This is the third part of a six part series to help simplify your search for a financial advisor. Our second installment discussed I Need a Financial Advisor – What’s Next?
When you start looking for a financial advisor, one of your first questions will almost definitely be, “How much is this going to cost me?” But to fully understand how much advisors charge, it’s important to understand how they charge. The wrong fee structure could lead to someone mismanaging your assets, overcharging you or even giving you bad advice.
Comparing Financial Advisor Fees
There are a few common ways financial advisors get paid: hourly fee, flat fees, percent of assets, commission or a combination of those things. In addition, some financial advisors say they are “fee-only” or “fee-based”.
If an advisor says they are “fee-only,” that means that they get paid an hourly fee, flat fee, percentage of assets, or some combination of those three. Their compensation is not tied to the specific financial products they sell you, nor any buying or selling that they do in your investment account.
Advisors that say they are “fee-based” charge a mix of fees and commission.
Another common fee structure is “commission”, where the advisor is paid when they buy or sell stocks (or any financial products) on your behalf.
Let’s look at each of these fee structures in turn.
This is what it sounds like—you pay your advisor for the time they work and it doesn’t depend on the size of your portfolio. Typically, this ranges from about $100 to $400 an hour.Advisors who charge hourly fees tend to focus on holistic financial planning. This includes thinking through student loans, mortgages, retirement planning, saving for college, dealing with a windfall and figuring out the right mix of investments for your portfolio.
This fee structure can avoid conflicts of interest, but the hours can add up. Also, paying this way means you’ll have to do the work of executing the financial plan yourself; generally, advisors who charge hourly will give you a blueprint for what to do, but you have to do it. As long as you can handle carrying out the plan, paying hourly is an effective way to get a roadmap of what to do.
Flat fee / Annual retainer
Rather than charging by the exact number of hours, some advisors charge a flat fee or an annual retainer. These are set amounts that you pay for a service. The details can vary by advisor, but in some cases, this might entail a set price for a specific service such as creating a financial plan or for full, unlimited access to the advisor and all the services they offer.
A good way to consider whether you’d do better with a flat fee versus an hourly fee is to estimate the number of hours that your financial advisor might spend servicing your account. If all you want is to meet with someone for a few hours to make sure your current plan is working, then an hourly fee structure might be better for you.
But if you want a comprehensive financial plan with the ability to follow up, ask questions, make changes, and receive ongoing services like investment management, then an annual fee might be a better solution for you.
Percentage of assets
In this fee structure, the advisor charges you based on the size of your portfolio. A standard cost for this is 0.5% to 1.25% of the assets they invest for you annually. Advisors often charge smaller percentages for larger portfolios. So for example, if your portfolio is $250,000 and the advisor charges you 1%, you’ll pay them $2,500 for the year. This same advisor might charge someone with a $1M portfolio only 0.5% which is $5,000. Why is that?
If you think about it, most of the work that goes into managing a $1M portfolio also has to be done for a smaller, $250K portfolio – determining the appropriate asset allocation, investing the funds and dealing with the individual’s financial needs. There is likely a bit more work in the $1M management but it’s not 4 times the work.
The advantage of paying as a percentage is that it gives their advisors an incentive to grow your portfolio. The more money you make, the more they make; your goals are aligned!One drawback, however, is that advisors who charge this way typically won’t take on clients who don’t have big enough portfolios.
So, if you have a smaller portfolio and are looking to work with an advisor who charges a percentage of assets, make sure to ask about account minimums or specifically look for an advisor who is willing to work with smaller portfolios.
This fee structure is commonly used by financial advisors at large brokerage firms (think Merrill Lynch or Morgan Stanley). When your advisor is compensated through commissions, she’s making money on each financial product bought or transaction made. The main drawback here is the potential conflict of interest: Your advisor has an incentive to sell you financial products (even if they are unnecessary) or to make trades in your investment account simply to charge you commissions.
In some cases, advisors might say it’s free to work with them—but this isn’t strictly true. Even if you’re not paying for their services, they might encourage you to purchase specific products that provide them with commission, rather than other products that might actually be more appropriate for your situation. Additionally, a commission-based advisor typically can’t help you with other things like general financial planning, paying off student loans, or saving for a home.
However, this fee structure can be appropriate for people who are very financially savvy and have a solid understanding of the finance world, meaning they completely understand the fees and commissions involved in each transaction and can discern which products are worth paying the extra fees for. If that isn’t you, try a fee-only or fee-based or fee-only advisor instead.
Fee and commission (fee-based)
Paying a fee to your advisor doesn’t mean she’s not also getting a commission. Some advisors not only charge flat fees or percentage of assets, but also earn a commission on certain products like mutual funds, annuities, and life insurance. In this case, you’re generally not the one paying the advisor’s commission, as it’s paid by the company providing the product.
The potential issue here, too, is a conflict of interest: Some financial advisors won’t tell you that they’re getting a commission if you buy a certain product. So you may think your advisor is recommending something because it’s the best fit for you, not because it’ll give them a financial boost, too.This structure can sometimes be a more affordable way to get a holistic financial plan since an advisor might charge lower per-hour fees for financial planning, since she’s able to supplement her income with commissions.
If you’re thinking about working with a fee-and-commission advisor, make sure she is extremely clear about where and how the commission is charged, both before you become a client and whenever she buys or sells a product for you. That way you can always say “no” and also become aware of any potential conflicts of interest.
Have you ever heard of the term Fiduciary? We will cover this topic in our next post: What Should I Consider When Looking for a Fiduciary?
Thank you for reading all the way!
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