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Confessions of a financial advisor

Most investors know their financial advisors take a percentage for managing their portfolios, but they probably didn't know the mutual fund industry is also giving these advisors commission for pushing specific equity mutual funds, unbeknownst to investors.

I'm not talking about front-end load fees. I'm referring to commissions and bonuses that financial planners get after they put their clients into these funds.

The industry and SEC call these payments "commission" but in reality, they are a "kickback" or "incentive" for financial planners to push specific equity funds, even if they are not in their client's best interest. This payment structure raises ethical and legality concerns on whose interest is being served: the financial planner or the client.

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Even more disconcerting, most investors don't know this is happening.

I've seen how this works following two decades of working on Wall Street for well-known brokerage firms. This payment structure to financial planners is hidden behind a smokescreen that is covered by layers of payments through different sources. First to the brokerage houses, then to the brokers.

This hidden-fee structure was addressed in the Dodd-Frank reforms, which went into effect on January 1, 2014. Under Dodd-Frank, disclosures for "commission" or "kick-back fees" are now required for pension and 401k retirement accounts, but accounts that aren't regulated by the Employee Retirement Income Security Act were excluded from the new law.

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This is why it's so important to educate yourself as an investor to make sure your financial advisor is putting your needs ahead of his.

John Rensten | Photographer's Choice | Getty Images

Here are a few questions to ask your financial advisor that will help you identify whether he is getting an additional payment incentive from equity mutual funds.

Question: What commission did you earn on the stocks you sold me?

If your financial advisor says "none," that doesn't mean he/she is still not making additional revenue from your portfolio. You should also ask your advisor if he/she is earning a "markup" or "spread" from your funds.

"You told me I paid no commission on the bonds or mutual funds you bought for me? Did you earn a "markup" or did I pay any of "spread?"

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It's important to make sure your financial planner is aligning his/her financial goals with your goals. This is another way to make sure your financial planner has your interest at heart.

Question: Would you be willing to show me where your money is invested?

If your financial planner is in the same investments, you know he believes in that investment strategy, otherwise, he wouldn't risk his own capital. But don't be alarmed if your advisor is not in your same portfolio. He/she may have different short or long-term financial goals.

Question: Would you be willing to get paid only if my portfolio makes money?

The financial industry hates this fee-model structure because it shakes the current system and forces financial advisors to perform, but it is one of the best ways to keep your financial planner honest and transparent.

Look for a pay-for-performance financial planner and yes, they do exist. This is how my firm, Sag Harbor Advisors, gets paid. Under this financial model, your advisor only gets paid if he makes you money. If your portfolio loses money, he doesn't get paid. Under this structure, there is no way to hide the fees, commission or "kickbacks" that an advisor receives from the financial industry.

Commentary by James Sanford, a portfolio manager for Sag Harbor Advisors (www.sagharboradvisors.com). He has also worked with Credit Suisse Securities, JP Morgan Securities and Gleacher & Co.

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