Understanding How Your Financial Advisor Gets Paid

Understanding how your stock broker gets paidInvestors should always inquire with their financial advisor about the fees charged for managing brokerage accounts. In general, there are two ways a financial advisor gets paid: (1) the financial advisor can charge an annual fee on the total assets invested; or (2) a financial advisor can charge commissions on a transactional basis.

Commission-based accounts

In a commission-based or transactional account, the financial advisor charges a commission on every transaction she makes in the account. For example, if a financial advisor buys ABC stock in an account, she charges a commission on that transaction. If she sells ABC stock, she also charges a commission. The amount of the commission can vary. Commissions charged for each transaction do not always appear on monthly statements. Instead, commissions appear on the trade confirmations. To calculate the amount the financial advisor makes on the transactions require a careful review of trade confirmations.

Commission-based accounts might benefit investors who require few transactions. For example, suppose an investor holds stock positions with low cost-bases. Suppose also that these stocks generate a dividend used for income. The investor might want to hold these positions long term, as opposed to selling them and incurring capital gains. In that instance, it might be desirable to hold these positions in a commission-based account (as opposed to fee-based account described below) because the investor has directed the financial advisor to hold those positions indefinitely. And it would make little sense to pay a financial advisor an annual fee on the total assets in an account with few or no transactions.

Note also that financial advisors are not permitted to place trades in an account if the purpose of the trade is to generate commissions as opposed to making securities transactions in the investor’s best interest. This practice is known as “excessive trading;” and in more extreme cases, “churning.”

Fee-based accounts

If an account is “fee based” (also known as a “wrap fee”) the financial advisor charges a percentage of the total assets held in the investor’s accounts.

The fee remains constant regardless of how many transactions are made in the account(s). Fee-based accounts are typically used in accounts that require a high volume of transactions. For example, suppose an investor authorizes her financial advisor to use discretion to make any trade the financial advisor sees fit based on an agreed-upon investment strategy. The strategy might require many transactions. Under these circumstances, a fee-based account might be optimal to prevent incurring exorbitant commissions from an account with high trade volume.

If you believe you are being charged excessive fees in your accounts, it’s important to consult with a qualified professional to assess your situation.