Many investment advisors are paid by fees these days. However, you might be better off with an advisor who gets compensated by the traditional method of charging commissions.
Suppose, for example, you invest via mutual funds. Many funds have different classes of shares, with varying sales charges. You might invest $5,000 in a mutual fund’s “A” shares, which could have a 5.5 percent front-load. You’d acquire $4,725 worth of shares while a $275 sales commission (5.5 percent of $5,000) goes to your investment advisor.
Why would you pay $5,000 to buy $4,725 worth of fund shares? Because you’re paying the advisor who recommended this fund to you, and you trust this advisor to provide sound recommendations. If you hold onto this fund for many years, you’ll pay little or no additional amounts to your advisor, regarding this fund. Thus, paying upfront commissions may be a good choice is you’re an investor who uses a professional’s advice to build a portfolio and then holds onto what you’ve bought for the long term.
If you hire an investment advisor, you may pay fees based on assets under management. Suppose, for example, you have a $300,000 portfolio and the advisor charges an annual fee of 1 percent. You’d pay $3,000 a year–$750 every three months, assuming no change in the size of your portfolio.
Advantages: This fee includes all transaction costs so advisors won’t be tempted to trade your portfolio heavily and pocket sales commissions. With this method, your advisor’s compensation will be higher if your portfolio gains value so your advisor will be motivated to manage your money well.
Drawbacks: You pay a substantial amount each year with this method. If you set up an investment plan and hold onto the same assets, in this example you’ll pay $3,000 each year–you’ll pay even more, if your portfolio grows–even if you’re not receiving ongoing advice.