How are Financial Advisors Paid?

Oct 18, 2018

Would you ever purchase a house or car without knowing the full cost up front? Of course not! Unfortunately, in my experience, most clients do not understand how their financial advisors are paid. To the average investor, these fees are complex, buried in fine print, or described so ambiguously that they are hard to decipher.

My goal for this guide is to help you understand the most common ways clients compensate their financial advisors using as little jargon as possible.


One popular way financial advisors are paid are with commissions. The word commission tends to have a negative connotation in people’s minds. Paying a commission means that when an investor purchases a financial product, the advisor is paid by a financial institution instead of directly from the client.

For example, mutual funds commissions are either an upfront load, backend load, or an ongoing internal expense (12b-1 fee) depending on the share class.

The following explains the differences between common mutual fund share classes.

A Shares

When an investor purchases a mutual fund in the A Share Class, they pay an upfront load (commission). Currently, the maximum allowed upfront load for a mutual fund is 8.5%. For example, pretend you invest $1,000 in ABC Mutual Fund (Class A) with a maximum load of 5.75%. In this case, your net investment in the fund is $942.50. The remaining $57.5 goes to your advisor. Note, you pay this upfront load every time you invest into the fund.

Pros –

  • Class A shares have lower annual operating expenses (12b-1 fees) than C shares.
  • For larger investments A shares have breakpoints. For example, a $250,000 investment into a fund may have a smaller upfront load.
  • Class A shares are cheaper than C shares for investors who want to hold on to an investment for a long period of time.

Cons –

  • Due to the upfront load, your contribution is not fully invested.
  • Class A shares are not ideal for people who plan on selling the fund within a few years. This is because it takes around seven years, assuming a maximum load of 5.75%, for A shares and C shares to reach the break-even point. Note, if you qualify for a breakpoint, the break-even takes less time.

C Shares

When an investor purchases a mutual fund in the C Share Class, they do not pay an upfront commission. For example, pretend you invest $1,000 in ABC Mutual Fund (Class C), your net investment in the fund is $1,000. Usually if you sell a C Share within one year, you will pay a 1% CSDC (contingent deferred sales charge) as a penalty. Afterwards, the CSDC goes away. Additionally, the annual operating expenses (12b-1 fees) are more expensive than A shares.

Pros –

  • Since Class C shares have no upfront load, your contribution is fully invested.
  • The total cost of ownership for Class C shares is cheaper than Class A shares before the break-even point. Even if an investor sells within a year and is subject to a 1% CSDC, the cost of ownership under this circumstance is cheaper than Class A shares.

Cons –

  • Typically, there is a 1% CSDC if the shares are sold within a year. However, this goes away after one year.
  • Class C shares are the most expensive share class if held for longer than the break-even point. Note, some mutual fund families convert investors’ Class C shares to Class A shares (with no upfront load) so an investor can take advantage of lower operating expenses.

Institutional Shares (Class I, X, Y or Z)

This share class is available for institutional investors or in advisory platforms where a financial advisor charges a percentage of assets under management. Unlike A shares or C shares, Institutional shares have no upfront or backend loads. Additionally, the annual expenses are cheaper than any other share class because there are no 12b-1 fees compensating the financial advisor. Instead, financial advisors will charge a fee outside the fund.

Assets Under Management (AUM)

Sometimes financial advisors charge a percentage of assets under management. For example, pretend you invest $1,000 in a portfolio with multiple mutual funds. Assume a financial advisor charges you a 1% AUM fee on an annual basis. Under this scenario, assuming no market fluctuations, your financial advisor would charge you $10 a year. Note, many financial advisors have a fee schedule that decreases as you add more assets.

Pros –

  • Under the AUM model, investors directly compensate their financial advisor.
  • Client’s interests and financial advisor’s interests are more aligned compared to the commission model. This is because as an investor’s account balance goes up, a financial advisor makes more money. Conversely, if the account balance is down, a financial advisor is paid less money.
  • The focus of the professional relationship is on advice instead of specific transactions. In my opinion, this is a better suited compensation model for comprehensive financial planning.
  • For investors who make regular changes to their portfolio, this compensation model could be cheaper and easier to manage than commission.

Cons –

  • For investors who never make changes to their portfolio and hold on to their investments for a long time, this compensation model is more expensive than Class A shares.
  • For investors who own conservative investments that will most likely produce low returns, it may be hard to justify an ongoing AUM fee.

Pro Tips – 

  • Usually when financial advisors charge an AUM fee, they use institutional share classes of mutual funds (Class I, X, Y, or Z) within an advisory platform. This means that the fund family does not compensate the financial advisor for using their products.
  • Be cautious if your financial advisor uses non-institutional share classes while charging an AUM fee. This would be “double dipping”. If this is the case, ask your financial advisor if they refund 12b-1 fees to your account.
  • Ask your financial advisor if there are any other transaction costs for buying or selling funds. Some advisory platforms charge a separate fee while others bundle the cost within the AUM fee.


Some financial advisors charge a fixed monthly retainer for financial planning. The amount charged may be based on a variety of factors such as income, assets, or the scope of services provided.

Pros –

  • Client’s interests and financial advisor’s interests are more aligned compared to the commission model.
  • The focus on the relationship revolves around financial planning instead of the investments that the advisor manages.
  • Retainer model might be cheaper than the AUM model if a client wants the advisor to manage a substantial amount of assets. Note, a financial advisor can lower their AUM fee to match a retainer fee.
  • Ideal if a client does not want their financial advisor to manage their assets.

 Cons –

  • In practice, the retainer model might be more expensive than the commission model for clients with fewer assets.
  • In practice, some retainer model firms may charge you up front (est. $500 – $2000) to produce a physical financial plan.
  • If a firm uses the retainer model for financial planning while also managing your investments, you might incur a separate fee.


A small subset of financial advisors charge an hourly rate for advice. This compensation model is similar to attorneys and accountants.

Pros –

  • Client’s interests and financial advisor’s interests are more aligned compared to the commission model.
  • There is more service flexibility if a client only wants help with a couple of specific topics.

Cons –

  • Clients may be less likely to seek out help as their financial advisor would charge them every time they meet.
  • In my opinion, the hourly model is not conducive to a long-term professional relationship compared to the AUM and Retainer models.


There are no perfect compensation models in the financial services industry. Each of them has positives and negatives depending on the type of professional relationship you want to have with your financial advisor.

If you work with a financial advisor, I hope this article encourages you to have a conversation about their compensation at your next review meeting. If you do not work with a financial advisor, but may do so in the future, I hope this article empowers you to do your research to find the right advisor match.

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