Perhaps the financial advice you are getting is free. It may be from reading Money, Smart Money or Kiplinger’s Personal Finance. It may be from watching television shows, attending a workshop or talking to someone you know who is experienced at investing. However, if you are led astray by the advice you get without paying, "free" could turn out to be very expensive.

Although it’s an uncomfortable area for many people, compensation is one of the most basic things you must understand when you enter into any professional relationship that involves your money. Whether you’re starting a new relationship or reevaluating a continuing one, you could have more options than you realize. And the choice you make could matter more than you realize.

There are four basic forms of compensation, with many hybrid combinations. If you understand the basics, you’ll be able to recognize them in hybrid plans.

Each one of these forms of compensation gives the advisor some sort of incentive.

A broker whose compensation depends on transactions has a financial incentive to generate transactions in your account. A broker or a commission-based financial planner might determine that the most appropriate investment for you is Treasury bills. But he or she cannot afford to tell you that, because there’s no commission involved. A mutual fund salesperson whose compensation includes commissions has more incentive to persuade you to invest in a fund with a 5.75 percent load than one with a 3 percent load.

A money manager whose pay is based on the size of your assets has an incentive to see those assets grow – and of course to persuade you to place a higher percentage of your assets under his or her management. A fee-only advisor has a financial incentive to take as much time as necessary to do the work you need – but no incentive to steer you to any particular product.

Incentive-fee arrangements, if they are negotiated properly, can make your interests and your manager’s interests nearly identical. If you pay the advisor a straight percentage of any profits, then you and the advisor both want to achieve exactly the same thing: profits. Just make sure this doesn’t lead you to take too much risk as you pursue high profits.

Some of our clients with larger accounts like an arrangement in which we don’t make a dime unless they achieve at least some minimum return, typically 8 percent. Because we can’t guarantee an 8 percent return, we run the risk that we could have a year, or even a series of years, in which we get no compensation for managing the account. To compensate us for that risk, our arrangement typically provides for a higher fee when the client does achieve his or her minimum target return. In some cases, we charge 2 percent of the year-end account value, which is roughly twice our normal rate.

From our point of view, this arrangement doesn’t really give us an extra incentive. We don’t invest the money differently because of this arrangement. But some clients see this arrangement as a way to make sure we are on their side. And we like it for two reasons: First, a client is less likely to close an account after a disappointing year if there’s the consolation that we didn’t get paid. Second, we expect that most of the time we will meet or exceed the client’s minimum target return, giving us a higher than normal fee.

Whatever arrangement you prefer, any top-notch financial advisor will be glad to discuss this topic with you quite candidly. Seek an advisor who’s willing to be open with you. Remember, advisors are in business to make money, not to take pity on you and do charity work. If yours dodges this topic or gives vague answers, look elsewhere.

Some investors balk at paying an hourly fee for something they think they can get free. But in the case of investment advice, doing that can be "penny wise and pound foolish."

In fact, an interesting question to ask an advisor is: Are you willing to work for me on a strictly hourly basis? In my book, the perfect advisor would be glad to take your business on an hourly basis. You might be surprised by how many people will be willing to work for you if you offer to pay $200 an hour. That’s in the ballpark of what you might expect to pay a good attorney in a metropolitan area.

If you’re paying $200 an hour, you will pay careful attention to how you use an advisor’s time. You can be sure the advisor is aware that "the clock is ticking," and a good advisor will try to avoid wasting your time and money. (Of course, it you’re in a $200-an-hour meeting and you spend 30 minutes talking about sports, you should expect to be billed $100 for that conversation.)

This avoids some potential conflicts of interest, if you do it right. Some financial planners may want you to buy load funds, and they offer to subtract the load from their fee. That makes it seem that you’re getting a fair deal. But there’s a reason that planners prefer load funds. They may collect "trailing" fees each year that you continue to own the fund, and they may collect commissions if you make subsequent investments. In addition, load funds often have higher expenses than no-load funds, and I’ve never seen any evidence to convince me that investors get any performance advantage from owning a load fund.

I recommend you invest in no-load funds whenever it is possible. If you have $10,000 to invest and you need help selecting a fund, you could pay a financial planner $200 for an hour-long consultation to evaluate your needs and make a recommendation. Or you could get "free" advice from a commissioned planner or a fund salesperson, who might suggest funds that carry a 5.25 percent load. That "free" advice would have cost you $525 out of the starting gate. And the cost of that "free" advice could keep mounting as long as you owned the load funds in the form of higher expenses and 12b-1 marketing fees.

