If you want to benefit from independent financial advice, the chances are that your advisor will be paid either by fees, commission or a combination of both.

Many people prefer for their IFA to take commission because it means that they don’t have to pay an up-front charge. However, actually paying fees could end up being more cost-effective in the long run.

Our guide looks at the pros and cons of fees and commissions.

Commission

Most financial products pay some sort of commission to the advisor that recommended them. Yet, different providers and advisers will charge differing rates of commission even for the same products.

Consumer group Which? reports that IFAs tend to charge 3-8 per cent of an initial investment for a unit trust while most also charge between 0.5-1.5 per cent of the value of the investment each year as renewal commission.

This means that on a £10,000 investment you will pay somewhere between £300 and £800 as an initial fee (this is deducted from your investment) as well as between £50 and £150 a year.

For personal pensions, Which? reports that IFAs charge between 20-79.3 per cent on the first year’s payments as commission. On a £100 per month contribution this means you pay somewhere between £240 and £950 in commission.

Commission based advice can appear to be free, but the cost of advice comes out of product charges which dramatically affect the return on your investment long after you have taken the advice.

Fees

Independent financial advisors are also obliged to offer a ‘fee based’ service. Instead of taking commissions from product providers, these commissions will be reinvested into your product and the IFA will instead charge you a fee based on their hourly rate.

IFA fees can range significantly, from around £50 to £400 per hour depending on the level of expertise involved and whereabouts you are in the UK. You will often benefit from your first meeting free of charge, but them the IFA will start to charge you on an hourly basis for their advice.

Which is best: fees or charges?

Historically, most IFAs and advisors have earned their money through taking commissions from product providers. However, times are changing with increasing numbers of firms moving towards fee based services.

While commissions may seem preferable as you don’t have to pay anything directly out of you own pocket, it can affect the long-term return on your investment. As the total return on an investment can be reduced substantially because part of your money is being used to pay commission rather than being invested, you don’t get as much back in the long term.

Steve Wilson at Alan Steel Asset Management told the Daily Telegraph that consumers should: “Beware high allocation products which look too good to be true and ultimately try to hide the initial commission. All that happens is the charge is ultimately taken out of the contract over a number of years and back end penalties will apply. Investors should look for a transparent charging structure.”

His view is shared by Andy Cowan of IFAs Towry, who told the newspaper: “Commission-driven advice is by definition not independent. So, if an individual is looking for independent advice, they should be prepared to pay a fee for it. Avoid commission altogether and opt for time charged advice from a highly qualified fee-only adviser.”

When choosing an IFA, ask them to give you two illustrations – one assuming the advice is paid by commission and one assuming an hourly fee. You can then compare the two quotes and make an informed decision about the best way to pay for the advice.