Recently, the financial services industry has come under scrutiny for hidden and unexplained costs. These fees are not only unfortunate, but are also besmirching the reputation and integrity of the industry. In order for financial planning to become a respected profession, we need complete transparency of fees. In other words, NO HIDDEN FEES, NO UNDISCLOSED COMMISSIONS, and NO UNEXPLAINED COSTS. Advisor fees should be clearly communicated to clients so that they can make informed decisions with their money. This post will explain how advisors are typically compensated.
Advisors typically hold themselves out as being either commission based, fee-based, or fee-only.
Commission based advisors earn income based on a percentage of the product they are selling. For example, if you buy an American Funds “A” share fund you will usually pay a 5.75% commission to the advisor. On a $100,000 investment, that means you pay the advisor $5,750 for one transaction. The benefit is that it is a one time fee, and you do not have to pay any more advisor fees. The downside is that you may never hear from the advisor again unless they want to sell you another product for a commission. In this type of relationship, the advisor clearly works for the company of the product they are selling.
Fee-based advisors advise clients for a fee based on the amount of assets they manage AND can make a commission when they suggest a particular product such as life insurance or long term care insurance. This form of compensation really puts the client at the mercy of the advisor. A good advisor will charge a fee for most investment advice and ONLY charge a commission when the product is ABSOLUTELY necessary for planning purposes, like when life insurance is necessary. IF the advisor charges a fee for managing the investments AND receives a 5.75% commission from the sale of the funds, they would receive $5,750 up front, followed by an annually percentage, or about $1,0oo. (According to a recent Financial Planning Association Research Center study, 60+% of fee advisors charge 1% or greater.) This is a worse case scenario. What’s also concerning is that the advisor is working for both you, and the company whose product they are selling. This causes a conflict of interest as to their loyalty. Whose interest are they putting first? What is most important with a fee-based advisor relationship is that the advisor disclose ALL their compensation so that you know if they are double dipping by charging fees and commissions.
Fee-Only Advisors are the only advisors that are paid STRICTLY by the client, therefore eliminating many conflicts of interest, and introducing objectivity. Fee-only advisors can be compensated a few different ways:
- Hourly – The advisor charges an hourly rate for time spent working on a project. Typical hourly rates range from $100 to $500 an hour, averaging $180/hr.
- Fixed Fees – The advisor quotes a fee for a project based on the the number of hours he thinks it will take him to complete the plan. Costs range from $1,000 to $5,000 depending on the complexity of the situation.
- Retainer – The advisor charges a flat annual retainer fee for services rendered throughout the year. Retainer fees range from $2,500 to $10,000 a year.
- Percentage Based Fees – The advisor charges a percentage fee based on the Assets (investments) Under Management, often called AUM.
Hourly and fixed fee payment methods are most utilized by the Do-It-Yourself (DIY) and beginner investors seeking a second opinion on their personal finances without a long term commitment. This also keeps the costs down long term because you can get your advice, and save money implementing the advice yourself.
Retainer and AUM Fees are mostly utilized by investors that have enough money or income to justify paying their fees out of pocket. Typical retainer and percentage based clients are well into the accumulation phase of life, or retired investors that are in the preservation phase of life.
Retainer fees are good because you can easily judge whether you are getting your money’s worth. The downside is that it doesn’t give the advisor incentive to do any additional work.
Percentage based fees are good because they align the interest of the client and the advisor to either maintain or increase the value of your portfolio. The downside is that the advisor may suggest planning techniques, like not paying down debt, that maximize the amount of money they manage, or worse, they may take too much risk in order to increase their fees.
All forms of compensation have their conflicts. Finding the form that is right for your depends on how much advice you need. If you are new to investing, you might consider doing it yourself using online resources. If you are nervous about making these decisions, you could hire a fee-only advisor on an hourly basis, or seek a commission based advisor and pay a one time fee. If you are a seasoned investor, you might delegate your investment, financial planning, and tax needs to a retainer or percentage based advisor. Or, you could do it yourself and not hire an advisor at all. It all depends on how comfortable you are making decisions that can have an impact on your golden years.
As an advisor, I’m biased towards using an advisor. One reason I’m am biased is because a good advisor can navigate the HIDDEN FEES in Investing.
