What you should know about Financial Advisor fees.
Let's get the elephant in the room out of the way...
Financial Advisors don't have the greatest reputation out there. One of the big reasons is the unclear and not very transparent way many charge for their services.
You have probably experienced these situations. You go to the hospital and the whole time, you are feeling anxious about how much the medical bill will be at the end. They can't really give you an exact price as they don't know what treatments you might need. So not only are you worried about the medical side, but you are also uneasy about how much it will cost you.
The same can happen with attorneys, auto shops, general contractors, and many more.
So it is a bit ironic that you want to engage with an advisor to help you with your finances, yet it may not be clear how much the financial advisor costs. That would be a frustrating situation and often offputting. It may even deter you from engaging with a financial advisor due to the lack of clear pricing.
Let's walk through the three main fee models an advisor can charge for their services.
THE THREE MAIN FEE MODELS:
1. Assets Under Management (AUM for short): The fee is a percentage of your assets that are under management by the advisor.
For example, let's say you have $500,000 in various investment accounts that the advisor manages on your behalf. If the firm charges 1%, then the annual fee will be $500,000 x 1% = $5,000. Since the value of your investments will vary due to market fluctuations or other activity, the dollar amount will change, but the percentage will stay static.
This fee model is the most popular model for financial advisors.
2. Fixed or Flat fee: The fee is predetermined in your contract with the advisor. It is fixed and doesn't change until an updated fee is renegotiated for various reasons, such as inflation adjustment, complexity, etc.
For example, you work with an advisor who charges $5,000 a year for their services. The fee will be static, regardless of how much money they manage for you. In fact, they might not even manage anything directly. This arrangement is not connected to your investable assets. You may not even need to have any investments at all for the advisor to manage.
This fee model, while not new, is becoming more and more popular. It can behave like a subscription since the annual fee can be paid monthly, quarterly, or annually.
3. Commissions: The fee is based on the financial product, how it was structured and how much of it was sold to you. The amount of commission will vary greatly. Typical financial products that are commission-based are Annuities, Life Insurance and certain mutual funds.
Usually, there is no direct exchange of money that covers the fee separately. The commission is built into or deducted from the product that is purchased.
For example, you may purchase a mutual fund with a 5% front-load sales charge. So, if you buy $100 worth of the mutual fund, $95 will be invested, and the $5 will be deducted as commission.
Insurance products, such as Term Life Insurance, Permanent Life Insurance and Annuities are another set of popular financial tools that come with commissions.
To be clear, none of the above three fee models are either good or bad. Each can serve a purpose depending on the situation. As Financial Advisors, you will hear us often say "It depends". It always depends on YOUR unique situation.
But you need to be aware of the three models and take into consideration how the financial advisor charges for their services. Unfortunately, depending on the fee model, it may bring conflicts of interest. I believe that any fee model can have a certain level of conflict. Some more than others depending on the situation.
A conflict of interest is when an entity or an individual may have a reason not to put your best interests first. I don't want to pick on commissions, but it is the easiest way to explain how a fee model can potentially cause a financial advisor to not work in your best interest.
If you are offered a financial product and that product is commission-based, is the product offered to you because it is in your best interest or because that's how the advisor will get paid? Are they acting in your best interest? Are they an advisor or a salesperson?
There is nothing inherently wrong with commissions. Many jobs receive commissions. Also, certain financial products, like Insurance, are mostly commission-based. That doesn't make them bad products.
The above is a high overview to get you familiar with the three main fee models. A future blog will dive deeper, going over different variations of each, PROs and CONs, and other "hidden" fees that you should be aware of.
At the end of the day, there are three things that I believe in when it comes to how an advisor sets up their fees:
1. Transparency. The pricing should be clear and available on their website or upon request. You should not have to guess how the advisor charges.
2. Advisor should do what is best for the client, at all times. Compensation should never be a driver for recommendations.
3. Advisor should provide value above what he or she charges for their services.
