How much does a financial advisor cost? You've gotten to the point in your life where hiring a financial professional seems like the next best move. You're looking for that trusted individual who is going to help guide you through all the financial obstacles you anticipate running into in the near future. Whether you're a young family looking to grow your wealth or a pre-retiree looking to confidently enter your golden years, hiring a financial advisor can make sense in a lot of ways. However, one of the more difficult questions to answer when evaluating financial advisors is how much will it cost? More importantly, is that cost worth the value I anticipate receiving in return? The financial services industry has done a good job of making the answer to this question pretty difficult. You could ask 10 different financial advisors how much they charge, and you may end out getting 10 different answers. So in this blog, I will break down four primary ways financial advisors get paid in order to help you understand what the true costs of retaining the services of a financial advisor really are.
- How much will it cost you to work with a financial advisor under a commissionable compensation structure
- How much will it cost you to work with a financial advisor under an Assets Under Management model
- How does a flat fee cost structure work
- When is the best time to look for an hourly financial advisor
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In order to determine how much it's going to cost you to work with a financial advisor, it's important to first start with how advisors themselves get paid. And it isn't always as straight forward as client pays advisor directly. Actually, it's much more convoluted than that. Back in the 1980's, most financial advisors were better known as stock brokers. Because the internet wasn't around yet, it was very difficult for an average investor to find information or investment opportunities. So they would lean on the advice of stock brokers to help them find, buy, and sell stocks. Every time one of these transactions was completed, the broker would receive a commission.
Now fast forward 35 years and instead of stock brokers, we have financial advisors. And many financial advisors that receive compensation via commissions are working within the same construct as stock brokers did before them. So how does that have anything to do with how much it would cost an individual who is looking to hire an advisor? Well, it's obvious that no one works for free. And if a financial advisor is working strictly under a commission compensation structure, the cost you will pay to work with that advisor will be embedded within the cost of whatever commissionable transaction you end out doing.
This can make it extremely difficult to actually determine your overall cost. It usually works like this. A financial advisor will help you open an account, analyze the different investment options available to you, and help you make the purchase of whatever investment product you both decided fits your needs best. You leave that meeting feeling pretty good about your decision because the advisor didn't charge you anything! However, the investment product you purchased has an underlining cost associated to it. So even though you are not being charged directly, money is still being allocated away from you via those underlining costs. And a good portion of that money will be redistributed to that advisor via a commission payment.
What makes it worse is that those underlying costs that are associated with the purchase of the investment product vary widely depending on what kind of investment product you actually purchase. You could buy stocks, bonds, mutual funds, ETFs, fixed annuities, variable annuities, term life insurance, permanent life insurance, etc. All of those different investment "options" come with varying underlying costs. Some will end up costing you far more than others. This means that under this structure, the actual cost of working with a financial advisor is directly correlated to which financial product you end up buying in the end. And if you don't end up making a purchase, the advisor doesn't get paid.
This can become a big problem because now the financial viability of a financial advisor is strictly determined on if they can get you to purchase a product or not. It creates massive conflict of interest. It may be that your best interests and long term objectives are in direct competition with the financial advisors next paycheck. So the total cost you may pay to work with a financial professional may not just be the indeterminable underlying fee's of the investment product you buy, but it could also be the opportunity cost of your overall financial wellbeing.
Assets Under Management (AUM)
This type of financial advisor compensation model is a great way for advisors to show that they are on the same side of the table as you. Both of your interests are mutually aligned. AUM works like this. A financial advisor will charge you a fee that is based on a percentage of whatever amount of money they are managing for you. That fee usually doesn't just pay for the investment management of the money, but it also compensates the advisor for providing you with other financial planning work as well.
Ex: Mike is a financial advisor who is compensated under the AUM model. He meets a prospective client named Katrina who is interested in retaining Mike's services. Katrina is looking for someone who can manager her IRA and help her become more prepared for her upcoming retirement. Mike charges a 1% AUM fee and Katrina's IRA has a total balance of $800,000. Which means that if Mike and Katrina end up working together, it will cost Katrina $8,000/year ($800,000 x 1%). For that $8,000/year, Katrina will get Mike's help with the investment manage of that IRA and guidance on how to become better prepared for her upcoming retirement.
This model has worked well in the past. The $8,000 that Katrina will pay Mike every year will be taken out of her IRA account. This means that Katrina will not have to feel the pain of writing a personal check every year for that amount. It's a cost that becomes out of sight and out of mind for clients. However, as investment markets go up over time (which history has shown us they do), Katrina is more than likely going to see her IRA increase in value. Which means every year that her account grows, the 1% AUM fee that Mike charges will result in a larger fee deduction coming out of Katrina's account each year.
Ex: After the first year, Mike has done such a wonderful job of investing Katrina's money that her IRA has now suddenly jumped to a value of $1,200,000. $400,000 more than what it was at the beginning of the year. This means that if Mike charges his same 1% AUM fee, the new cost to Katrina to retain Mike's services in year 2 would be $12,000. (1% x $1,200,000).
