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Conflicts of Interest

A GOOD ADVISOR could prove to be your financial salvation. But it doesn’t always work out that way. The risk: Your advisor is either incompetent or puts his or her interests ahead of yours.

With any luck, after spending time perusing HumbleDollar, you will know what prudent investment advice looks like, so you can tell if an advisor is pushing some dubious strategy. But you also need to be alert to the potential conflicts of interest that come with the four different methods of compensating an advisor:

Commissions. If advisors are paid through commissions, they have an incentive to get you to trade more frequently and to buy higher-commission products.

Percent of assets. If an advisor is compensated by charging, say, 1% of the assets that you have invested, that helps to align your advisor’s interests with yours because you both benefit if the account grows in value. Nonetheless, it does create subtle conflicts. For instance, advisors might dissuade clients from taking money from their investment account to pay down debt because the shrunken account would generate less in fees. Advisors might also push clients to claim Social Security early, so the investment account shrinks more slowly in the early years of retirement and hence generates larger fees. Looking for an advisor who charges fees, not commissions? You might try the National Association of Personal Financial Advisors, located at NAPFA.org.

Hourly fee. Only a small number of advisors work on an hourly basis. There is a risk they will drag out the work, costing clients more than is necessary—and there’s a risk you won’t get as much value as you expected, because you don’t have the necessary discipline to follow through on your hourly advisor’s recommendations. But the potential financial loss would be relatively modest. Many hourly advisors are part of the Garrett Planning Network. You can search for members at GarrettPlanningNetwork.com.

Flat monthly or annual fee. Again, only a small number of advisors charge flat monthly or annual fees, though this includes some of the fast-growing online advisors. The risk is that, even if you get a lot of value in the initial months, your need for help diminishes over time and yet you keep paying that regular fee. But as with the hourly arrangement, the risk seems modest and is more than offset by knowing precisely what you’re paying.

The method of compensation and the total cost are crucial. But price isn’t the only consideration. You also need to ask tough questions, so you’re confident an advisor is likely to provide good advice.

Next: Interviewing Advisors

Previous: Fee-Based Accounts

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