Today’s column for the Keys Weekly.

Island Investing
Cale Smith
June 20, 2009

Q. How does my financial advisor get paid?

A. Many people have no idea how much they pay their broker, planner or advisor every year. There is no shame in asking, though. Wall Street makes it hard if not impossible for many customers to figure out.

It’s important to understand how your advisor gets paid because of the potential conflicts of interest. For instance, an advisor who works on commission may have a different motivation than one who works for a set price.

There are three ways financial advisors get paid:

1. Commission. These advisors are compensated exclusively by commissions made from selling financial products including stocks, bonds, mutual funds or insurance.

2. Fee-based. Advisors in this category are compensated by both commission and fees. For instance, they may receive a fee for developing your financial plan and then receive commissions on the investment and insurance products recommended in your plan. The majority of advisors employed by Wall Street firms fall in this category.

3. Fee-only. Fee-only advisors charge in one of three ways – by the hour, flat fee (to complete a financial plan, for instance), or on a retainer which is usually based on a percentage of assets managed by the advisor for you. These advisors cannot earn any compensation through referrals or based on commissions. There are no conflicts of interest.

In the spirit of full disclosure, I should point out that my firm is currently the only fee-only shop in the Keys. (Way to plant that question, Mom.) That said, we solely provide investment management services and send clients to other experts here in the Keys whenever needed.

Employees of many discount brokerage firms and banks are compensated with a base salary in addition to bonuses given for bringing in new client accounts. Those bonuses can vary significantly based on the products and services sold.

If you’re not sure how much you’re paying for financial guidance, ask your advisor for an explanation. It’s one of the first things you should do to get smarter about investing. Next week we’ll talk more about mutual fund fees, too.

Cale Smith is the portfolio manager for the Tarpon Folio and Gecko Folio. His firm’s website is www.islainvest.com and his blog is www.caleinthekeys.com.