(This is the second in a two-part series on the things you deserve to know from your financial advisor.)

We previously discussed how to delve into an advisor’s background, to what extent you will be involved and the investment approach. Now let’s look at other aspects of working with an advisor, including costs.

What are the terms of the relationship? A number of investors have complained to me that their advisor either didn’t execute a transaction as they had instructed or had executed a transaction without their knowledge. As many sins as there are in financial services, these situations are actually quite rare. On further questioning, it became clear that these investors had no clue as to how the arrangement they had willingly approved actually worked.

Unfortunately, many investors have a preconceived notion of working with a financial professional and do nothing to confirm it, or they may assume that since the person who referred them to the advisor was happy that it would work for them as well. Even worse, they may be seduced by a sophisticated sales pitch and dutifully sign anything. If there were ever a time to delay action until your questions were answered to your understanding, this is it.

The most obvious question is the actual services provided. Some advisors restrict themselves to investments only, others incorporate related financial areas such as retirement planning and budgeting, and still others offer comprehensive financial planning which may include developing estate plans and doing taxes. (The National Association of Personal Financial Planners, a group of comprehensive planners, offers information at www.napfa.org.) The ongoing communications associated with those services is also important, so you are not left in the dark. As we discussed earlier, you should also be clear on the level of your ongoing involvement.

The biggest area of confusion is the degree of discretion, or independent decision-making authority, granted to the advisor. More investment programs today do not require investor approval for every transaction. If discretion is not granted to the advisor, then prior approval is required for all transactions, and that is your opportunity to question the advisor if necessary. Under no circumstances should any authority other than the limited discretion to execute transactions within an established account be granted to any advisor.

One final factor is the advisor’s business affiliations, particularly with “clearing” firms that hold the investments. These affiliations can directly impact the availability of investments and programs and could be a significant factor in total cost.

So what is the total cost? Even restricting the discussion to direct costs, the list of possible fees is quite long.

• Flat fees – also referred to as a “retainer” fee, and based on assets, net worth or a price “menu”, this amount covers all the services provided.
• Percentage fees- commonly known as “assets under management”, this percentage fee is based on the portfolio value and may or may not include other fees.
• Service fees – fees for specific services not covered by other fees.
• Mutual fund expense ratios – these fees may or may not include initial or ongoing sales charges.
• Commissions – a portion of these transaction-related fees is typically revenue for the advisor.
• Transaction fees – also triggered by transactions but without creating revenue for the advisor
• Account/option fees – fees related to a specific account or account feature.

It’s confusing, to say the least, and even more so when combinations of these fees are involved. While firms have responded by trying to create “all-inclusive” pricing, it is still worthwhile to understand and compare fee structures. Keep in mind that many investments pay fees to the advisor or the advisor’s firm, which can influence the investment advice.

How is the advisor compensated? Clearly, the more business an advisor generates, the greater his compensation. Still, apart from how the firm makes it money, the advisor’s personal compensation is another consideration.

Some advisors are paid a straight salary, typically with a bonus tied to the quality of service provided to clients and business generated. As long as the bonus for new business is not disproportionate, you can concentrate on the other aspects of the relationship in making your decision.

Other advisors are compensated primarily on the level of assets represented by their clients. In this case, you should inquire as to the investment programs chosen to make sure the advisor is not favoring those programs based on compensation.

The traditional compensation model for brokers, which has become less commonplace, is based on sales charges, transaction fees and commissions. While your advisor may truly be acting in your interest, this type of compensation has been criticized as having an inherent conflict of interest in generating frequent transactions and portfolio changes and has been the basis for a number of the recent sales and trading scandals.

It may seem daunting to put your advisor through such an inquisition, but it is quite necessary to develop a relationship which best matches your needs and goals. Coming to the realization that the relationship is not working for you, and making a change, can be even more difficult and quite costly as well. You can’t afford to be intimidated or embarrassed to pursue these issues. After all, it is your money at stake.