What it means
Financial advice is paid for in one of three broad ways: commission from providers, fees paid directly by the client, or a mixture of both. A commission-based advisor sits in the first camp, earning an upfront payment when a product is sold and often a smaller ongoing trail payment for as long as the client keeps it.
The money still comes out of the client's pocket, just indirectly through the product's charges. The appeal is access.
Someone with $30,000 to invest may be unwilling or unable to write a cheque for $2,000 of advice, but they will happily take advice that appears free, so commission structures reach savers who would otherwise get no help at all. For the advisor, commission also matches income to activity in a way that supports a business built on smaller clients.
The problem is the incentive built into the arrangement. If product A pays 5% and product B pays 1%, the advisor's income depends on a choice the client cannot easily evaluate, and the pull towards recommending action over inaction is constant.
Regulators in the UK, Australia and elsewhere have responded by banning or restricting commission on investment advice, while commission remains standard for insurance, protection and mortgage products. Standards of care differ too.
A commission-based advisor may operate to a suitability standard, meaning the recommendation must be appropriate, whereas a fee-only adviser more often works under a fiduciary duty requiring them to put the client's interests first. Both can give excellent advice, but the safeguards against a poor recommendation are not the same.
The practical nuance is that commission is not automatically expensive. For a client who buys one life insurance policy and holds it for twenty years, a one-off commission can cost far less than two decades of annual fees.
The mistake is assuming the answer is the same for a portfolio that will be reviewed and adjusted every year.
In practice
Real-world examples.
Example
A couple in their thirties buys $500,000 of level term life cover through a commission-based advisor. They pay no separate advice fee, the insurer pays the advisor roughly $1,100, and because the family will simply keep the policy for twenty years the arrangement costs them very little in practice.
Example
A retiring engineer with a $650,000 pension pot is recommended an annuity paying the advisor 3.5%, or $22,750. She asks what a fee-only review would cost, is quoted $3,500 for a one-off recommendation, and uses that comparison to negotiate a partial rebate of the commission.
Example
A small business owner arranges a $1,200,000 commercial mortgage through a broker paid 0.4% by the lender. The broker's incentive is to place the loan somewhere that pays, so the owner independently checks two direct lender quotes before proceeding and finds the broker's option is genuinely the cheapest.
Think of it
“Commission-based means paid by selling products-potential conflict of interest.
Formula
Calculation
Total cost under a commission model = (Investment amount x Upfront commission rate) + (Invested balance x Annual trail rate x Years held), and this can be compared with a fee model of Total cost = Portfolio value x Annual fee rate x Years held.
Take a client investing $200,000. A commission-based route charges a 5% front-end load, so $200,000 x 0.05 = $10,000 goes to the advisor and $190,000 is actually invested, plus a trail commission of 0.25% a year on the balance, which is $190,000 x 0.0025 = $475 in the first year.
A fee-only alternative charges 1% a year on $200,000, which is $2,000. In year one the commission route costs $10,000 + $475 = $10,475 against $2,000, so it looks much more expensive. Holding balances flat for simplicity, after six years the commission route has cost $10,000 + (6 x $475) = $12,850 while the fee route has cost 6 x $2,000 = $12,000. After seven years the figures are $10,000 + $3,325 = $13,325 against $14,000, so the commission route becomes the cheaper option somewhere between years six and seven. Holding period, not the label, decides which is better value.Case study
Seen in the real world.
The following is a fictional, illustrative story. Marla Devane, an invented dental practice owner, inherited $340,000 and was introduced to an advisor at Ridgeview Financial Partners, another invented firm, who recommended a bundle of funds carrying a 4.5% initial charge. That meant $15,300 in commission and $324,700 actually invested on day one.
Marla asked two questions that changed the outcome: how the advisor was paid, and what alternative products had been considered. She learned that a near-identical set of index funds available through a fee-only adviser carried no initial charge and an ongoing advice fee of 0.75%, which on $340,000 is $2,550 a year.
She chose the fee-only route for the investment portfolio but kept the commission-based advisor for her income protection and practice insurance, where commission was the market norm and the products would be held unchanged for years. The illustrative point is that commission is not automatically wrong; it is simply a cost structure, and the only sensible response is to ask how the person advising you gets paid before you take the advice.
Watch out
Common mistakes.
- Believing commission-based advice is free. The cost is embedded in the product's charges, so the client pays it, just without seeing an invoice.
- Assuming any commission means bad advice. Plenty of commission-based advisors give sound recommendations, particularly in insurance, where the alternative for many clients is no advice at all.
- Comparing only the upfront charge. Ongoing trail commission, exit penalties and the product's own annual charges often matter more than the initial percentage over a long holding period.
Questions
People also ask.
What is the difference between commission-based and fee-only advice?
Commission-based advisors are paid by product providers when a product is sold, while fee-only advisers are paid directly by the client and receive nothing from providers.
Is commission-based advice still allowed?
It varies by country and product; commission on investment advice has been banned or heavily restricted in several markets, while insurance, protection and mortgage commission remains widespread.
What should I ask an advisor about how they are paid?
Ask for the upfront and ongoing amounts in dollars rather than percentages, which products pay more than others, and whether they operate under a fiduciary duty or a suitability standard.
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