How Investment Pros Get Paid
When you're choosing among investment professionals, it's important to understand how they'll be compensated for their services. Typical compensation methods include:
- An hourly fee
- A flat fee
- A commission (or other sales charge) on the investment products they sell you
- Salary, with no commissions on product sales
- A percentage of the value of the assets they manage for you (often called "AUM" for "assets under management")
- Some combination of fees and commissions
You should ask every professional you interview to explain his or her fees and to put that information in writing. In fact, some firms provide a printed schedule of fees when you open an account.
Understanding fee arrangements is also essential in evaluating a professional's independence in making investment recommendations. That's why it is always a good idea to ask whether the person—or the person's firm—will receive any additional compensation for selling you a particular product, service, or type of account. Some companies offer incentives for selling certain products.
Sometimes fees are obvious like the commissions many investors pay to buy or sell a stock. Other fees are less clear. With bonds, for example, the price you pay to purchase a bond might be higher than the price the dealer handling the transaction paid—and this difference is known as a mark-up. And with mutual funds, some charges that compensate your investment professional or firm are baked in to the fund’s expense ratio. In other words, they aren’t charges you pay directly—but these fees do ultimately reduce your returns.
Be careful about doing business with a professional who doesn't want to discuss the fees and other charges that apply to your account and to the securities you buy or sell. Remember, even if you do not have to pay a fee for a particular transaction the professional may still receive some form of compensation.
All fee structures have advantages and disadvantages. For most investors, the best fee arrangement is the one that costs you the least money and makes you the most comfortable that you're making progress toward achieving your goals.
For example, in deciding between a commission-based brokerage account and a fee-based account, which may entitle you to additional advice or services from your investment professional, you may want to consider how much and what type of advice you need, if any, as well as how often you intend to trade. If you trade fairly often, you may save money using a fee-based account, but that's less likely to be the case if you trade only rarely.