On the list of problems everyone should have, deciding how to pay a financial adviser is near the top, just below picking a Porsche mechanic and choosing between Hawaii and Barbados for vacation.
As people wrestle with ensuring their financial well-being, consumers at all income levels are looking to professional asset managers for help. Few, however, know the options available for paying those advisers. There are pros and cons to each, and though many options exist, most advisers typically only offer one. The choice for consumers ultimately revolves around whether cost or value is most important.
Asset-Based Fee Arrangements
The concept is simple: the adviser takes a percentage — anywhere from 0.5 percent to 2 percent — of the total value of the asset portfolio being managed. The adviser’s compensation is based on how much money he or she makes for the client.
Despite being the most common arrangement, it’s not available to most consumers. The majority of advisers who use this approach require an asset value of at least $250,000 or $500,000. To be profitable serving clients below that level requires an adviser to take on a larger number of clients, making it hard to be effective.
Concern that advisers take more risk on behalf of clients who meet the required financial baseline — trying for a more substantial payoff — generally is mitigated by the fact that an adviser bears similar risk to the client. A more pragmatic conflict arises when a client wants to remove money from his account to invest in something else. For example, an adviser might want to advise his or her client against removing $300,000 to buy a rental home, not because it’s a bad idea, but because it lowers the adviser’s paycheck.
Net Worth and Income Arrangements
This is a newer option. At first glance it appears as something created by financial advisers for financial advisers, but in some circumstances it is a more cost-effective approach for clients.
Unlike the asset-based approach, fees are based on the client’s total net worth, income or both, and the fee percentages usually are lower. The math gets complicated, and generally for someone with less than $1 million in net worth and income it’s costlier. Above that level however, it’s an approach that can save investors money.
These are as straightforward as their name suggests. Clients pay a fixed monthly or annual fee, which covers the cost of developing a retirement or college savings plan and managing the clients’ accounts as those plans are implemented. These arrangements make it possible for advisers to serve smaller clients.
It’s a “low-touch” arrangement, meaning clients may only get to meet with their adviser once a quarter. That could be satisfactory for consumers who don’t need much ongoing advice. Consumers should understand, however, that they are neither paying for nor receiving comprehensive financial planning and advice.
“A financial plan is just that, a plan. And for some people that’s enough to get them started,” says Keith Springer, president of Springer Financial Advisors and host of “Smart Money” on KSTE-AM. “True money management, however, needs active engagement. It needs someone who’ll be on it all the time. It’s important to know the difference.”
In a typical arrangement, clients pay for a financial plan, either through a flat fee or an asset-based fee,
plus a commission whenever the adviser purchases an investment for them.
Its supporters say that, since consumers have to pay commissions on their investments anyway, it’s efficient to have everything handled under one roof. Critics, however, say it places more costs on the shoulders of the clients — often without them knowing. It also creates a scenario susceptible to conflicts of interest, since the adviser makes money regardless of whether the client does.
“You don’t want someone who, at the end of the month, starts conducting a whole bunch of transactions so they can cover their car payment,” Springer says. “You want to work with someone who’s only being paid by you.”
Hourly Fee Arrangements
It’s not uncommon for consultants — including financial advisers — to charge for every hour they work. But, like most other consultants, what they sell is value, and sometimes an hour of their work is worth more than the hourly rate. Hence, hourly fee arrangements are more the exception than the rule.
Picking the Right Fee Arrangement
Stephen Horan, head of private wealth with the international CFA Institute, says consumers shouldn’t be shy about asking an adviser how they get paid.
“You want to take note of how they react to the question,” he says. “They should be very comfortable telling you about their sources of compensation.”
And while asset-based arrangements might seem the best option on paper, customers should read the fine print. Many advisers rely on mutual funds and other products that come with additional fees and operating expenses that can transform a 1 percent fee into 2 percent.
“You want to focus on how much your all-in costs really are,” Horan says. “One or 2 percent may not seem like much, but it adds up over time and can consume a large percent of an investor’s wealth.”
From there, it may come down to a simple matter of calculating the cost of whatever arrangements are available, but it may be worth paying a little more for the peace of mind that comes with knowing someone is really working for your best interest.
“You want someone who’s independent and not tied to a list of company products that they can sell you for a commission,” he says. “You want someone who’s only on your team, who only makes or loses money when you do.”
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