Why Your Advisor Is Incentivized To Think Inside The Box
- Steadfast Equity
- Jun 15
- 15 min read
Updated: Jun 17
Financial advisors often recommend safe, conventional investments, but their advice is influenced by how they’re paid and the regulations they follow. Here’s what you need to know:
- Advisor Pay Models:
- Commission-Based: Earn from selling products, often prioritizing high-commission options.
- Fee-Based: Combine client fees with commissions, creating potential conflicts of interest.
- Fee-Only: Paid directly by clients, offering more transparency but still subject to biases.
- Regulations and Compliance: Strict rules push advisors toward low-risk, familiar investments, limiting creative strategies like alternative investments.
- Incentives and Biases: Advisors may stick to firm-approved products or avoid unconventional strategies due to loyalty programs, performance bonuses, and legal risks.
Quick Comparison of Pay Models
Model | How They Earn | Risk of Conflict | Typical Focus |
Commission-Based | Product sales only | High | Investment transactions |
Fee-Based | Client fees + commissions | Moderate | Broader planning with some bias |
Fee-Only | Client fees only | Low | Holistic financial planning |
To make better investment decisions, ask your advisor about their pay structure, potential conflicts of interest, and explore ethical, transparent options like those offered by firms focusing on long-term value and fairness.
Kitces & Carl Ep 19: Is Any Financial Advisor Business Model Truly Conflict Free?
How Advisor Pay Structures Work
Knowing how your financial advisor earns their paycheck is more than just a curiosity - it’s a key factor in understanding the advice you’re getting. After all, the way they’re compensated can shape their recommendations, often nudging them toward safer, more conventional strategies. In the U.S., there are several pay models in play, each with its own set of incentives that can influence an advisor’s approach to your investments.
Main Pay Models in the U.S.
In the U.S., financial advisors typically work under three main compensation structures, and each comes with its own potential for conflicts of interest:
- Commission-Based Advisors: These advisors make their money by selling financial products. This creates a strong incentive to recommend products that pay higher commissions, which might not always align with your best interests.
- Fee-Based Advisors: These advisors get paid through a combination of client fees and commissions from product sales. While the dual income streams reduce reliance on commissions alone, conflicts of interest can still arise. For instance, a survey by Envestnet | MoneyGuide found that 62% of advisors use an Assets Under Management (AUM) model, where they charge a percentage of your portfolio’s value. This setup can influence their advice, such as discouraging you from paying off a mortgage early since it could shrink the assets they manage - and their fees.
- Fee-Only Advisors: Fee-only advisors are paid directly by their clients, without earning commissions or taking third-party payments. This model is often seen as the most transparent, but even here, biases can creep in. As Jennifer Specter, Chief Operations and Compliance Officer at Schultz Financial Group, explains:"The choice of how you charge for your services most definitely shapes the firm's conscious decisions, activities and goals."
To break it down further, here’s a quick comparison of these models:
Compensation Model | How They Get Paid | Risk of Conflict | Typical Advice Focus |
Commission-Based | Product sales only | High (focus on commissionable products) | Investment transactions |
Fee-Based | Client fees + commissions | Moderate (dual incentives) | Broader planning with some product bias |
Fee-Only | Client fees only | Low (no product sales incentives) | Holistic financial planning |
It’s worth noting that fee-based assets grew from 26% to 45% by 2018. This shift reflects growing skepticism about conflicts of interest, as highlighted by NerdWallet:
"It's important to understand the incentives created by different cost structures. Commission-based advisors may be under pressure to generate commissions, and may not give advice that is in your best interest."
Long-Term Pay and Loyalty Programs
Beyond the basic pay models, many advisory firms use long-term incentives that further shape advisor behavior. These can include stock options, profit-sharing plans, and loyalty bonuses - all of which tie an advisor’s income to their firm’s performance. As a result, advisors may feel pressured to stick with firm-approved strategies and products.
For example, some firms reward advisors for bringing in assets or keeping clients invested in specific product families. One case revealed an advisor earning $30,000 for every $5 million referred to a partner firm, even though that firm charged higher fees. These incentives can steer advisors toward decisions that benefit their firm more than their clients.
Russell Schultz, CEO of Schultz Financial Group, experienced firsthand how compensation structures can affect client relationships. When his firm used hourly billing, clients hesitated to reach out until they had significant issues:
"Having hourly fees caused friction with the client because many were less likely to contact you until they actually had a bigger problem."
To address this, Schultz’s firm shifted to a flat-fee model, aligning their interests more closely with their clients’ needs. As Specter puts it:
"This compensation structure boils down to lining up our business model with what we say we do for our clients which is to provide objective, comprehensive financial planning and advice."
Currently, 90% of advisors charge financial planning fees, with 40% using fixed-fee structures. However, many firms still layer on additional incentives like performance bonuses, retention awards, or partnership tracks. These rewards often prioritize adherence to firm policies over personalized advice, pushing advisors to stick with familiar, firm-approved strategies.
Ultimately, these long-term incentives can limit creativity and personalization in financial planning. Advisors may hesitate to recommend unconventional approaches if doing so could jeopardize their standing or career advancement. Recognizing these underlying incentives is key to understanding potential biases in the advice you receive.
Regulatory and Compliance Limits
Regulations play a crucial role in shaping the behavior of financial advisors, adding another layer of influence beyond compensation structures. While pay incentives often guide advisors toward conventional investments, regulatory frameworks create an environment that discourages risk-taking. These rules, designed to protect investors, can inadvertently push advisors toward safer, more traditional investment options. Together, compensation models and regulatory mandates narrow the range of choices advisors feel comfortable recommending.
Why Regulations Lean Toward Conventional Investments
The U.S. regulatory system prioritizes investor protection, but it can unintentionally restrict the variety of investments advisors consider. Two major regulations - the SEC's Regulation Best Interest (Reg BI) and the fiduciary standard under the Investment Adviser Act - require advisors to act in their clients' best interests. This often translates into favoring conventional investments that are easier to justify under these standards.
Under the fiduciary standard, advisors must meet strict obligations, including ensuring their advice aligns with a "reasonable understanding" of a client's goals. The SEC explains:
"The duty of care requires, among other things, investment advisers to provide investment advice in the client's best interest, based on a reasonable understanding of the client's objectives."
While the principle seems straightforward, the real challenge lies in defining what qualifies as a "reasonable understanding" and proving that this standard has been met. Alternative investments, such as private equity or hedge funds, often carry complexities that make them harder to justify under these rules. Advisors must demonstrate not only that they fully understand these options but also that they are genuinely in the client’s best interest - a task that can be daunting.
The issue becomes even more complex when conflicts of interest are involved. The SEC has been clear that simply disclosing conflicts is insufficient:
"Disclosure of conflicts alone does not satisfy the obligation to act in a retail investor's best interest."
Concerns about higher fees, lack of transparency, and complicated compensation structures surrounding alternative investments often lead advisors to stick with mutual funds, ETFs, and blue-chip stocks. These options are easier to defend under fiduciary rules and carry less risk for the advisor.
Adding to the complexity, the Department of Labor’s Retirement Security Rule imposes stricter fiduciary standards on retirement accounts. In 2022, employees transferred $770 billion from 401(k)-type plans into IRAs, bringing these assets under tighter regulatory scrutiny. This makes recommending unconventional investments for retirement accounts even more challenging.
Internal Policies and Legal Risks
Beyond federal regulations, individual firms impose their own compliance frameworks, which often limit advisors even further. These internal rules are designed to reduce legal risks but tend to result in overly conservative investment options. Firms typically favor well-established products, avoiding alternatives that require extensive due diligence and legal review. The time and cost involved in vetting new investment products discourage firms from expanding their offerings.
Drew Bowden, former Director of the SEC's Office of Compliance Inspections and Examinations, underscored the importance of these due diligence processes:
"Money continues to flow into alternative investments. We thought it was important to assess advisors' due diligence processes and to promote compliance with existing legal requirements, including the duty to ensure that such investments or recommendations are consistent with client objectives."
These internal policies often mirror external regulations, reinforcing a preference for conventional strategies. For most firms, sticking with established products minimizes compliance costs and legal risks. However, this approach also limits the range of personalized solutions advisors can offer their clients.
Registered Investment Advisors (RIAs) face significant compliance challenges. For instance, a NASAA audit revealed that 44% of firms had at least one deficiency in their client agreements. Meeting all regulatory requirements is a constant struggle, and the legal risks extend beyond regulatory penalties. Advisors also face potential lawsuits from clients who experience losses. Conventional investments, even when they underperform, are generally easier to defend in these situations compared to riskier, unconventional options.
