Financial advisors can charge their clients fees, commissions, or some combination of the two. Commissions can be problematic due the conflicts of intrest they create.
If an advisor gets paid through commissions, they are motivated to “sell” you financial instruments that pay them the highest commissions. These are often not the instruments that are in the best interest of the client. It is not uncommon to find the highest commissions tied to some of the worst products, such as variable annuities. These advisors may also have special relationships with certain fund companies, causing them to steer their clients into those specific funds, whether they have a good track record or not. It is important to remember that people generally work for the person who pays them. An advisor who gets paid through sales commissions from fund companies is working for the fund companies, not the client.
Fee-only advisors, on the other hand, are compensated exclusively by the client, and therefor they should be working for the client. There is little room for the types of conflicts of interest that exist with commission based compensation. Fee structures are generally based on either a flat fee, or a percentage of assets under management, or some combination of the two. Either method is generally acceptable, and a fee-only advisor is much more likely to be focusing on client’s best interests.
It is worth mentioning one potential conflict of interest that exists with fee-only advisors who charge fees based on a percentage of assets under management. They may be motivated to encourage their clients to keep assets invested verus withdrawing them to pay down debts, as this will keep their compensation higher. On the other hand, they are also motivated to invest their clients’ assets wisely to increase their compensation as the account values grow.