This is why it can be said that the financial advisor and the client's interests are aligned. When the client makes more money, the advisor gets paid more. When the client loses money, the advisor gets paid less. They have the same goal. Grow that account as much as possible. The tricky part about this type of relationship is determining if the increased fee is actually correlated to the advisors value. If over the next 6 years, Katrina's IRA doubles in value, is that enough to make it worth paying double the fee. A 1% fee on $1,600,000 is twice as much as a 1% fee on $800,000.
The question then becomes, is it really the investment management skill of that advisor that is solely dictating the account value in her IRA going up? Or could this increase in account value have more to do with the natural increase of investment markets over time? If you believe the latter is the case, then does it seem right to pay an advisor more every year just because your account balance goes up? Especially if that increase in value isn't 100% due to that financial advisor's investment management work.
Now think about getting charged under this model over the course of a 30 or 40 year period. If we assume that an investment account will double every 15 years, it means the difference between costs in year 1 for Katrina ($8,000/year) and and costs in year 30 ($32,000) is $24,000/year. The slight rise in costs each year means that much more money getting pulled out of your investment account each year. That means less money left in your account that could have been used for additional investment growth and compounding.
This becomes irrelevant however if the financial advisor is delivering enough value in other areas of your life, like do you have enough money to retire, to make it worth it. And there are a lot of great financial professionals out there doing just that. But ultimately it's up to the client to determine if the cost they are paying the advisor each year under this model is worth the value they are receiving in return.
The other type of cost an individual may encounter when working with a financial advisor may be in the form of a flat fee. This is one of the easiest and most transparent ways to determine how much it will cost to work with a financial advisor. A flat fee model is one that lists out how much an advisor will charge based on a set of underlying circumstances.
The fee may be calculated by the amount of income your earn. It may be calculated by how large your overall net worth is. It may be calculated by what type of work the financial advisor will be doing for you. It may be a combination of any one of those things in determining what your cost will be. Regardless of how the fee is determined, once it's set, it remains at that level. It doesn't matter which investment products you purchase or how big or small your account value is each year. You pay the financial advisor whatever that flat fee amount is and everything you have engaged the advisor to do for you is covered under that flat fee amount.
This is the type of fee model that PharmD Financial Planning uses. We determine your net worth, and depending on what that value is, will determine what fee you will be charged each year. We believe that when a fee is agreed too and it isn't aligned with a product purchase or an account value, it eliminates as much conflict of interest as possible. It allows us to deliver financial advice and guidance in whatever areas the client needs. And our fee isn't affected by any action a client takes throughout the year. So most clients can feel really good about the advice we give knowing that there is no direct link back to our compensation based on that advice. It remains the same regardless.
It's important to note that a flat fee still needs to be directly attributable to the value you are receiving in return. It doesn't matter how large or small the fee is, if there isn't massive value being delivered to you, you are paying to much.
The final way you could be charged in order to work with a financial advisor is the hourly model. It is as straight forward as it seems. You engage with a financial professional. Usually it's because you have a problem you are looking to get solved. The advisor gives you their hourly rate with a projected amount of hours needed in order to solve your problem. You multiple those two inputs together and the output is what it'll cost you.
Ex: Larry is a financial advisor who charges his clients $275/hr. If Larry were to do some work on your behalf and it takes him 6 hours to complete, it would end up costing you $1,650.
This is more reminiscent of how other professionals, like lawyers, may charge. The hourly model is a great option for individuals who like to do financial related activities themselves. But may be looking for a second opinion or help navigating a specific issue.
It can be difficult trying to determine how much it'll cost you to work with a financial advisor. Especially considering some advisors have the ability to jump between the different fee structures we've laid out above. It's not uncommon to find advisors who can offer each of those different fee models to their clients. It makes understanding how an advisor is going to get paid extremely important. Because how they get paid will directly effect how much you will end up getting charged to work with them in the first place. It also makes it important to determine if you are working with a financial advisor who is fee-only or fee-based. A fee-only advisor can't get compensated under the commissionable payment structure. Where a fee-based advisor can. This makes working with a fee-based advisor more difficult when trying to uncover any underlying conflicts of interest.
And it's also important to understand who else is an interested party involved in your engagement with a financial advisor. If a financial advisor works for a broker, (you can usually tell this is the case if the brokers name is posted on the front of their office or website) that broker has a financial interest in what kind of dealing you will have with their advisor. This may be a sign that it could be costing you even more. After all, everyone needs to get paid, right? This is why many people who are looking for a financial advisor are seeking out full-time fiduciaries. That way they don't have to worry about a financial advisor putting their employer's needs above their own.
But in the end, it all comes down to value. Regardless of how much you have to pay or in what way, is it worth it to you? Is the financial advisor skilled enough to be able to provide you with the services and advice that you need to make it worth the cost that you are going to pay? If that is the case, everything else becomes far less important.