The SEC has emphasized that firms recommending complex or high-risk products must establish specific procedures to evaluate and justify these recommendations. This adds to the administrative burden and legal exposure, further discouraging advisors from venturing beyond a narrow selection of "safe" investments.
These regulatory pressures, much like compensation incentives, steer advisors toward low-risk, conventional investments. While these rules are vital for protecting investors, they also contribute to an industry where advisors often feel compelled to play it safe, avoiding unconventional strategies that could better serve some clients' needs.
How Incentives Affect Client Recommendations
The way financial advisors are compensated and the regulations they follow play a big role in shaping the investment advice they give. Advisors often lean toward standardized strategies, driven by financial incentives and regulatory pressures, which may not always align with your unique financial needs. Let’s dive into how traditional strategies compare to alternative options in today’s market.
Standard Strategies vs. Alternative Options
Advisors frequently recommend conventional strategies, leaving alternative investments underutilized. For example, while only 26% of financial advisors currently include alternative investments in their portfolios, a whopping 86% of institutional investors actively use them. This gap can largely be traced back to the way advisors are paid and the rules they operate under.
Commission-based advisors, for instance, often stick with products like mutual funds that offer steady trail commissions. These options provide predictable income and are easier to manage under current regulations. On the other hand, alternative investments come with more complex fee structures and higher compliance costs, making them less appealing to advisors who face these hurdles. Fee-based advisors, who earn through a mix of asset management fees and commissions, also tend to favor conventional products that keep assets under management, avoiding the extra challenges posed by alternatives.
Here’s a quick breakdown of how different investment types align with advisor incentives and impact clients:
Investment Type | Advisor Incentives | Client Impact |
Traditional Mutual Funds & ETFs | Predictable commissions, simple compliance, low legal risk | Limited diversification and potential missed opportunities |
Blue-Chip Stocks & Bonds | Straightforward fees, regulatory approval, defensible choices | Conservative growth, lower volatility, may not suit aggressive goals |
Alternative Investments | Complex fees, higher compliance costs, legal challenges | Potential for better returns, improved diversification, access to niche markets |
Despite these barriers, there’s a growing interest in alternatives. 85% of financial advisors plan to increase allocations to alternative assets in 2024. However, many have yet to make this shift, largely due to the challenges tied to their compensation structures and limited resources.
Darby Nielson, Chief Investment Officer at Fidelity’s institutional group, sheds light on the issue:
"Alternative investments are becoming more widely accessible, but many advisors lack the resources to determine how to incorporate them in their portfolios."
This highlights how financial incentives and regulatory complexities can limit access to investments that might better suit your goals.
Missing Personalization and Custom Solutions
Compensation models don’t just affect product recommendations - they also impact how personalized your financial plan is. When advisors prioritize products that align with their income models, they may miss opportunities to tailor strategies to your specific needs.
Fee-only advisors, who are paid directly by clients, are often better positioned to create customized solutions. In contrast, commission-based advisors may default to familiar products that generate reliable commissions, even if those products don’t perfectly match your financial goals.
This lack of personalization is especially evident when looking at client preferences. Nearly 74% of millennials favor one-time fees for service, and 73% prefer a subscription model. Yet, many advisors stick with asset-under-management fee structures because those generate steady revenue for their firms. This mismatch often leads to oversimplified risk assessments and cookie-cutter strategies.
Take, for example, a typical advisor earning 1.02% annually on a $1 million portfolio - the average rate for clients with $1 million in assets under management. That advisor has a financial incentive to keep your funds in products that maintain steady asset levels. As a result, younger clients who could benefit from higher-risk, higher-reward strategies might receive overly conservative recommendations.
Advisors also tend to overlook key factors like timelines. As Darby Nielson explains:
"The first thing I would say is: It depends on the investor. It depends on the investor's time horizon, liquidity needs and eligibility for different alternative structures."
When advisors rely on standardized fee structures, they may not fully consider these individual factors. A 35-year-old saving for retirement has vastly different needs than a 55-year-old planning for college expenses, yet both might receive similar portfolio recommendations if the advisor’s incentives favor certain products.
Another issue is the lack of specialized knowledge. More than half of advisors report difficulty explaining alternative investments to clients. This communication gap, combined with the extra effort required to understand complex products, often leads advisors to stick with simpler, more familiar options.
The end result? Many clients end up with portfolios that reflect their advisor’s business model rather than their personal financial goals. For example, someone with a high risk tolerance and a long investment timeline might still receive the same mix of mutual funds and bonds as someone preparing for retirement - all because the advisor’s compensation structure supports that approach.
