One of my biggest pet peeves is when a company doesn’t list their fees on their website. These companies usually do a great job describing their product or service, but there’s usually a mystery as to what it costs.
Financial Advisors have historically been very notorious for this sort of practice. In fact, I remember the training I received when I first got into this business 12 years ago. I was told that if a prospective client ever asked about the cost, we were to say things like, “we don’t need to get under the hood right now” or “let’s schedule a meeting to discuss this in person”. I never implemented this advice because it made me feel like something was being hidden.
The cost to hire a financial advisor has been a mystery for far too long. In today’s blog post I will discuss the 3 different types of financial advisors and the cost for each.
THE MYSTERY OF FINANCIAL ADVISOR FEES
Looking back on the training I received, I realized that some of the companies I worked for didn’t want to scare away the potential client by discussing fees. But that’s absolutely ludicrous because rational people expect to pay a fee for something they receive in return. No one questions why Target or Walmart charges a fee, so why would financial advisors be concerned that clients would question it. In fact, financial advisors should expect that clients ask about fees since we don’t have products sitting on a shelf with a price tag underneath. But for whatever reason, our industry has shied away from the topic.
Even to this day, I hear people all the time say, “I’m not sure what fees I pay”, or “I’m not sure how my advisor gets compensated”, or my favorite, “I don’t pay anything”. We’ve even observed that some financial advisors don’t know how much the client is paying. For example, we manage a 401k for a local company here in St. Louis, Missouri. Prior to us, it was managed by a “financial advisor” that worked for an insurance company. The advisor was asked what the fees were and he didn’t know. To make matters worse, the fees were buried in a 170 page contract and they still were not fully discernible. This is hard to believe, but it’s all too common in our industry.
THE COST TO HIRE A FINANCIAL ADVISOR
You can rest assured that if you are working with a financial advisor then you are paying something. But the fee shouldn’t be a mystery, nor should it be shied away from.
Financial advisors are paid in a variety of ways, but it usually is dependent upon the type of advisor that you are working with. Essentially there are 3 types of advisors:
ADVISOR TYPE #1: REGISTERED REPRESENTATIVES
This type of advisor legally “represents” the company that they work for; hence the title Registered Representative. They’re usually someone who works for an insurance company, bank, mutual fund company, investment company, or broker dealer. One of the biggest drawbacks of working with a Registered Rep is that they DO NOT have to do what’s in your best interest. Remember, their first loyalty is legally to the company for which they work, not to you.
Another distinguishing characteristic of a Registered Rep is that they are paid commissions by some product that is sold to you. Commissions on investment products typically range anywhere between 0.25% and 7%. It’s not so much that the fee is inappropriate; it’s that people usually don’t know what the actual amount is. And as I stated earlier, even the advisors often times don’t know what fee their own clients are paying. This is very frustrating!!!
There’s also an inherent conflict of interest with Registered Reps. Once a product is sold, the advisor usually receives the bulk of their commission up front. This doesn’t leave any incentive for the advisor to continue working with the client or to properly service the client over time. Once the sale is made, one could argue that the advisor is moving on to the next sale. Additionally, there have been some abuses in our industry over the years where a Registered Rep would move you out of your original product, into a new one, just to get paid again. This is an illegal practice known as Churning. To be fair, most Registered Reps don’t engage in illegal practices like this. However they have an uphill battle to fight simply because of this perceived conflict of interest.
At the end of the day, this type of advisor is product-centered and commission-based. And usually they are required to meet sales and product quotas, which prompts the question: are they recommending a product to you because it’s in your best interest or theirs? Again, I believe that most Registered Reps operate in an ethical manner, but they do have to overcome this negative perception.
The fact that there are sales and product quotas in the financial services industry is terribly problematic. Remember last year when Wells Fargo was fined $185 million because employees were creating fake accounts in order to meet their quotas? What the employees did was absolutely wrong, but it was actually the top echelon that fostered an environment of unrealistic sales goals and high pressure. The pressure to sell was so great because employees were told they would lose their jobs if the unrealistic goals were not met. How many financial advisors (Registered Reps) have felt this type of pressure over the years? I suspect quite a few. And this puts advisors in the awkward position of selling a product to a client even if it is not in the client’s best interest.
