simply babysit the bonds.

This is the same reason you pay a commission when you buy a house. Would you ever pay an annual fee to a real estate agent who has nothing to do with your home for the 10 years you live in it?

David B. Armstrong CFA, is a Managing Director and co-founder of Monument Wealth Management in Alexandria VA, a full service Private Wealth Planning and wealth management firm. Monument Wealth Management is backed by LPL Financial, the independent broker-dealer and Registered Investment Advisor. He has been named one of America's Top 100 Financial Advisors for two straight years by Registered Rep magazine (2009 & 2010) based on asset under management. David and Monument Wealth Management can be followed on their blog at "Off The Wall", their Twitter account @MonumentWealth, and on their Facebook page. Member FINRA/SIPC.

*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for individual. To determine which investment is appropriate please consult your financial advisor prior to investing. All performance references is historical and is not guarantee of future results. Municipal bonds are subject to market and interest rate risk if sold prior to maturity. Bond value will decline as interest rate rises. Interest income may be subject to the Alternative Minimum tax. Municipal bonds are federally tax free but other state and local taxes may apply. Securities and financial planning offered through LPL Financial, Member FINRA/SIPC.