How Fee-only Financial Planning Works

Part 1 in a Series on Understanding Direct (and Indirect) Financial Advisor Fees

You know your personal financial advisor gets paid. They run a business, after all. Have you ever had a discussion with your personal financial advisor about how he or she makes a living? Do you know the differences in compensation types for financial planners? In this post, we’ll look at how fee-only financial planning works, describe the pros and cons and share questions you can ask your financial planner.The money your financial advisor earns generally comes in the form of a commission for products sold or a percentage-based fee for assets managed. Sometimes it’s a combination of the two. But aside from the dollars and sense associated with these direct costs, what indirect costs might you incur based on your financial advisor’s business model? If you are feeling timid about asking, just think about how much he or she already knows about your private information. Go ahead and ask away!

Fee-Only Financial Planning: A fee-based financial planner gets paid an annual percentage of the assets managed on your behalf, generally .50-2.5% or 50 -250 basis points.

Example: An investment advisor is managing an account for a client and charging an annual fee of 1.65%. The average account balance for each quarter of the year was exactly $100,000. The client paid the fee quarterly, totaling $1,650 for the year.

  • Advisor Motivation: If your account value goes up, your fee-based financial planner will make more money. He or she is motivated to grow your account and minimize losses. As a percentage, the fees tend to be higher when total investment value is low and they are reduced as investment values go up. So, while you might pay 1.65% for your fee-only financial planner to manage $100,000 in assets, that fee might be reduced to 0.75% if you have $1,000,000 in assets.

Fee-only Financial Planning: The Investor Advantage:

What are the advantages of fee-only financial planners? There are several advantages to this model.

  • Fees are directly debited from investment accounts and do not need to come out of the investor’s monthly budget. That means you don’t have to find a separate way to pay for the financial advisors’ fees.
  • Fee-only financial advisors are not motivated to push certain investment or insurance products to earn a commission. As an investor, this may give you added confidence in your advisor’s recommendations.
  • Fee-only financial advisors tend to have access to a wider variety of investments because they do not represent just one family of investments. This may help you get access to investment opportunities you would not get with a commissioned investment advisor.
  • There tends to be greater flexibility to move among different investments because the investor is not hit with a commission each time new stocks are purchased. This may provide a long-term financial advantage as your investments grow.

 

Investor Disadvantages:

What are the disadvantages of fee-only financial planners? Investors may face these challenges:

  • Clients may lose track of what services are provided for the fees that are assessed. There is a potential for fees to be collected on “auto pilot” with very little ongoing service provided by the financial advisor. You may feel that your advisor is not actively engaged in your investment plan.
  • Clients may not know the percentage that is collected from their investments and therefore cannot compare financial advisory services or investment techniques. You may pay more than is typical for your investment portfolio.
  • Annual fees are less costly in the beginning compared to commissions, but over time they can cost more than commission-based shares of the same investment. You may find that your once-competitive rates no longer are.

 

Questions to ask a fee-only financial advisor:

If you’ll be meeting with a fee-only financial planner, here are some questions you can ask to help you understand how you’ll be charged for the work they do on your behalf.

  • On what percentage are your fees based? Do they vary by investment? At what points do the fees change based on the value of your investments?
  • How is that percentage figured? (Many companies use the average quarterly balance of your investments and make quarterly or annual withdrawals.)
  • Where and how is this amount recorded and on what statement(s)? (This will help you identify where to look for fees, so you can monitor what you are being charged.)
  • What ongoing planning and brokerage services are provided for the fees paid?

 Fee-only financial planning has been deemed the most transparent fee structure because it separates investment services from investment funds by putting the focus on your account balance instead of the promotion of specific funds. Working with a fee-based financial planner allows you to quickly and easily determine the fees you will pay by using your period ending balance and the agreed upon annual percentage rate for financial planning services.

Comments

  1. I really liked that there was an easy to understand list of questions provided to ask financial planning services. My favorite was asking about the percentages the fees are based on. There was a coworker of mine that was researching something similar who would like knowing these questions.

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