How to Spot and Handle Advisor Bias
Advisor incentives can sometimes influence recommendations, making it crucial to recognize and address potential biases. While identifying these biases can be tricky, there are clear warning signs to watch for.
Key Questions to Ask Your Advisor
Start by asking how your advisor is compensated and whether they receive extra incentives for recommending specific products. This includes understanding if they earn higher commissions from certain investments or if their firm offers bonuses for promoting particular options. As Morgan Housel, author of , points out:
"Financial advisers are not immune to behavioral biases themselves. They may be more likely to recommend investments that they are familiar with, or that they have a personal stake in. They may also be more likely to recommend investments that are consistent with their own financial goals, even if they are not the best fit for their clients."
Dig deeper into their recommendations. For instance, if a product carries high fees or seems tied to extra incentives, ask for clear, detailed reasoning. Also, challenge their decision-making process. If an advisor appears overly confident - claiming they can predict market trends or guarantee outcomes - request evidence from their track record and ask how they account for potential risks.
Understanding their research approach is equally important. Advisors can sometimes rely on information that aligns with their own biases. If they repeatedly suggest familiar investments, inquire about alternative options to ensure your portfolio stays diversified.
Finally, verify their fiduciary status. Request documentation like their Form ADV, which outlines conflicts of interest and explains how their firm is compensated.
Here’s a quick framework to evaluate their responses:
Warning Sign | What to Ask | Red Flag Response |
Same products repeatedly recommended | "Why do you consistently suggest these specific investments?" | Vague, unsupported answers |
High-fee products dominate portfolio | "How do the fees on these products compare to alternatives?" | Avoids fee comparisons or dismisses concerns |
Trend-chasing recommendations | "How does this strategy align with my long-term goals?" | Focuses solely on recent performance |
Proprietary products emphasized | "Do you receive higher compensation for these products?" | Denies conflicts or avoids discussing pay |
These questions can help you uncover potential biases and ensure your advisor’s recommendations align with your best interests.
Why Clear Pay Disclosure Matters
Transparency about compensation is essential for building trust. When advisors openly share how they’re paid, it’s easier to determine whether their advice truly serves your goals.
Clear disclosure also fosters accountability. Ben Carlson, author of , cautions:
"The financial advice industry is rife with behavioural biases. Advisers are human, and they are just as susceptible to these biases as their clients. This can lead to poor advice, and it can cost clients money."
Ask about hidden fees or ongoing compensation, such as trail commissions, bonuses for meeting sales targets, or payments tied to selling specific products like annuities. These arrangements can create conflicts of interest that may impact their recommendations. If proprietary products are suggested, request detailed explanations to ensure they align with your financial objectives.
For added clarity, request written documentation of your advisor’s compensation structure and any potential conflicts of interest. This not only clarifies the relationship but also provides a reference point for future discussions. Dr. John Grable, professor of personal financial planning at Texas Tech University, emphasizes:
"It is important for financial advisers to be aware of their own biases, and to take steps to mitigate them. This includes seeking out diverse perspectives, and using evidence-based decision-making."
If you suspect conflicts of interest, gather all the relevant facts and consider seeking a second opinion from another qualified advisor. Above all, trust your instincts - if your advisor becomes defensive or evasive about discussing compensation, it may be time to reevaluate the relationship.
Ethical and High-Yield Investing with Steadfast Equity
Steadfast Equity takes a unique approach to investing, moving beyond the constraints of traditional advisory practices. While conventional advisors often rely on standardized strategies shaped by regulatory and compensation structures, Steadfast Equity focuses on ethical, high-yield investments designed to foster long-term value, financial security, and social responsibility.
Prioritizing Stability, Safety, and Social Responsibility
At the heart of Steadfast Equity’s strategy is a commitment to enduring value. As the firm states:
"At Steadfast Equity, our investment philosophy is rooted in the principles of long-term value creation, safety, and ethical stewardship."
The firm’s portfolio is built around private credit and asset-backed royalties, which deliver consistent and measurable income streams. Importantly, Steadfast Equity avoids investments that exploit or harm, underscoring its dedication to creating wealth responsibly.
What’s notable is that ethical investing doesn’t come at the cost of returns. Steadfast Equity’s annual bond yields have ranged from 9.0% to 18.5%, with some limited series achieving even greater returns. This performance reflects a disciplined focus on resilient investments, steering clear of high-risk ventures.