ADVISOR TYPE #2: REGISTERED INVESTMENT ADVISORS (RIAs)
An RIA is legally required to do what’s in your best interest. Technically they are considered a fiduciary. Under this structure, there is no influence to use any one company’s product(s) since the RIA doesn’t work for a product-centered company. This type of advisor is free to choose from any investment within the universe of investments and would choose options that don’t have built in commissions.
There are no sales or product quotas under this structure. The fee that a client would pay is very transparent and is known upfront by the client. The fee comes directly from the client and is not buried in some product. RIAs typically bill their clients in one or a combination of 5 ways:
- Hourly (likely to range anywhere from $100 to $300 per hour)
- % of Assets Under Management (ranges from 0.50% to 1.50% per year)
- Flat Fee (ranges from $1,000 to $10,000+ per year)
- Subscription Basis (ranges from $150 to $250+ per month)
- % of Net Worth (~ 0.50%) and / or Income (~ 1.00%)
As you can see, none of the fee options are based on any type of product that is sold. As a result, RIAs are advice-centered, not product-centered. Their fee is the same regardless of which investments are recommended. And even if investments change over time, the fee will remain the same. With this structure, you have the comfort of knowing that an RIA only recommends solutions that are truly in your best interest; not because they will get paid more.
As a result of being advice-centered, RIAs tend to be much more than just “investment managers”. They typically hold themselves out as Financial Planners. Many are CERTIFIED FINANCIAL PLANNERS™ who help their clients make good financial decisions and avoid bad ones. They help with so many other financial related items in a person’s life which goes above and beyond just an investment or a product. Therefore, it is common to see the fee vary from one company to the next depending upon what services are being provided.
ADVISOR TYPE #3: HYBRIDS
A hybrid advisor is one that can be both a Registered Representative and a Registered Investment Advisor at the same time. This is somewhat problematic because how do you know which hat the advisor is wearing at any one time. A hybrid advisor has a competing allegiance. Do they serve the client or do they serve the company? One minute they’re selling a commissioned product and the next minute they are not. The financial advisors who engage in this sort of practice are the ones to steer clear of in my opinion.
On the other hand, there are hybrid advisors that were created out of necessity. Many hybrid advisors exist essentially because of how the industry has evolved over time. The financial advisory industry started out selling products for a commission many years ago. Since that time many advisors have “seen the light” and have converted to an RIA in order to get away from commission-based business. However, in order to continue servicing their existing commission-based clients and receive ongoing commissions from those clients, financial advisors had to also maintain their Registered Rep status.
WHAT ARE WE?
In case you’re wondering, we are Advisor Type #2 – an RIA. We feel this is the most transparent advisor type with the least conflicts of interest. There will be no mystery in what you pay and what you receive in return. There will be no mysterious fees buried in some type of product that we sell, because we don’t sell products – we sell advice and manage investment portfolios!!
Most of our clients are billed as a % of Assets Under Management (AUM) and our fees are clearly listed on our website. An AUM fee essentially means that our fee comes from our clients’ investment returns. This ultimately aligns our interests with that of the client. We have an incentive to grow the investment portfolio because our compensation will go up. And of course the client desires that their portfolio grow as well. This is in stark contrast to the commission-based model (Advisor Type #1) where the commission is often times received upfront. That advisor has no desire to grow the portfolio because they’ve already been paid.
So, in conclusion, the next time you’re talking with your financial advisor or interviewing one, ask them what type of financial advisor they are, how they are compensated, and what their fee is. Check to see if their fee is even listed on their website. But I warn you to not be surprised if the advisor doesn’t know the answers to your questions. If they hesitate or talk in circles then that may be your clue to look elsewhere. Even if the advisor can’t immediately answer your questions, at the very least they should say they don’t know and offer to get back to you with an answer. But of course if they don’t know their fees in the first place, that would be a red flag.
Hopefully I have provided a little clarity to the mystery of financial advisor fees and you now have a better understanding of how the different types of advisors are paid.
Stay tuned for a future blog post where I will help you to know what sort of additional questions you should ask your current or future financial advisor.
If you’re new to our blog and don’t want to miss out on that article, then sign up to receive our eContent.
I would love to hear your thoughts on today’s blog topic. What type of advisor do you use? Are you surprised to learn that there are different types of advisors who are paid in different ways? Is it frustrating to you when you can’t figure out how advisors are paid? Please feel free to leave your comments below.
RELATED CONTENT / RESOURCES: