When looking for a financial advisor, make sure you ask how they’re compensated. Some earn a commission, while others might be fee-only or fee-based. And then there are advisors who charge a percentage of your investment. When choosing an advisor who works off commissions, there are several factors at play that you should be aware of.

Financial Advisor Commissions, Explained

While some financial advisors take commissions when their client simply opens an account, others earn them from selling you a specific financial product. In that case, the advisor gets paid by the corporation, such as an insurance company, that issues the product.

There are several forms in which an advisor can receive their commission. These can include upfront sales fees; loads on mutual funds; commissions from annuities or other insurance products; a surrender charge on an annuity; or trailing commissions, in which the client pays a fee for each year they own an investment. 

To protect consumers, there are rules and standards that financial advisors must follow. If an advisor is a licensed fiduciary, for example, then by law they must prioritize your interests before their own and avoid any conflicts of interest in recommending products. 

Similarly, registered advisors who observe the suitability standard — regulated by the nonprofit Financial Industry Regulatory Authority (FINRA) — are held to a lesser standard. Though they are required to sell financial products that suit a client’s needs, those products don’t necessarily need to be the very best ones for the client. In other words, as long as an advisor has a “reasonable basis to believe” something is in your best interest, they can sell you whatever product they want, even if they receive a kickback from the company hocking it.

Sources of Commissions

Financial advisors can receive commissions from a range of investment products, including:

• Insurance products: There can be big incentives associated with selling insurance products. Some advisors may see commissions as high as 70% of the first year’s premium. After that, they may receive an additional 3% to 5% of the premium per year as long as the policy is active.

• Mutual funds: Typically, advisors making commissions on mutual funds get paid via a trailer fee. This commission can range from 0.25% to 1% of the assets invested in the fund on an annual basis. The advisor may receive this fee as long as the investment remains in the mutual fund.

• Annuities: Annuity commissions are generally built into the price of the contract. Commissions usually range anywhere from 1% to 10% of the entire contract amount, depending on the type of annuity. For example, fixed-indexed annuities generally earn advisors a 4% commission.

The Case Against Commission-Based Advisors

There are a few disadvantages to working with a commission-based financial advisor. For one, they may recommend you move forward with a product because it benefits them financially. While the product may yield a greater return, it might not be suitable for your risk tolerance and financial goals. If your financial advisor relies on commissions to make a living, this may put your best interests in jeopardy.

As a client of a commission-based advisor, you also risk being misguided, resulting from the advisor’s reluctance to offer anything unrelated to the product they want to sell you.  

Finally, since they are receiving a one-time commission for the sale, there’s not much incentive for the financial advisor to monitor the account in a careful manner, since there is no financial gain for them in the long run. So unless you are buying a product that doesn’t require regular transactions, you may want to find an advisor who’s amenable to maintaining an ongoing dialogue with you.

Also of note: Financial advisors who work for brokers or insurance agencies are often more concerned with sales. So while they may abide by the suitability standard, their allegiance is to their employer’s bottom line — not to you. 

One good thing to remember, though, is that most financial advisors don’t receive payment from commissions alone. If an advisor has a certification or designation, they may have an independent fee structure. Additionally, some certifications and designations have strict guidelines that mandate the financial advisor to act in the best interest of their client.

The Bottom Line

While not all commission-based financial advisors are unethical, some may prioritize their desire to make money from a sale over a client’s best interest. That’s why it’s important to ask a potential advisor how they earn their money — and make sure you’re comfortable with their fee structure — before signing on.

Tips for Finding a Financial Advisor

• If you don’t already have one, finding an advisor who fits your needs doesn’t have to be difficult. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.

• Consider a few advisors before settling on one. It’s important to make sure you find someone you trust to manage your money. As your consider your options, these are the questions you should ask an advisor to ensure you make the right choice.

• Worried about the costs of hiring a financial advisor? Consider using a robo-advisor instead. Robo-advisors typically require less investments and charge lower fees, making them a better option for people with less money to invest.

Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/Drazen Lovric, ©iStock.com/kali9

The post What Commissions Do Financial Advisors Earn? appeared first on SmartAsset Blog.