You are ready to start a relationship with a financial advisor, but how do you tackle the elephant in the room? How do they get paid?

That’s the topic we are diving into today: financial advisor compensation.

Hiring a financial advisor is one of the biggest financial decisions you will make, and as you will see today, what they charge and the value they add will likely be a massive component of who you choose to partner with.

In this article, we reference the 2020 Kitces Research Study, which addresses advisor pricing and was authored by Dr. Derek Tharp, Ph.D., CFP®, CLU®.

3 Main Ways Financial Advisors Typically Charge

Flat Fee

This financial advisor business model gives you access to financial advice in the same way you would pay other professionals, like your CPA or attorney.

Depending on the financial planner, they could charge a flat annual rate or an hourly rate based on the work they do for you.

Some will manage your assets as part of this fee, and others will focus solely on giving financial advice and avoid managing the portfolio altogether.

This type of financial planner could be a good fit if you:

• Desire financial advice but want to continue to manage your portfolio yourself;
• Don’t have a portfolio built up quite yet; or,
• Prefer to pay your financial planner out of pocket instead of having the portfolio cover their fees.

According to the 2020 Kitces Research Study on Advisor Pricing, the average hourly financial planning rate was $250/hr.

Assets Under Management (AUM)

This financial planner business model uses the portfolio size that the advisor manages on your behalf as the measuring point for how much you pay. The bigger your portfolio, the higher the fee.

According to the 2020 Kitces Research Study on Advisor Pricing, a $1 portfolio has an average financial advisor fee of 1% of the portfolio value.

As you can see in the graphic below, as portfolio size increases beyond $1 million, the average AUM percentage charged decreases.

Source: 2020 Kitces Research Study on Advisor Pricing.

Financial planners structured in this manner may still offer a wide variety of services for the fee that they charge.

For example, many financial planners operating under an AUM model include other areas of financial planning beyond investment management. These types of services could consist of tax planning, estate planning, and retirement planning, to name a few.

On the other hand, some financial planners limit the scope of their services to purely managing the portfolio in exchange for their AUM fee.

Commissions

One compensation model not included in the Kitces study revolves around commissions.

While this model goes all the way back to the “stockbroker” profession of old, some modern examples of this business style are insurance products like annuities or life insurance, commission-based mutual funds, or non-traded REITs.

While commissioned financial advisors may have an abundance of knowledge, they are, by definition, selling a product rather than giving financial advice (which is my guess as to why this model was left out of the study.)

That said, this model certainly exists and is worth noting as you search for the right financial advisor for you.

If you simply seek access to financial products and do not desire financial planning services, this could be a fit for you.

Conversely, if you desire advice surrounding tax planning, retirement planning, and other key areas of your financial life, this style of financial advisor will likely be much more limited in their offering.

The true cost of this advisor compensation style can vary dramatically depending on the financial product being sold. As a result, the best advice I can give is to ask the advisor for the total cost of the investment.

Below are some keywords that can help obtain that information:

• Front-end load
• Expense ratio
• CDSC (contingent deferred sales charge)
• Surrender period
• M&A expenses
• Annual account fees

Again, while none of the above-listed compensation methods is wrong, it is massively important that you understand how your financial advisor is getting paid and exactly what services are included with that fee.

What Value Does a Financial Advisor Provide?

Now that you are familiar with how a financial advisor can get paid, it’s time to look at the flip side of that coin, value.

What value are you looking for out of your relationship with your financial advisor?

Depending on your answer to that question, the right-fit financial planner for one person could be drastically different than the right fit for you.

For instance, you may be a real estate agent seeking advanced financial planning surrounding the tax implications of your business and the options available to you to not get nailed by the IRS. You will likely seek the advice of a financial planner offering tax planning and not just investment management.

Conversely, you may simply seek access to an investment account that you can delegate the management of and are uninterested in lowering your tax bill. In that case, a lower-cost, investment-only financial advisor could be right for you.

The best-case scenario for you as the client is to find a financial planner whose value outweighs the cost of hiring the professional.

While it can be difficult to put a hard number on the value of a financial planner, Vanguard makes a good attempt in compiling their Vanguard Advisor’s Alpha® report.

In this study, they attempt to assign value to each of the following areas:

• Suitable asset allocation
• Cost-effective implementation (expense ratios)
• Rebalancing
• Behavioral coaching
• Asset location
• Spending strategy (withdrawal order)
• Total-return vs. income investing

Additionally, we would argue that tax planning (which includes how you order your withdrawals) can deliver quantifiable value to the trajectory of an individual’s financial plan.

Our Spokane, WA firm provides fee-only, no-commission financial planning that is strategic, all-encompassing, and ongoing. We invite you to schedule a no-obligation complimentary insight meeting to discuss how we can help you.