When Jon Yankee and his two partners started their Reston, VA-based firm six years ago, they wanted to do it right. Among other things, that meant putting in place a clearly-thought-out compensation plan for both advisors and staff. “We weren’t going to do this by the seat of our pants,” says Yankee, whose firm, Fox Joss and Yankee has about $312 million in assets.

To help them design the best pay plan, Yankee and his partners hired a compensation consultant. They started with an underlying premise—that the pay structure would need to support the firm’s ensemble team approach. This meant choosing a model that would allocate salary and incentive compensation to all seven employees depending on the job and experience level of the individual. Bonuses were based on a variety of specific criteria, from regular attendance at firm-wide parties to, when appropriate, new business development. New advisors, they determined, would be offered plenty of mentoring and on-the-job training to help them get up to speed.

So far, it’s worked. Since the firm was founded, turnover has been low, pre-tax profit margins have grown from 10 percent to 23 percent, and there has been a steady increase in revenues. Yankee credits at least some of that success to the firm’s compensation approach. “Our people know they’re being paid fairly and the way they’re paid helps the firm achieve its overall goals,” says Yankee. “That’s the only way to do it.”

As Yankee discovered, paying your employees the right way involves a lot more than just, say, choosing a starting salary level that strikes you as reasonable or doling out a bonus based on your perceptions of an individual’s performance. It requires a hard look at your goals, how you want your staff to help you achieve those goals, and a systematic plan for figuring out how much to pay and what form that compensation should take. It also requires sticking to your guns so that, if, say, the firm doesn’t meet its revenue objectives, you won’t bust your budget, paying a bonus that you can’t afford. “A compensation system needs to be transparent, disciplined, and explainable,” says Andrea Schlapia, CEO of Ironstone Communications, a Fort Walton Beach, Fla-based firm specializing in practice management for financial advisors.

What’s more, not putting a structure in place can have all manner of negative repercussions. It can create poor morale, reduced productivity—and even set employees up for failure. “When you’re too subjective, it leads to unrealistic expectations, disappointment, and poor performance,” says John Nersesian, managing director of Nuveen Investments in Chicago.

For many advisory firms, the matter of getting their compensation right is especially critical now. That’s because it’s harder than ever to find new advisors. On average, there are about two junior advisors available in the market to replace each more-senior professional as he exits, according to Eliza De Pardo, principal and director of consulting at FA insight, in Tacoma, WA. And compensation is going up. In 2010, 80 cents of every dollar of costs were related to staff expenses compared to 77 cents in 2008, according to a recent study by FA Insight.

Your starting point should involve something many advisors never think about: a compensation philosophy. “Before you make any decisions, you need to have some guiding principles that would tell you what’s right and what’s wrong, what fits and what doesn’t,” says Philip Palaveev, president of Fusion Advisor Network, in Elmsford, NY. What’s more, according to Palaveev, those factors need to be consistent, applying to all your employees, not just administrative staff or advisors. That includes such considerations as whether you’re willing to pay above or below market rates; the level of previous experience you require; and the role of short and long-term incentive compensation.

Just as important is figuring out what your overall goals are and shaping your compensation system to help make them happen. For Yankee, for example, individual advisors don’t own their clients; instead, revenues are shared. For that reason, according to Yankee, it’s important for the firm’s compensation system to underscore that team environment. Advisors and staff receive a base salary, along with incentive compensation based on factors encouraging teamwork, such as referrals from existing clients and participation in the firm’s monthly happy hour. If attendance is less than 90 percent, that hurts the bonus. “The idea is to build a culture where everyone works together, everyone likes each other, everyone wants to hang out with each other,” says Yankee.

In addition, as a general rule, compensation needs to reward the specific behaviors you want each employee to engage in, according to De Pardo. It’s not the best idea, for example, to base a junior advisor’s individual bonus on bringing in new business if that person mostly focuses on serving existing clients. Similarly, there will be little incentive for an advisor to develop new relationships if a very large percentage of his compensation is based on existing revenue, she says.

Writing job descriptions for every employee is another step to take early on. Of course, you need to go through such an exercise to pinpoint skills appropriate for each position. It also helps you figure out not only what to pay people, but also the duties you need to measure later on in performance reviews. “You really can’t hire someone or figure out how much to pay them without knowing what they’re going to do,” says Palaveev.

In some cases, you can turn to existing staff to help produce job descriptions. Take Bill Stevens, whose Sterling, VA-based Raymond James Financial Advisors practice has about $50 million in assets. Now in the process of hiring an additional administrative staffer, he has sought the advice of his long-time assistant to pinpoint the appropriate skills to look for. “She has a really good grip on what our strengths are and where we need the most help,” he says.

