Two common misconceptions need to be cleared up before you can even start to understand how financial planners are paid and which one you should choose.
Planners paid by commissions are inherently bad, evil, selfish, snake oil salespeople.
The word “commission” immediately conjures this very persona and is quickly rejected as a respectable compensation method. Understanding the business model behind commissionable products will bring perspective.
The most common commissionable products sold are annuities, life insurance, long-term care insurance, and disability insurance. Each is sold by an insurance agent who makes a commission on the sale, sometimes a seemingly large one.
Example: Agent sells someone a $1M annuity. The agent might receive a $70K commission check from the insurance company a month later and never again.
If you actually learn how much the agent is getting paid – which you most often don’t – your reaction might be “Whoa! That’s waaaaay too much money for that sale!”
Let’s put that in perspective for a moment.
First of all, this is how insurance companies sell their products.
Insurance companies have agents out explaining these products to consumers and making those sales. This is these companies’ sales and marketing budgets. These are valuable products that can play a significant role in your planning. Just because the product is commissionable doesn’t make it or the agent bad or evil.
Second, “you didn’t pay the agent.”
The insurance company did. Your entire $1M is still in your account growing. Now, I put that in quotes because your mom is right – there’s no free lunch. You likely made a commitment to keep your money in that product for as many as 20 years, and any premature closing of that product results in a financial penalty to you. But so long as you keep the product – which should have been part of the strategy in acquiring it – you didn’t pay anyone out of your pocket to get it.
Third, understand the math behind the business structure.
If you place $1M on a planner’s wealth management platform and you get charged 1% for its management every year, that financial professional is going to make $10K the first year and future years, assuming that the assets don’t increase (or only increase the 1% to pay the professional). After 10 years, you’ve paid that person $100K.
All of a sudden that $70K commission payment is looking pretty competitive. Here’s a real twist for you: An advisor who might only make $70K in commissions might instead encourage you to place those assets under management instead. If you are worried you were getting “sold” a product because of a commission, you should be equally concerned that you’re not being sold the product because the commission is lower than the income on the longer-term money management relationship!
Fourth, commissions might be the best way to compensate a planner.
For many people, having a salesperson get compensated by commission is the most cost-effective way for them to get exactly what they need. Many people with lower asset levels and/or lower incomes can get help within their budgets.
Lastly, if you like the product, compensation doesn’t matter. You probably got something very attractive out of the product you chose, typically guarantees of some sort (guaranteed income, death benefit, etc.), and/or you got some financial peace out of it (won’t run out of money before you die, can pay for long-term care expenses, etc.). Again, just because it was a commissionable product doesn’t make the product or its salesperson bad or evil.
Paying fees for financial planning hurts your investment returns, so avoid paying fees.
This is what the index fund industry has been touting for years. By “index funds” I mean funds that are designed to mimic the returns of the stock and bond indexes, which I would have included all “target date” funds which are based on a year “when you will retire.”
The logic goes like this: No one can beat the market, so why pay for that? Just buy index funds! You’ll be fine! Or like this: If you pay your advisor 1% on $500K over 20 years at 8%, you’ve given up almost $250K! Don’t do that! Invest in index funds!
Here’s what that logic is missing.
Fees only matter in the absence of value. This logic above presumes that are getting zero value for that 1% fee. If that fee is more than made up for in tax advice or savings, more strategic money management that reduces your losses, or better planning or discipline to improve your life or help you achieve your desires, what better to spend your money on?!
Free up your time. If you want to spend your evenings and weekends doing your own financial planning, do so. Or think about it this way: If that 1% fee allows you to enjoy your loved ones and your hobbies, that’s money well-spent.
On a related note, don’t collapse performance with planning. Often investors think “If I’m paying for someone to manage my assets, I should get better returns.” This is only true if you’re hiring a professional to “beat the market.” Planning is a completely different exercise and skill set. Make sure you understand what you’re paying for.
Ideally, hiring a planner increases your assets or saves you money such that the impact of the planner’s fees on your overall financial situation is the same or better than using index funds. Beware, though, that how the planner’s fees ultimately impacted your situation must be evaluated over a market cycle, which is usually a five to 10-year window.
Index funds are not the only answer. Index funds have their place, but they should be implemented in concert with your time horizons, the type of accounts you have, your tolerance for losing money, your schedule of withdrawals, your age, any required minimum distributions, etc. Your life is not generic or cookie cutter. Your investments likely shouldn’t be either.
Then don’t buy coffee or vacations. If you’re fixated on the loss of $250K over 20 years’ time, then you probably ought to stop all your unnecessary spending. An argument can be made that you don’t need a $5 coffee every morning ($90K over 20 years) or spend $5K on vacations every year ($250K over 20 years). Not spending money on those items would save you money, too.
Let’s face it, we all spend money on what is important to us. If having professional financial planning advice is important to you, then build that fee into your spending plan, find a planner you like, and buy those services.
Pick a Planner With a Compensation Structure You Like
There are professional, skilled financial planners everywhere, and they earn their money in a variety of ways. Don’t let the word “commissions” have you pass on hiring a good person, and don’t avoid planning fees because you’re convinced you will lose money. Instead, ask lots of questions, understand what you’re buying, and hire someone you like, trust, who does good work, and talks openly about how they make money and discloses that amount freely.
If you want to explore these two misconceptions more, please reach out. If you have other financial concepts which you would like me to explain, please send them my way.
About the Author:
Jessica Lanning JD, CFP® brings focus and perspective to your individual financial needs to identify your opportunities for investment and wealth. Regardless of what you’ve done before or what “mistakes” you think you’ve made, Jessica can help get you back on track quickly and safely. As a former practicing lawyer, she brings a comprehensive approach to legal, tax, and financial challenges so that her clients can enjoy peace of mind. A huge proponent of conscious decision-making, Jessica makes sure her clients are educated and informed so that they make sound decisions with clarity and confidence.
Lanning Financial Inc. is a registered investment adviser. The information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.