Are You Paying Too Much for Financial Planning and Investment Advice?
Donovan Sanchez, CFP®
Most financial advisors are compensated through commissions or by a fee based on a percentage of investment assets under their management. This article strives to help you better understand how the asset under management (“AUM”) fee structure works.
Practices that operate under the AUM fee arrangement, regularly charge 1.5% on investment accounts with “smaller” balances (say $50,000) and 1% on accounts with balances up to $1,000,000.
Many individuals look at that 1% figure and don’t think too much about it. One percent, after all, is such a small number.
Doing a little arithmetic may reveal otherwise.
When 1% is just too much.
To determine whether a 1% fee is actually “worth it,” it’s necessary to explore the services being provided. After all, shouldn’t cost be tied to the service offering?
Investment management services often include:
- Investment selection
- Asset allocation and portfolio construction
- Ongoing monitoring and rebalancing
- Asset location (for tax purposes)
- Behavior and accountability coaching
Financial planning services often include:
- Tax planning
- Retirement planning
- Education planning
- Cash flow management
- Debt reduction planning
- Insurance planning
- Estate planning
- Student loan planning
If these services are attractive to you, it can make sense to partner with a financial advisor. But what about the rules of arithmetic mentioned previously?
For someone with a $100,000 investment account receiving fiduciary financial planning and investment management advice, a 1.5% fee could be reasonable. The annual fee comes to $1,500.
But as the account grows, consumers should be thoughtful about the extent to which their fees grow as well. If the advisor is doing their fiduciary duty (acting in the best interest of clients), they should be providing best interest advice no matter the size of your account. If the service that you receive doesn’t change, should your fees?
Here are some examples for you to consider:
- At a standard 1% fee, your $500,000 account is charged $5,000 per year.
- At 1% your $1,000,000 account is charged $10,000 per year.
Suddenly that 1% fee doesn’t seem so small, does it? (Even with fee breakpoints, financial planning and investment management services become increasingly expensive as your account grows. I’ll let you do the math on accounts at the $2,000,000 and upward range.)
A reasonably informed consumer might shrug this off because “all financial advisors charge 1% on assets under management.” Yet while asset under management fees may be the traditional model under which financial advisors earn a living, a growing group of project-based and hourly advisors are offering services that aren’t based on your investment portfolio.
Compensation drives concentration.
Humans are social creatures that respond to economic incentives. Understandably, the method with which advisors are paid influences their behavior, or at the very least, creates conflicts that they must navigate carefully in order to put your interests first.
For example, if a financial advisor tells you that their advice is “free,” be careful—there’s a reasonable chance that they are paid on commission from the sale of insurance or investment products. They will necessarily be focused on convincing you to purchase what they sell (at least eventually). If they don’t do this, they won’t get paid, and it’s hard to make a living and get ahead without earning money for one’s time and energy.
Similarly, compensation will influence the advisor that is paid based on a percentage of assets under management. If you engage in this fee arrangement, don’t be surprised if your advisor regularly brings up that outstanding 401(k) rollover that needs to be processed to your IRA (under their management), or focuses much of the planning conversation on your investments. This type of advisor increases their compensation when they can convince you to bring more assets under their management.
This focus on assets under management can create conflicts. In his book, Financial Boot Camp Dr. Jim Dahle of The White Coat Investor blog writes:
Also be aware that even fee-only advisors can have biases and conflicts of interests. For example, if the advisor is only paid on a percentage of assets under management, they may recommend an IRA rollover that is ill-advised (which would increase assets under management), recommend against paying off student loans or mortgages (which would decrease assets under management), or recommend against investments that they would not manage such as real estate. (116)
Some final thoughts.
To date, many financial planning and investment management firms adopt compensation models that put advisor interest in direct conflict with their clients, or that can become excessively expensive over time. Ask yourself these questions:
- Do you really want your financial advisor to only get paid when they sell you a product (commission model)?
- Do you really want your financial advisor’s compensation tied to the value of your investments (assets under management model)?
- Is it reasonable to pay someone $10,000 per year (or more) for financial planning and investment management advice?
This isn’t to say that it is never appropriate to engage financial service professionals if you answer in the affirmative to any of the above questions. For example, obtaining life and disability insurance generally entails working with someone who earns a commission on the sale of a product. (As an aside, while there are many ethical insurance agents, it’s still a best practice to go into an insurance conversation with an idea of the type of coverage you want to obtain—particularly as it relates to life insurance).
Additionally, if the asset under management, project, or hourly fee is reasonable for the services being provided, then even significant fees can make sense. I’m thinking here about a $10,000+ fee for a particularly complicated, and time-consuming, planning situation.
If you’re paying a five-figure sum every year for ongoing financial planning and investment management, however, it’s worth taking a few moments to carefully consider whether services provided add up to the cost being charged. After all, in most financial planning relationships, the heaviest lift is at the beginning to sort out an individual’s financial plan and create a path forward. What follows in future years may often be described as “maintenance” of the plan.
Consider Dr. Dahle’s words from Financial Boot Camp once more:
No matter how you are paying your fee-only advisor, be sure to add up the total annual fee you are paying and then determine whether you feel you are getting that much value out of the relationship. Since high-quality financial advice and investment management services can be obtained for a four-figure amount per year, if you find you are paying $10,000 or more, I highly recommend you negotiate a lower fee with the advisor, switch advisors, or learn how to manage your own investments. (116)
The thoughtful individual recognizes that if additional value is obtained by paying a higher fee, it may be worthwhile. But when comparable services are offered for reduced rates, what purpose is there in paying higher fees?
For those in search of independent advice for a fair price, they should explore the growing group of financial advisors who charge based on project, hourly, or flat annual fees.
This content is for informational purposes only and should not be construed as personalized advice. Your unique situation needs to be considered, and the ideas presented here may not apply.
Please be sure to do your due diligence BEFORE implementing anything. Due diligence may include hiring a qualified professional who understands your situation completely and can offer you personalized advice.