If you are a regular consumer of personal finance blogs, I'm sure you've seen a lot of discussion on financial advisor fees. How do financial advisors get paid? What's fair? What are the options? How do you know if you're paying too much? Too little? What's the benchmark?
These are all great questions. Unfortunately, there are no easy answers.
As a financial advisor myself, I too have struggled with how to charge for my services. Like any business, competition and new technologies challenge the status quo. Back when I started in the industry over thirty years ago, we were all considered “stockbrokers.” We picked up the phone, cold calling people in targeted neighborhoods to sell them a product. Some people sold stocks. Others sold bonds. Many offered mutual funds.
We all got paid on commission. In other words, when you bought something from us, we were paid based on what you purchased. The stock had a trading commission. At the time, it was in the one percent range. A bond (municipal or corporate) had a markup built into the price. In other words, the firm bought the bonds at a specific cost, marked them up and resold them to the public at a profit. That's the way we did it back in the day.
Some firms still hold to this model.
Competition forces change
Then Charles Schwab introduced discount brokerage and do-it-yourself investing. The commissions they charged were substantially less than the traditional brokerage firm commission rates. The competition forced the big firms to lower their commissions as they started losing clients to the new discount broker.
Like many industries, competition and technology continue to change industry practices and how they charge for their services. Registered investment advisory (RIA) firms brought the next wave of changes. They introduced the fee-based or fee-only compensation structure. Under this arrangement, investors paid the investment advisor a fee that wasn't based on the products sold. Instead, they charged base on the size of assets they managed on behalf of their clients.
That fee structure brought further competition to the brokerage industry. It forced them to make yet another change in their structure. Firms began forming registered investment advisor entities as part of their business structure. Doing so allowed them to compete with the RIA competition. Reacting to competition often brings additional problems.
That was the case when brokerage firms entered the advisory space.
Conflicts of interest
Brokerage firms kept the commission business and added the fee-based platform to compete. That's where the conflicts of interest and confusion come to consumers. Many RIAs operate as fiduciaries. That's the highest legal standard of care for consumers. It requires advisors to always act in the best interest of their clients. It comes with a duty of care standard similar to what trusts use.
The commission based model is based on the suitability standard. That's a much less stringent standard. It only requires the products and services offered to be “suitable” for the client. There is no requirement for the product to be in their best interest. It sounds odd but that's the way it works.
I want to be crystal clear here.
There are excellent advisors in both RIA and brokerage firms. Most operate in the best interest of their clients as a matter of principle, not out of obligation. I was one of those advisors in the years I spent in the brokerage world. It is harder for sure. But it's more common than not.
Most of the ire toward advisors come out of a bad experience(s) with brokerage firms. That causes many consumers to indict an entire industry based on their personal experience. Look, I have no love lost for the brokerage industry. They've earned their bad reputation.
What I want to do in this post is to provide education on the various ways financial advisors get paid and arm you with questions to ask the advisors you interview. If you know what you want an advisor to do for you and understand the options on how they get paid, you'll be better able to sort through the maze of confusing information that comes your way.
Competition continues to change the way financial advisors get paid today. I'm excluding the commission-based model for this discussion. That model still exists and has its place in the conversation. For this discussion, I'll focus on the following five compensation methods.
- Assets under management (AUM
- Flat fee
- Hourly rate
- Subscription based
We will go into some detail of each. If you're looking for an advisor, you will gain the knowledge you need to decide how you want to pay for financial advice.
Let's get started.
1. Assets under management (AUM)
I think it's safe to say that the fee-based and fee-only model, even today, is largely under the AUM model. In this model, firms charge clients based on a percentage of the assets they manage on their clients' behalf. The fee percentage we see tossed around and blasted in the blogosphere is 1%. A 1% fee says that if you have a $500,000 portfolio, you would pay your advisor $5,000 a year for them to manage that money for you.
Many firms, including mine, offer a tiered fee structure. The larger the account, the lower the fee percentage. There are arguments for and against this fee structure. I'll let the reader decide for themselves. I've always believed in choice. The same goes for financial advisor fees.
Here's an example of a tiered fee schedule.
If you look at the AUM structure in a vacuum, the fees seem very high. That's the overwhelming opinion of the personal finance bloggers, especially the physician bloggers. I get it. Many docs have been targeted and swindled by a financial advisor or insurance salesperson. When you've been cheated, it definitely has an impact on how you view the next person representing those who cheated you.
What's missing from the view is that the AUM fee represents a much larger array of services provided by the advisor. It's rarely the only thing they do for clients. The fee often includes a comprehensive financial plan, including review of outside investment accounts such as 401(k), 403(b), and other employer retirement plans. It includes analysis of pension, Social Security, insurance, estate planning, college education funding, and asset protection.
Advisors stay with their clients through all stages of their lives. The relationship is deep and long-term in most cases.
Value for service
Like anything we pay for, the value we receive from the product or service gets weighed against the fee we are paying. It's no different when paying for financial advice. There are ways to pay for asset management that are far less expensive than the fees quoted here. Robo advisors are the newest competition to enter the investment management space.
Robo advisors are technology companies that use algorithms to develop low-cost portfolios that automate the investment management function. Automated investing is much less expensive than the normal custom AUM model. Fees range from 0.25% to as high as 0.75%. Investors can choose from different management styles and portfolios. Some allow investors to build their own portfolios. Many of these firms are start-up companies funded by Venture Capital and other private investors.
Competition from the robos has forced firms to lower their fees to compete. The downside of robos is that, for the most part, robos provide investment management with no other financial services. On the other hand, the robos find their customers want more than investment management. To compete, some have added financial planning services.