This situation creates a potential conflict of interest between you and your advisor. Your interests are probably best served when you invest in no-load funds that have low expenses and no marketing fees. But the planner’s interests are probably best served when you buy load funds.

(If you’re thinking about a $10,000 investment, it shouldn’t take a good advisor more than an hour to evaluate your needs and make a recommendation. Last year, a man hired me for $200 an hour to make no-load mutual fund recommendations on $1.2 million he needed to invest in long-term investments, short-term investments and emergency money. We did the whole thing in 90 minutes. It cost him only $300.)

This is an example of why, when you interview a prospective financial advisor, you should ask if there will be any actual or potential conflicts of interest in your relationship. Ideally, you’ll find an advisor who is pleased that you are savvy enough to ask such a question and who is happy to discuss it with you. If an advisor is insulted that you would ask, run the other way.

Let’s look at some important potential conflicts.

A broker who is paid on commissions can make money only if you buy or sell products on which the broker gets a commission. Your broker might conclude that your best bet is to make no transactions in your stock portfolio. But the broker can make money only if you do something, so there’s an incentive for him or her to recommend a transaction, even if that transaction might not be what’s best for you.

A money manager who gets paid on the basis of the growth of your assets would seem to have no conflict with you. But there could be a conflict if, for example, you need low-risk bond funds that aren’t likely to make your account grow in size very fast. The manager’s interest might be best served by putting your money into growth funds instead.

An advisor who sells no products and is paid only by the hour may have the least potential conflict with you. This advisor’s incentive is to generate billable hours on your behalf. But you can keep this under control by making it clear what work you are authorizing and what you’re not. In addition, you may want to periodically ask the advisor (or any other professional, for that matter) if some proposed piece of work is likely to be worth the amount of time you will have to pay for having it done. A good advisor will be happy to discuss this with you and happy to do only the most productive tasks.

Some advisors use a combination of hourly fees and commissions, and some give their clients a choice. If you have a choice, you will need to think about the potential conflicts and about how you can manage any particular arrangement. For instance, you may find it distasteful to bicker about the hours that somebody bills you for, yet you might have no trouble at all setting strict limits on the sale of commissioned products.

There are more dimensions to compensation than you might think. The financial industry is basically a sales business, and salespeople are given incentives to sell. Your advisor may never volunteer the information that he or she is eligible for a free trip to Hawaii or Bermuda for selling a certain volume of a particular product. But if that’s the case, wouldn’t you want to know about it?

That’s why it’s a good idea to get in the habit of asking, when an advisor makes a recommendation, "Why are you recommending this product to me?" In a worst-case scenario in which that particular product turns out to be a disaster and you wind up in a legal situation, you might have a much stronger case if you asked the question and the salesperson failed to disclose some incentive for pushing that product.

Even better, ask the salesperson to put his or her recommendation – and the reason for it – in a letter to you explaining why it is a good way for you to achieve your objectives. While you’re at it, ask for a written statement about the worst-case one-year loss you should expect in this recommended investment. That should bring you and the advisor back to reality if you have been fantasizing about high expected returns.

If an advisor won’t put recommendations to you in writing, along with the reasons for them, that’s a tip that you should look elsewhere for advice. This single request, if it were regularly pursued by clients, would avoid billions of dollars worth of grief at the hands of brokers and planners who are mostly just looking out for themselves and their sales goals.

You should ask two other things before you get into an investment: how much it will cost you to get in, and how much it will cost you to get out. If you buy a fund that pays a 5.75 percent sales commission, then only 94.25 percent of your money is invested on your behalf. If you write a check for $10,000 to that fund, you’re investing only $9,425 and paying a commission of $575. Your commission, as a percent of what you invest, is higher than the nominal rate; it’s really 6.1 percent.

Many products have various exit fees or penalties. Variable annuities are a prime example, typically charging investors 7 percent to withdraw their money in the first year, 6 percent in the second year and so on until the penalty is finally waived. These fees can take a big chunk out of your capital, so make sure you know about them ahead of time, before you invest. If you don’t ask this question, you could end up as just another irate, discouraged investor who writes (often in vain) to a bank or brokerage house, saying something along the lines of: "Had I known then what I know now, I would never have agreed to it."