Transparent and Client-Centered Investment Practices
Steadfast Equity sets itself apart by offering transparent, clearly disclosed rates at the time of purchase, avoiding the variable commissions that can cloud traditional advisory relationships.
The firm takes a facilitative role rather than acting as a broker or providing personalized financial advice. Instead, it focuses on ensuring mutual understanding and fair terms. As the firm explains:
"Our role is to facilitate investments, not to offer personalized financial advice. Our conversations are focused on ensuring that our requirements are met and that a fair trade is made based on mutual understanding."
This approach aligns with Steadfast Equity’s commitment to working exclusively with investors who share its vision for ethical, long-term growth.
With over $800 million in assets under management and more than double that amount in diversified outstanding bonds and promissory notes, Steadfast Equity operates from a position of financial strength. This solid foundation supports its mission of offering high-yield opportunities that benefit all parties involved.
For accredited investors seeking an alternative to conventional advisory models, Steadfast Equity provides access to investment options that emphasize fairness, transparency, and sustainable returns. It’s an approach that aligns financial success with ethical principles, creating a win-win for investors and society alike.
Conclusion: Making Better Investment Choices
Understanding your advisor’s motivations is key to making smarter, long-term financial decisions. As we’ve discussed, traditional advisory models can sometimes create a disconnect between what benefits the advisor and what truly serves the client’s best interests.
Advisors often lean toward recommending familiar, low-risk products, partly influenced by how they’re compensated. These compensation structures can subtly (or not so subtly) shape their advice. By taking the time to understand how your advisor is paid, you can better assess whether their recommendations align with your financial goals and personal priorities.
Before you commit to working with an advisor, ask direct questions about their compensation structure and any potential conflicts of interest.
The encouraging news? There are ethical and transparent investment options out there. Research shows that partnering with the right financial advisor can boost net returns by roughly 3%, particularly when the advice prioritizes your best interests instead of sales-driven incentives.
For those exploring alternatives to traditional advisory models, Steadfast Equity provides a client-first approach. Their focus on high yields, upfront pricing transparency, and long-term value ensures that your success takes precedence over advisor commissions.
FAQs
How can I tell if my financial advisor’s payment structure affects their investment advice?
To figure out whether your financial advisor's payment structure might affect their recommendations, start by understanding how they get paid. Advisors who earn commissions from selling specific financial products might be more inclined to push those products, possibly prioritizing their own earnings over your financial goals. In contrast, fee-only advisors - who charge a flat fee, hourly rate, or a percentage of your portfolio - are generally less tied to product sales.
It’s important to ask your advisor directly about their compensation model and watch for any signs of potential conflicts of interest. Warning signals might include overly aggressive sales tactics, unclear explanations about fees, or cookie-cutter recommendations that don’t seem tailored to your unique situation. By staying informed and asking the right questions, you can better ensure that your advisor’s guidance truly supports your financial well-being.
How can I make sure my financial advisor's recommendations fit my goals and comfort with risk?
Aligning Financial Advice with Your Goals
To make sure your advisor's guidance matches your financial goals and comfort with risk, start by clearly defining what you want to achieve and how much risk feels manageable for you. Be open about these details with your advisor and ask them to explain how their recommendations fit your priorities. It’s also a good idea to revisit your goals and risk tolerance regularly, especially if your financial situation shifts.
Take it a step further by asking your advisor to explain the reasoning behind their strategies. Are they exploring alternative approaches or sticking to standard methods? Understanding their thought process can help you spot any biases and ensure their advice is tailored to your specific needs. Keeping the conversation active and engaged can lead to financial planning that feels more personal and effective.
Why do financial advisors usually recommend traditional investments, and how can I explore other options that might better fit my goals?
Financial advisors often lean toward traditional investments like stocks, bonds, and mutual funds. Why? These options tend to carry lower risk, are easy to sell when needed, and are straightforward to explain to clients. Plus, industry regulations and compensation models often nudge advisors toward sticking with these tried-and-true strategies.
But if you're curious about alternative investments - think private equity, real estate, or other less conventional options - it’s worth diving into the potential upsides. These alternatives can offer benefits like or even providing higher returns. Start by learning the basics and understanding how they work. Then, have an open conversation with your advisor about your financial goals and ask how these options could fit into your plan. Taking this initiative might open the door to more tailored and creative investment opportunities.
