Have you ever wondered how financial advisors get paid?
What are some of the implications in the way they get paid?
Let’s take a closer look into the financial industry, understanding how the remuneration structures may affect the advisory you receive. Let’s explore the 4 most common sectors:
Banks
Insurance Agencies
Fee-Based Advisory
Robo-Advisory
Each sector presents a unique structure of compensation, reflecting the intricate interplay between services and advice rendered and how the remuneration structure may influence their advisory.
Banks
Bankers are often compensated through a transactional model, with earnings closely tied to the volume and frequency of transactions facilitated for clients which comes with a processing or upfront fee.
Banks often come with their own database of clients, this model encourages a focus on the volume of transactions, underscoring the significance of client engagement and the promotion of financial products within the bank's portfolio.
Bankers’ remunerations often come with a fixed salary and a percentage of commission from the revenue earned via transactions. With monthly or quarterly revenue KPI to hit, the nature of the pay structure drives bankers to conduct as many transactions as possible within the stipulated time frame to hit the KPI.
The compensation models in the bank do not give the bankers incentive for continuously reviewing your portfolio, providing advice to ensure you are on the right track because it takes time away from them to hunt for new businesses, very often the reviews that bankers conduct come with transactions involved which contribute to their KPI.
If a banker does not hit their KPI, they will be asked to leave as it is not commercially viable for the bank to keep the banker. Which begs the questions -
“Can I trust my banker’s advice?”
“Is this transaction truly the best way to approach my portfolio?”
“Is this product the most cost effective way to manage my portfolio?”
Insurance Agencies
Operating as a self-employed individual, insurance agents typically operate on a commission-based structure, earning a percentage of the premiums paid by clients for insurance policies.
This framework incentivised agents to sell products that come with a higher premium. (e.g whole life policies, endowment, and investment-linked policies (ILP)) over cost-efficient products such as term policies, or exchange-traded funds (ETF) to address your wealth planning needs.
The arsenal of products within their advisory scope will likely exclude many other cost efficient instruments such as corporate bonds, government bonds and direct unit trusts because it does not give them the same remuneration over selling an insurance product.
For some newer agent’s in the industry, remuneration comes with a “monthly basic pay” with a clause requiring them to hit their sales target. If the target is not met, they may have to repay a portion of the “basic pay” at the end of the agreement.
This model forces the agents to focus on driving product sales with the highest premium, possibly introducing some conflict of interest.
Fee-Based Advisory
Fee-based advisors stand out in their approach, charging a flat fee or a percentage of the total assets under administration. This remuneration model aligns the advisor's success with the growth and performance of the client's portfolio, emphasising a shared interest in achieving long-term financial goals and sustained asset appreciation.
However, fee-based advisors may come with a flat fee even if there are no transactions done, because their services are charged based on time spent on preparation to ensure that the advice you receive are of quality and also to the best of your interest.
Any portfolio rebalancing with fee-based advisors usually does not come with any additional switching fees (brokerage fees may still apply) and over the long term, it is more likely that you will be working with an advisor who is on your side, providing quality advice to help you achieve your financial goals.
Robo-Advisory
The emergence of robo-advisors has revolutionised the financial landscape, introducing a technology-driven approach to investment management.
Robo-advisors offer automated template portfolio management, catering to individuals seeking a streamlined and cost-effective investment solution.
The challenges that come with a robo-advisor is the lack of human touch and inability to address any personal concerns you may have as a client.
It is mainly an execution platform suitable for individuals who want to DIY their investment plan, but comes with the downside that there is no advisory given when there is volatility in the financial markets.
Navigating through different market conditions with actionable plans is a critical aspect of the investment journey that can be provided by a human advisor. It involves adapting a client's investment approach to align with their ever-changing life stages, whether it be mitigating risks in their portfolio or incorporating factors like the arrival of a new-born child or changes in financial capacity.
As an individual with a clear understanding of the remuneration structure and incentives driving each sector, you as a client can then make an informed decision on which aligns best with your goals and which you should engage to be your partner in your financial journey.
This is an article by InvestAble
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