As I've said from the beginning, competition forces change in an industry. The ultimate winner, in the end, is the consumer.
What Does a Financial Advisor Do?
2. Income-based fees
A relative newcomer to the field, income based fees are based on the income clients earn rather than the investable assets they have. I like this model a lot. In fact, I've switched my fees for financial planning to the income-based model.
One legitimate complaint about the AUM model is it excluded people without assets. Everyone needs financial planning. Whether they do it themselves are hire someone to help. It's important for financial success to have a plan and execute that plan. Income-based fees open up planning to anyone. You don't have to have a big account to get planning. Here is my fee schedule as an example.
|50,000 - 100,000||1%||$100,000||$1,250||1.25%|
|100,000 - 250.000||0.75%||$250,000||$2,375||0.95%|
|250,000 - 500,000||0.60%||$500,000||$3,875||0.78%|
Every financial advisor or firm is different. Be sure you understand what's included with the fee. Do they require asset management as part of the plan (I don't)? Is the plan a stand-alone service? What's included in the financial plan? Is the fee a one-time fee? Is it annual? If annual, how often does the plan get reviewed? How many meetings does it include? It's important to ask questions so you know what you get for the fee.
If you're interviewing financial advisors, ask them if they offer an income-based fee option.
Flat-fee financial plans are another recent addition to the mix. Advisors using a flat-fee charge a set amount for the services they provide. I've seen a wide range of flat-fee charges. Some are as low as $500.00. At the high-end, I've seen them charge $10,000 or more. Obviously, that kind of fee is out of reach for the average consumer. They are targeting high-income clients with complex planning needs.
Flat-fee planning is a clean, straightforward way to pay for planning. You know up front what you're paying. You should also know what the fee includes. Ask the same questions I suggested earlier to be sure you understand what you get for the fee.
One-time flat-fees shouldn't mean one-time engagements. Financial planning isn't a set it and forget it proposition. Your life, like your investment returns, does not happen in a straight line. It's important to evaluate and review your plan at least annually. In most cases, the fee charged for ongoing service will be the same as the initial fee. In some cases, firms offer a reduced fee for annual reviews.
Dig deeper in each of these fee models to find out what's included and the ongoing services that come with the agreement.
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4. Hourly fees
There is no mystery as to what an hourly fee means. Planners under this fee model set an hourly rate and charge for their services based on the time spent creating, implementing, and managing your plan. Rates vary wildly, as they do with all fee methods. I've seen rates as low as $75.oo an hour (though rare) up to $500.oo or more. Once again, the rate you decide is reasonable should be based on the value you receive for the money.
The complaint against hourly rate planning is the same complaint waged about lawyer's fees. Clients often wonder why it took so many hours to complete the work. When listing or quoting their fees, many advisors estimate the time they will spend on creating the plan. if they say it will take twenty hours and their hourly rate is $100.00, the fee for the plan will be around $2.000. If the hourly rate is $200.00, the cost is $2,000.00.
Ask the same questions. What's included in the fee? Does it include ongoing service? If so, is the hourly rate the same?
Though some would complain the hourly rate gives advisors the opportunity to take longer than necessary, there are ways to monitor the hours. Like lawyers, advisors can provide a time sheet showing the hours they spent on the plan. Some might even include what they were doing during those hours.
If you're sensing a theme in my commentary, it's pretty simple. Know what you're getting for the money, regardless of the fee structure you choose. Ask lots of questions.
5. Subscription-based fees
Subscription-based fees are the newest entry into the fee structures and very popular among younger Millennial investors. When you pay subscription fees, you make automatic payments via a secure payment system. Firms may offer monthly, quarterly, semi-annual or semi-annual options. The most common are monthly and quarterly.
The services collecting the subscription fees charge a handling fee. One of the more popular services charges 3.5% + 0.30% per credit card transaction. For ACH (direct debit from a bank account) the fee is 1.50% per ACH transaction. The fee is ongoing. The financial planning or advisory agreement states the amount, frequency, and length of the payment schedule. As with any of other fee agreements, know what the terms are and what you get for the fees you agree to pay.
Some advisors ask for an upfront payment. For example, if the subscription is a $250.00 monthly ($3,000 annual) fee, they might collect the first quarter up front and divide the remaining balance over the next ten months. The monthly payment stays at $250.00 after the initial $500.oo downpayment.
Advisors may be open to working with clients on the fees. Though under the subscription model, they are less likely to do so. Come with your list of questions and get them answered before deciding if this plan is right for you.
Competition is alive and well in most industries. Those willing to adapt and adjust will continue to do well.
In the financial advice industry, it's as true today as it was over thirty years ago when I started out as a broker in a regional midwest firm. Back in those days, advisors freaked out about what discount commissions would do to their bottom line. Soon after, it was the threat from fee-based advisors who charged asset-based fees. In the last ten years, asset-based fees have been forced lower with competition from automated investment management firms (a.k.a. robo advisors).
My investment advisory firm is no different than any other. I've had to adjust and adapt my ways of doing business due to the competition. When I left the brokerage world, I made the decision to become a registered investment advisory firm and leave behind a lot of revenue from brokerage products. It was the right decision for me. Others left and kept a brokerage relationship in addition to their RIA firm. There's nothing wrong with either model. There are great advisors in both worlds. There are bad advisors in both worlds.
I hope you found this discussion of fee structure helpful. If you're seeking financial help from an advisor, this should give you questions to ask to help flesh out how they get paid. If they can't answer in clear, concise terms or waffle in their answers, I'd be very careful about working with them.
Nowadays, there are plenty of choices of good advisors on all channels. Educate yourself on the fees you're most comfortable paying and the services you want to be provided. Let that guide the decision on what advisor to choose.Follow me on social media