Financial advisors are reimbursed by mutual funds in exchange for the investment and financial advice they provide. A financial advisor receives a trailer fee, which is a fixed percentage of a client's investment in a mutual fund, as long as the client's money remains invested in the fund. Also, financial advisors are typically paid out of front- or back-end loads that a mutual fund charges when its shares are bought or sold. Financial advisors receive a small percentage of these load fees that are negotiated between a mutual fund and its advisor.
The Trailer Fee
Mutual funds typically pay financial advisors ongoing trailer fees. These fees range from 0.25 to 1% per year and are designed to motivate financial advisors to recommend that their clients invest in a particular mutual fund. As long as a client remains invested in a particular mutual fund, the fund pays the financial advisor a percentage fee based on the client's allocation to the mutual. These fees reimburse financial advisors for sales and financial advice provided to their clients in exchange for investing in mutual funds.
Certain categories of mutual funds pay higher trailer fees, such as mutual funds that specialize in equity investments. Financial advisors are known to be biased toward recommending these classes of mutual funds to their clients.
Financial Advisors' Share of Load Fees
Mutual funds typically charge investors front-and back-end fees. Every time an investor purchases shares of a mutual fund, he is charged an upfront percentage of the transaction amount, which is called front-end load. A financial advisor receives a small share of this front-end load, and the same applies to the back-end load, which is a contingent deferred sales charge by a mutual fund.
Stephen Rischall, CFP®, CRPC
1080 Financial Group, Los Angeles, CA
If your financial advisor is a broker, the answer is yes. Brokers are paid commissions based on the products they sell and are oftentimes incentivized to sell certain products over others. When you purchase a mutual fund with a sales load, part of that additional expense is used by the mutual fund company to pay a commission to the advisor. Additionally, most mutual funds charge a 12b-1 fee as part of their expense ratio collected each year. Part of that fee goes toward paying the broker a trailer commission, so long as the client remains invested in the fund.
In contrast, if your financial advisor is a fee-only, fiduciary advisor, then they do not receive commissions or compensation from outside parties.