Your Financial Adviser Charges What? Understand the Value of Advice
Here's a breakdown of how compensation for financial advice works, and what kinds of services you can expect to receive for the price you pay.
If you are considering hiring a financial adviser, you may quickly discover that every adviser charges a little differently and oftentimes offers slightly different services — or levels of service. It can be a confusing decision for investors, because it may be unclear why fees can vary so dramatically between financial professionals.
While I can’t speak specifically to what other financial advisers charge and why, I can provide context for the value of financial services and how you can identify the highest value for what you’re being charged.
Here’s what investors need to know about the fees financial advisers charge and what those fees actually pay for.
Understanding Advisory Fees
I recently leased a new car and was amazed at all the fees that we as consumers are faced with. From sales fees, the dealer fee and destination charge to document and tax, title and license fees, the trail of charges adds up to quite a significant amount on top of the cost of the car itself. I have to admit that when I started the process I felt a little frustrated and embarrassed by not knowing how much was appropriate to pay in fees and if any of them were negotiable. Compound that with the confusion I felt from getting two separate quotes ($100 difference per month) for the same exact car from two dealers!
While leasing a car is very different from finding the right adviser, my car-leasing situation got me thinking about how mystifying financial advisory fees must be for investors. Advisory fees, commissions, expense ratios, sales charges, wrap fees, planning fees, investment management fees, every financial adviser charges a little differently depending on the type of financial professional they are and their business model.
In order to know if you are getting the highest value, you must first understand the three most common financial service models for how financial advisers structure their fees.
3 Common Fee-Models: Fee-Only, Fee-Based, Commission
For starters, let’s first address the three separate fee models that most financial professionals use.
- Fee-Only: This is the compensation model that is most commonly recommended for Registered Investment Advisory firms, which are held to the fiduciary standard. The fiduciary standard sets the highest bar for advisers, requiring them to legally act in the best interest of their clients, regardless if that is the most profitable for the adviser. The clients’ needs must always be put above the advisers’, no matter what. You simply pay fees for services received: financial planning and asset management.
- Commission: Financial professionals who are paid on commission sell financial products. They are compensated through the sale of financial products like life insurance or mutual funds. Due to the inherent conflict of interest, these financial professionals are not held to the same fiduciary standard. Instead, they are held to the lower suitability standard, meaning investments merely must be suitable for their clients’ age and risk tolerance, and they aren’t required to put the clients’ best interests ahead of their own. For example, two suitable investment options, A & B, are presented to a client. A is a better fit for the client but pays the sales professional less than B. Under the suitability standard the sales professional is incentivized (and legally allowed) to recommend B, despite it not being the best choice for the client.
- Fee-Based: This is a hybrid compensation model. These advisers might charge a fee for their services, but also get compensated when you invest in or purchase certain products. Many of the big companies pay their employees on commission, but you'll also pay a fee for their services.
It’s Your All-In Cost That Counts
It’s important to understand your all-in cost when working with a financial professional so that you can compare financial advisers and assess which one can offer you the highest value for the fees they charge.
I see so many people who say they only pay their adviser 1%, because that is all they see on their statement. However, you may be paying much more than that. If you hold any mutual funds or exchange traded funds in your account, you are also paying the company that manages the mutual fund or exchange traded fund product. The fee you pay these managers is called the expense ratio. According to Morningstar, the asset-weighted average expense ratio across funds in 2015 was 0.61%. Investors rarely see these fees coming out as these are commonly paid by a reduction in the fund share price.
Additionally, you will also be paying an investment transaction fee when stocks, bonds or mutual funds are bought or sold. These transaction costs are not included in the advisory fee charged by your adviser.
What That 1% Advisory Fee Should Cover
It’s easy enough to understand the management fees a mutual fund charges or a transaction fee. So what does that standard 1% that your financial adviser charges actually cover if it isn’t paying these other fees? (If you are interested in an in-depth review of fees, check out “Financial Adviser Fees Comparison – All-In Costs For The Typical Financial Adviser?”)
Your advisory fee (whatever percentage it winds up being), typically covers having a qualified and educated financial expert on your team managing your finances. The fee pays for your financial professional’s time and expertise, but more than that — it covers the time and expertise they share with you so that you can understand your financial situation and make smart choices with your money.
The fee you pay should cover the ongoing maintenance of your personalized financial plan, meetings you have with your adviser and the regular access to ask questions and get personalized answers. It is the continual oversight of your financial accounts, recommendations for important money moves, the act of processing financial transactions on your behalf and being accountable to you and your financial success. The advisory fee you pay should cover the customer service you receive and the ability of a financial professional to help make the complex world of finance manageable.
In the end it’s about value, not cost. As with any service, understand the value you are receiving. Ask for an itemized list of the services you will receive for the fee your financial adviser charges, and also be sure you understand the other embedded fees that may not show up on your monthly statement. Ultimately, the benefits you receive should outweigh the fees you pay.
About the Author
Founder, Lake Road Advisors, LLC
Paul Sydlansky, founder of Lake Road Advisors LLC, has worked in the financial services industry for over 20 years. Prior to founding Lake Road Advisors, Paul worked as relationship manager for a Registered Investment Adviser. Previously, Paul worked at Morgan Stanley in New York City for 13 years. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network (XYPN). In 2018 he was named to Investopedia's Top 100 Financial Advisors list.