Our most recent blog posts have covered what you should look for in a financial plan, and whether you need a financial plan. If you have decided you do want to work with a planner, this post should help you choose the best financial advisor for you.
The first thing you’ll want to understand in working with an advisor is how they are compensated. There are a couple of basic models used in the industry, and they are:
Commission-based – these advisors charge you nothing, and earn their income instead from the products you purchase based on their recommendations. While the low or no-upfront cost for planning might be attractive, critics believe this business model is more subject to conflicts of interest. As Andrew Lewis said, “If you’re not paying for something, you’re not the customer; you’re the product being sold.”
If you do elect to work with a commission-based advisor, make sure you carefully consider both the products being recommended and the fees involved. Remember, the impact of high fees over your investing lifetime can be dramatic.
Fee-based – with the rise of fee-only financial planning (more on that in a moment), the large investment firms began promoting a model referred to as “fee-based.” Careful investors might assume that fee-based and fee-only are the same, but generally they are not. A fee-based planner might offer to put together a plan and recommend investments that don’t involve a commission. However, beyond that, fee-based planners do typically receive commissions when it comes to recommending insurance, and they may accept referral fees as well. If you are concerned that this outside compensation might represent a conflict of interest, then consider a fee-only planner.
Fee-only – true fee-only advisors sell no commissionable products and accept no referral fees. The only income they earn is what you pay them, and they fully disclose the cost of their advice. This model removes most conflicts of interest, and the primary one that remains is that those advisors that charge on the basis of assets under management will earn more if you decided to increase the amount of assets they manage. To find a fee-only financial advisor near you, visit the National Association of Personal Financial Advisors.
One last point to consider when reviewing how an advisor is compensated is whether the advisor adheres to a fiduciary standard. A fiduciary is required to act in the client’s best interest at all times, and fee-only advisors and some fee-based advisors generally follow the fiduciary standard. It is less common among commission-based advisors.
Beyond the simple question of how advisors are compensated, when it comes to fee-only advisors there are a couple of different business models. If you elect to work with a fee-only financial advisor, you’ll want to understand what model they use, and the most common models are as follows:
Hourly – some advisors simply charge by the hour, and they should be able to provide an estimate of time required before beginning work on a planning engagement.
Assets Under Management (AUM) – these advisors charge based on assets under management, and more specifically, they charge a percentage of the total value of the portfolio they are managing. One percent is a pretty common starting point for fees, so as an example, the annual fee for an ongoing financial advisory retainer for a client with a $1 million portfolio would be $10,000.
Net Worth – some financial advisors charge clients based on their overall net worth which includes real estate and other assets, less any liabilities like mortgages. The advisor’s rationale is that they do much more than just manage a client’s financial portfolio, and this holistic management positively benefits a client’s net worth. Advisors who bill based on net worth typically use a lower fee schedule than those advisors who bill based on assets under management.
Flat fee – some advisors provide ongoing financial planning and investment management services (also referred to as wealth management) based on a flat fee. The fee is usually determined based on your overall financial situation – portfolio size, income, the overall complexity of your financial situation and so on. The determination of the fee is more opaque than is the case with the AUM or Net Worth models, but the rationale is that such an approach is more reflective of the value an advisor brings than the former two approaches.
There is one last point to note with regards to how fee-only financial advisors determine their fee. Many planners working under the hourly model don’t offer ongoing investment management, while those who offer retainers (via the last 3 models above) may only work with clients who are interested in a retainer or have asset or fee minimums that put them out of reach for potential clients. Make sure you are aware of the services the advisor offers and whether or not there are any relevant fee or asset minimums. Here at Minerva, we provide both hourly comprehensive planning services and wealth management using the AUM model.
In next week’s blog post on how to find the best financial advisor for you, we’ll take review industry designations and what you should look for based on your financial planning needs.