September 2018

The Cost of Financial Advice

Author: Pat Sokolowski, CFP®

How much should a financial advisor or planner cost and what is the best way to compare firms? Is my financial advisor a fiduciary and looking out for my best interests? It can be difficult to find the answer to these questions, because not all financial advisors or planners charge their clients the same way, and fee structures are not always as transparent or simple as consumers would like them to be. Here is an overview of the various ways that financial professionals get paid and the standard of care to which they are held:

Fee-only. The easiest fee structure to understand is fee-only. A fee-only investment advisor, by definition, means that they will never take a commission or sales charge or mark-up; they don’t sell products, and they operate as fiduciaries. Those offering financial services on a fee-only basis can use several different methods of charging for their expertise and time.

First, someone who is managing assets can charge on percent of assets under management (AUM). For instance, if you have $100,000 in an IRA account managed by a fee-only advisor who charges 1 percent of AUM, you will pay $1,000 for these services per year. These fees are typically around 1 to 2 percent per year and often decrease in percentage as assets increase.

Another popular way for a fee-only advisor to charge for services, especially financial planners, is on an hourly basis. A Certified Financial Planner™ will often charge between $150-225 an hour for planning services, with an estimate based on the scope of the engagement.

Lastly, the advisor may charge a flat fee, either in the form of an ongoing retainer or on a per project basis. This is popular with financial planners, who might offer a full financial plan for $2,500, for example.

Financial advisors and planners who are fee-only are working as fiduciaries for their clients. This means that, by law, the advisor must put the client’s best interests before their own. It is the highest standard of care that a financial professional can adhere to. The best way to know if your advisor is a fiduciary is to ask them.

Fee-based. A second way that someone can be compensated for financial advice is a fee-based model. This is common for dually registered investment advisors, some financial planners, and insurance agents.

Those paid using a fee-based structure will bill you either hourly or a flat fee for financial planning. As part of the planning, the advisor or planner may recommend a product such as an annuity or mutual funds. If one acts on the advisor’s recommendations and purchases products through them, the advisor will receive a commission on that sale as well as the planning fee.

This creates a potential conflict of interest that should be disclosed. The best way to know for sure is to ask how they get paid. Fee-based advisors operate under the suitability standard when they are receiving commissions, not the fiduciary standard that fee-only advisors typically adhere to. The suitability rule means that the advisor must recommend products or securities that the advisor believes are reasonably suitable for their client without respect to the cost.

Commission-based. The commission-based fee-structure is very common among brokers and insurance agents. These advisors do not bill you separately for their service, and this can lead to a misperception that they provide their services for free. Commission-based advisors are compensated through commissions they receive for selling products and gathering assets. Commissions can come in the form of a flat fee or a percent of the amount invested in a product. If your advisor is purchasing individual stocks, ETF’s, and bonds for you, he or she may be getting a commission on the trade. The commission is charged when they buy and when they sell. At some full-service firms, commissions can be as high as 2-2.25 percent of the value of the trades.

Commissions on mutual funds are paid typically in one of two ways. The first way that an advisor earns commissions is by selling front-load (a.k.a. Class A) or back-end load (Class B or C) mutual funds. The client pays 3-6 percent, typically, of the value of the investment. The second is from the issuing company, often referred to as a 12b-1 fee, which is charged annually.

Some products pay more than others, so there is always a potential conflict of interest when a commission fee structure is used. Keep in mind that financial advisors who receive commissions are held to a “suitability” standard. This means that they could recommend a more expensive product if it were suitable for you.

Wrap account fees. Most full-service broker-dealers have developed managed account programs (or “wrap accounts”) that charge fees based on the assets they are managing, bundling the management and trading costs. At first glance, these seem similar to fee-only accounts. However, where fee-only advisors charge about 1 percent per year, wrap accounts are typically charging on average between 1.25 and 3 percent, and some invest in mutual funds, which also add an additional layer of fees. In fact, it can be difficult to tell how much the total fee is in wrap accounts, because the fee is broken down into multiple parts and often difficult to find. In short, wrap account fees are generally expensive and far from transparent.

So, which is best?
There are pros and cons to each fee structure mentioned above. Your goals, investment strategy, investment knowledge, and the amount of money you are investing will dictate which fee structure makes the most sense to you. In my opinion, while it is possible to be served well and honorably under all models, the fee-only model serves the public best. The two questions you must ask an advisor are:
1. How and how much are you paid?
2. Are you a fiduciary?
If your advisor is unable or unwilling to answer these two questions, then it may be time for a second opinion.

Pat Sokolowski is a certified financial advisor (CFP®), VP and senior financial planner at WestView Investment Advisors, located at 1 Corpus Christi Place, Suite 106, Hilton Head Island. For more information, visit www.westviewhhi.com or call (843) 271-6088.

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