Once you know what an employee’s duties will be, you can assign the job a title. With that information, you’ll be able to get a hold of market surveys and see what competitors are paying their staff in similar positions. Then, of course, you have to evaluate whether you have the resources to offer that level of compensation. If you don’t, then you might be able to make up for the gap by offering other perks, anything from footing the bill for classes aimed at achieving professional designations to allowing a work-from-home schedule.

For advisors’ compensation, there’s no hard and fast rule about whether or not to offer a salary. “The key is making sure the plan is a good fit for a given position,” says De Pardo. Generally, however, advisors whose job primarily is serving clients, as opposed to developing new business, probably should receive most of their compensation in the form of salary, with a considerably smaller amount from a bonus. On the other hand, a much higher percentage of the compensation for someone who is expected to make a lot of rain would be based on new business.

The big mistake to avoid is hiring inexperienced advisors with little business development track record and immediately expecting them to derive most or all of their compensation from revenue generation—especially if they’re thrown to the lions, with little guidance or training. “It’s a recipe for disaster,” says Palaveev.

The answer for those firms that choose to pay their advisors based on a percent of revenues, without a salary, is to provide daily training and mentoring. “You can’t throw them in the deep end,” says De Pardo. Take James Karabis, managing director of Vestor Capital. About a year ago, the Chicago-based firm, which has $600 million in assets, decided on a ten-year plan to reach $10 billion in assets. To achieve that goal, Karabis decided the practice needed to attract more advisors, partly by changing its compensation system. That meant only giving advisors a payout—up until that point, they had received a salary. But the firm also assigned all newbies a more senior-level-advisor to work with them on a daily basis. For example, mentors take the lead at all new client meetings, so inexperienced colleagues can see how it’s done. Then they share the revenues.

Even those advisory firms that pay a salary, however, also often provide extensive training. At Yankee’ s firm, for example, new advisors spend as long as six years or more involved in such activities as helping to prepare for and observing client meetings, learning how to complete paperwork, and attending networking events, before they have to develop new business. “The expectation is that they learn how to be good financial advisors, and that over time that experience will help them develop deep relationships with existing clients who will start sending over new business to them,” says Yankee.

John Graziano, who has a staff of 15, seven of whom are advisors, takes a different approach. He provides daily training to new advisors at his Bayonne, NJ-based firm Future Financial Advisors with about $1.2 billion in assets. But he also starts them on a combination of salary and bonus. That salary, in fact, is more like a loan that the individual needs to repay, usually in about six months. After that, they’re paid on a commission basis.

Support staff, of course, should earn a salary. But, ideally, according to De Pardo, it’s important for all salaried employees to get bonuses, although the incentive compensation for non-advisory staffers would comprise a smaller percentage of overall pay than for advisors. And, for best results, bonuses should be tied both to individual and firm-wide performance. Yankee, for example, pays all employees an individual bonus of up to 10 percent of salary. That’s based on individual performance goals that are agreed to by employees and their supervisors at the beginning of each year. Everyone also gets incentive pay based on how the practice does, triggered by a certain level of profits. Last year, for example, the firm determined that, once profits hit $350,000, then the next $150,000 of profits would go into a pool to be shared among all employees, as long as certain overall targets were hit. The amount each person got was determined as a percentage of their base salary.

Such a system means that, even if employees do really, really well, they still won’t receive everything they might have been hoping for if the firm fails to meet its targets. And, in fact, last year, when Yankee’s practice hit just 75 percent of the target, only 75 percent of the profit pool was distributed to employees.

Maintaining that kind of discipline is something advisors don’t often manage. Schlapia, for example, points to a firm whose revenues tanked after the market meltdown in 2008, but, nonetheless, took out a $100,000 loan, mostly to pay employees their promised bonuses. According to Schlapia, the two owners are still paying off their debt.

Ultimately, a smart compensation plan doesn’t exist in a vacuum, separate from an employee’s overall aspirations. That is, you need to tie it to a longer-term career path—the various positions available in a person’s career track and the skills needed to attain those jobs. Karabis, for example, has a specified trajectory for staff, from administrative assistant to junior client service associate to senior service client associate. “There’s a clear delineation of the skills and knowledge required to do each job—and to justify the increase in pay as you move up,” he says. As for Yankee, his firm has a career path for advisors, beginning as a para planner, moving to an associate financial advisor, then to a financial advisor, next to a senior financial advisor, and finally as a partner. As employees progress along that path, of course, salary levels increase. “We’re trying to build employees who stay with us for the long term,” he says.