With so many different compensation structures, it can be difficult to do an apples-to-apples comparison of financial professionals, their prices, and the value they offer to their clients. No one pricing method is necessarily better or worse than any other, but savvy investors know what they pay, how their pros are paid, and the value they receive from their financial advice relationships.
If you know what you pay your financial professional — or how much you would like to pay someone — but want to see the full picture of how he or she is compensated, read on to better understand the value your financial pro is offering you for the money, what that relationship is worth to you financially, and much more.
How financial pros are paid
There is no industry-wide standard for how financial professionals are paid. However, compensation structures tend to fall into three major categories:
1. Commission-based
One way financial professionals are paid is by commissions on the products they sell to their clients, like mutual funds, annuities, or insurance. Usually, these pros will — or at least should — use the titles “registered representative,” “agent,” or “broker.” The commissions turn into incentives for financial professionals who are paid this way: If they sell a client a more expensive policy, they can receive a bigger commission and, therefore, a bigger paycheck. Even still, the larger issue may lie in the lack of transparency involved. It’s often possible that the commission the broker is earning is unknown to the client, even though the financial product being bought and sold is structured to cover that compensation at the client’s expense. Of course, as the old saying goes: There are no free lunches.
2. Fee-based
Those who are paid on a fee-based platform typically will charge their clients fees — but can also receive commissions on products they sell, much like commission-based pros. While they’re not earning only commissions, the incentive of a bigger paycheck can still present a conflict of interest. Similar to commission-based advisors, the commission earned by a fee-based advisor is not always fully transparent. Complicating the matter further is the fee-based professional’s ability to switch hats from a fee to commission compensation structure at any time.
3. Fee-only
Lastly, we come to fee-only pros. There are many flavors of fee-only — whether hourly, flat, or a percentage of investments under their management, these professionals only charge and earn fees directly from their clients. They don’t sell products, so they can’t earn commissions on them. What this all means is that the fees such fee-only pros charge are their only sources of income. Perhaps best of all is the added transparency in that fact. If the fee is $X or Y%, the client can at least understand and explicitly agree to a specific cost at the outset of the relationship.
How much financial pros are paid
Commissions can range widely, and the commission-based or fee-based financial professional can earn varying percentages of the cost born directly or indirectly by the client. Some annuities can pay the commissioned agent 8% or more of the value of the contract the client purchases. Picture the purchase of a $100,000 annuity paying the agent $8,000 — it’s quite the compensation for a single transaction. At the same time, while the first statement might show the client that their purchase of $Z is worth $Z + interest, that money may be locked up for 15 years or more or the interest only available if taken as a series of payments.
Financial pros who operate on fee-only annual models tend to charge between $2,000 and $7,500 yearly for holistic, comprehensive financial planning. This can include everything from creating an initial financial plan and managing assets to regularly reviewing investment portfolios and preparing taxes for clients. It’s an all-inclusive fee for all things financial planning, and advisors can often break up the annual cost into quarterly or even monthly payments for their clients’ convenience.
Those who base their fees on investments or assets under management (AUM) may only manage or advise their clients on those assets. Others, however, may offer additional services free of charge or under a fee-plus-AUM model, charging a fee for planning plus a percentage on the assets they manage. The average percentage clients pay for these services is 1% of AUM.
An example
But how, you ask, do you make an effective cost comparison between a professional who charges a fee expressed as a percentage and another who charges a fee expressed as a dollar amount?*
To keep things simple, let’s say you’ve got a cool $1 million that you would like some help managing. You also want financial planning services to go along with it so you’ll have a solid idea of where that money will get you from today through your many financial goals. You’ve been interviewing financial pros and found two who you think will suit you well — but one provides a quote based on a percentage of AUM while the other quotes services for a flat fee. How can you compare their pricing structures?
Fee-Only Pro A quotes a flat annual fee of $7,000 a year for a suite of services including financial planning, investment management, and income tax preparation. In this scenario, Fee-Only Pro A’s total cost to you would be $7,000 per year.
In comparison, Fee-Only Pro B quotes a percentage of AUM fee at a below-average 0.9% annual rate to manage your $1 million. After all, with a larger account to manage, economies of scale take over and you wind up with a lower percentage fee than average. With that, the math would work out like so:
$1,000,000 x 0.009 = $9,000
Sure, Fee-Only Pro B’s percentage fee is below average — but that $9,000 is clearly quite a bit more than the $7,000 figure Fee-Only Pro A quoted you. At the same time, Fee-Only Pro B may charge separately for creating your financial plan and providing other financial services, such as tax preparation. Fee-Only Pro B’s fee will go up and down with the value of your investment account, and that may or may not reflect the reality of your financial situation and the amount of work required — it’s simply a reflection of the value of a single piece of your financial picture at a given moment in time.
With cost considered, it’s still important to evaluate the single most important thing you should seek in working with any financial professional — value.
Evaluating value
In our hypothetical example, you would’ve felt confident working with either professional as both had the same levels of education and experience and both offered the services you needed — albeit at different price points. But based on their available services and the fees they charge, how much value could each professional offer you?
Even if you’re not ready to interview prospective financial professionals yet, you can do a similar apples-to-apples comparison using one important piece of every advisor’s toolkit: Form ADV Part 2. In it, you’ll find how each financial professional charges clients, the scope of each pro’s services, and how each is paid. Armed with information, you can take your research to the next level when you’re ready, asking those same professionals a few questions, like what they provide for the price, including any “extras.”
The definition of value can be different for everyone, so it’s important for every investor to look at more than just cost. Finding an advisor you know, like, and can trust your investments — aka your future — to is key as is knowing what you’re getting in return for what you’re paying.
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