So you think you need a financial planner. The first question you are probably asking is how much is it going to cost you? And then, what services do you receive? Below lists the many different ways a financial planner can be compensated. You will find that the total cost is not necessarily the biggest factor in deciding which type of advisor to use. Choosing a financial advisor should be based on what your own financial situation and needs. I.e. do you need someone to review your 401k fund choices? Do you just want someone to manage your money for you? Do you value a financial plan and the peace of mind it brings?
This pay structure is most often associated with “Traditional” financial advisors simply because it has been around the longest. Think Edward Jones, Northwestern Mutual, or LPL Financial. In the investment world these advisors are often called “Broker/Dealers.” Broker/Dealers are really financial salesmen because their goal is to sell you products which in turn provide them with sales commission checks. If you have ever purchased a loaded mutual fund or are continually pushed to buy a whole-life insurance policy, odds are you are working with a commission based broker/dealer.
Individuals working with a Broker/Dealer will often say “My advisor doesn’t charge me anything.” While technically this is true; you aren’t directly paying the advisor. The advisor is indirectly paid through the mutual fund or insurance companies’ product you’ve just purchased. Which, you as the client pay through various sales-charges, loads, and ongoing management expenses for the fund. Remember, no one works for free. Someone who claims that warrants some skepticism.
This type of compensation structure can create conflicts of interest by incentivizing the advisor to push those financial products that generate the highest commission. This could also cause the advisor to “Churn” the account by placing trades to generate more sales commissions.
If it sounds like I’m not a big fan of commissioned based advisors it’s because I’m not. I’ve seen the most unnecessary fees and ridiculous investments coming from clients who were once with a broker/dealer.
Fee-Only financial planners are paid by you, the client. It is simply and transparent. This removes the inherent conflict of interest mentioned above regarding commission based advisors. Fee-only planners are independent, meaning they do not represent a large financial company or push one brand of products. Fee-only planners are also held to a higher standard, the Fiduciary Standard. This means they are required by law to act in the best interest of the client.
Usually all of the financial planner’s services are included in this one fee. This could include financial planning, investment management, estate planning, tax planning, and other services. The “fee” can be either an hourly rate, a flat fee, or a percentage the assets managed by the advisor – All of these types are described in greater detail below:
Fee-Only – Percentage of Assets under Management
This type of fee only advisor will typically charge anywhere from 1.5% to 0.75% of the assets that they manage. For example, a $500,000 portfolio at a 1% fee will pay $5,000 annually to the advisor. Typically the fee percentage decreases as the advisor manages more. For example, a $1,000,000 portfolio will likely pay less, as a percentage of assets, then the $500,000 portfolio.
This compensation structure incentivizes the advisor to grow the client’s assets because as the assets grow so do the fees that the advisor receives. As well, they don’t have a financial stake in recommending one investment over another (no commission check). Therefore, they recommend only what they believe is in your best interest.
This type of planner tends to manage all of your financial accounts, monitor, and rebalance on an ongoing basis.
Hourly is probably the most simple pay structure for an advisor. The advisor charges an hourly rate, which typically ranges from $150 - $250 per hour, for each hour of assistance they provide. This is ideal for people looking for advice on a few specific topics and do-it-yourselfers who want a professional second opinion to make sure they aren’t making too many mistakes. A full financial plan typically takes about 8 to 15 hours depending on the complexity of your situation. This equates to approximately $2,500 for the average plan. A client can then come back when they feel like their financial situation has changed enough to warrant an update of their plan.
Hourly planners will help with fund selection and portfolio allocation but do not manage the portfolio on an ongoing basis.
Fee-Only – Flat Fee
Flat Fee Advisors charge one monthly or annual fee for all their services which sometimes includes financial planning. Other times it’s just the investment management. This can be beneficial for high net worth clients because it caps their fees no matter how much they have but also means that there are no price breaks, as a percentage of assets. Therefore, someone with $500,000 and someone with $5 million pay the same even though the work involved may vary greatly.
You will also find flat fee advisors who charge a one-time fee for the upfront financial plan. This fee does not include on-going advice or investment management. When considering a onetime flat-fee you should always compare it to what you think it would cost if you used an hourly planner. Even with a flat fee advisor it comes down to an hourly rate.
While every advisor should have an incentive to grow a client’s assets, this incentive is not as strong when compared to the assets under management model because their compensation is not directly tied to the client’s assets.
The trend recently with some younger planners, like my friends over at XY Planning Network, has been to charge a monthly subscription fee of $150 - $250/month. The thought is this is better suited towards younger clients like Generation X & Y because they are used to paying monthly fees (cell phones, cable, etc.) and they may not have the assets required to work under one of the other fee structures.
Investment Management Only
Maybe you just want the advisor to invest your portfolio. Maybe you have a separate hourly planner you go to for advice when you need but you still want ongoing monitoring and management of your portfolio. Investment Managers charge either flat fee or a percentage of assets just to trade, monitor, and manage your portfolio. The fees are often much lower (advertised as low-cost) then a Financial Advisor, ranging from 0.25% up to 0.50%, but this does not include the financial plan or other advice such as college planning, debt management, insurance, estate planning, or tax planning.
With any investment portfolio there needs to be some up front due diligence to determine how a portfolio should be invested. The financial plan usually guides the investment decisions but with an investment manager you are not paying for this so they may instead perform some up-front risk assessment or survey to determine how your portfolio should be invested.
Remember, the incentive of the investment manager is to get assets in the door. So, don’t expect a lot of extra help when hiring this type of advisor.
Fee-Based financial planning is often confused with fee-only because of the similarity of the name. It is sometimes used by commission based advisors who want to get in on the popularity of Fee-Only planning, but are not quite ready to give up the lucrative commissions. Fee-based just means that the advisor is charging both commissions and fees. They will charge a fee for putting together a financial plan and then also collect commission when they sell you loaded mutual funds and insurance products recommended in your financial plan.
This type of compensation structure still provides the advisor with the incentive to sell particular products and churn your account.
Online Only Financial Advice
One of the newest types of advisors is online-only finance planners or “Robo Advisors”. There are websites that allow you to develop your own financial plan with the aid of on-screen questionnaires which in turn provides allocations for how your portfolio should be invested. The costs are obviously lower than the face to face financial planner, with fees averaging around 0.25%. This type of advisor is similar to the Investment Manager where you save on fees by stripping out services like a full financial plan but will still invest your assets in an efficient, diversified portfolio. This type of service could also be used in conjunction with an hourly planner for when you have specific questions that a computer just can’t answer.
You can always manage your own portfolio and prepare your own financial projections. This will obviously save you in fees. But unless you have knowledge and time (or a very simple financial situation) you should seriously consider seeking out the advice of a professional financial advisor – the lost returns or expensive investments by not being properly allocated could be far more costly than the advisor’s fees. If you go the do-it-yourself route you should consider supplementing this with an hourly planner for a “check-up.” We have actually have a guide for the DIY type of investors. You can get it here, its free. We just ask when you no longer have the time your situation becomes too complicated that you reach out to us.
The only cost to the do-it-yourself model is the commission that you pay to a discount broker. These typically range from $7 to $25 for each trade.
All of these compensation structures have their respective costs and benefits. When meeting with any advisor, if it is not already obvious, ask how they are compensated. If you are still confused or not quite satisfied with the answer, odds are you are talking to a Broker/Dealer who is paid through various compensation structures with the products he promotes. In fact, many time, the advisor doesn't even understand all the fees themselves. As with most things, it is better to keep it simple and transparent.
Schedule a meeting with a Fee-Only Financial Planner today!