Answers to Your Burning Advisor Questions, Part 3: Understanding Fees

In Part 3 of our series on questions you should ask your financial advisor, we look at how you should discuss the potential costs of your advisor's services.

In the first two parts of this series, we looked at the kinds of answers you might look for when interviewing an advisor about her qualifications and experience, and then the answers you’ll want to look for regarding the services provided. Here, we’ll look at compensation.

The original column included the following questions you may have around compensation:

• How are your fees calculated? Are you commission-based or transaction-based?

• Are you held to a suitability standard or a fiduciary standard?

• Is there a minimum level of investment I need to meet? Or a minimum level of fees I will be required to pay?

• Are there potential conflicts of interest I need to be aware of? Incentives to sell one company’s products at the expense of products that may work better for me?

No Better, No Worse: Just Different

Transaction costs are expenses incurred when buying or selling securities, and working with an advisor will almost always involve costs in some form. There are many different mechanisms by which advisors make money. Two of the most common are commissions and fees. These transaction costs are important, because they can eat significantly into investors’ potential returns. Advisors who don’t have the investor’s best interests at heart can take advantage of the fact that many people don’t necessarily pay very close attention to how much they’re paying in transaction costs.

Because there are many different ways fees and commissions can be structured, there are no hard and fast rules on how much you should expect to pay or what kind of fee structure will be most beneficial to you. The key is to make sure you’re paying close attention to fees, both before and after any transactions you’ve agreed to. Ask your advisor point-blank what the charges for any investment will be, how often you’ll be subject to them, and if there are any factors that can increase or decrease fees. Be vigilant, be inquisitive, and don’t accept vague or unsatisfying answers.

Commission-based advisors often come under more scrutiny, because there can be more opportunity to engage in nefarious business practices if there are a lot of seemingly small, transaction-based costs piling up. But the simple truth is that even non-commission fee structures can be exploited. Keep a close eye on all payments, no matter how small they may seem compared to your portfolio.

The Times, They Are A-Changin’

Earlier this month, the Department of Labor released a new “conflict of interest” rule with the express purpose of enhancing the protection of investors. The new rule will expand disclosure requirements for advisors and brokers, and require them to put the best interests of clients ahead of their own. While the rule was proposed with good intentions, it may impact your current payment structure. The provisions of the rule won’t be fully in place until the beginning of next year, but if you have questions about it, you should reach out to your advisor.

We’ll look more in depth at the new conflict of interest rule soon. For now, be aware that the rule has been issued, and expect to be contacted by your advisor, who should within a few weeks be capable of explaining whether the rule will necessitate any changes in his or her compensation structure.