Interestingly, 1 in 5 investors working with a financial advisor is not sure if they are paying the advisor’s fee for services offered.
Another 10% are completely oblivious if they pay the advisor at all.
The next question would then be, how do you pay a financial advisor or, better yet, how do they make their money?
Stay with me as we are going to cover:
We’ll go a step further and compare how the different fee models differ.
And we are not stopping there.
We will help you know when to hire an advisor and how exactly to find one that best fits your needs.
Let’s jump right in to see how financial advisors make money.
Fee-Only Financial Advisors
Fee-only financial advisors charge asset under management (AUM) fee, retainer, hourly rate, or a flat fee.
Registered Investment Advisors (RIA) fall under this category.
What sets RIA apart from other financial advisors?
They don’t sell investment products and hence are not paid on commission.
Secondly, they are fiduciaries. More about this later.
Investment advisors work with clients directly.
They are not affiliated with financial products or investment vehicles they recommend to clients.
Now, let’s dig deeper into assets under management fees. Shall we?
Asset Under Management Fee
Most RIA firms charge 1% per year as an AUM fee.
The amount an advisor earns depends on how the account is doing.
Suppose an investor’s asset under management starting value is $800,000.
It follows that the investment advisor will earn $8,000, charging 1% per year.
If the account grows the following year to $1,000,000, then the AUM fee will be $10,000.
This is to say, if the account has grown over the year, then an advisor’s 1% fee equally increases.
On the flip slide, if there are losses and the portfolio drops, their fee also decreases.
As an investor, this is a good tradeoff.
It’s in an advisor’s best interest to help you achieve your financial goals, since their income is tied to how your account is doing.
And, of course, your advisor reassesses your account annually to find out your account’s starting value prior to the AUM payment.
Of equal importance to note is that, although an investment advisor charges annually, the AUM fee can be paid quarterly or monthly.
Say the annual fee is $10,000. If you settle for quarterly payments, the fee will be $250,000. Suppose monthly charges are the best option.
You’ll part with $83k.
Robo advisors are also fee-only advisors.
They charge between 0.25%-0.5% annually on the client’s account balance.
Hourly, Retainer and Flat Fee
RIA may resort to hourly rates, a flat fee, or a retainer.
A financial advisor may choose to charge an ongoing annual retainer independent of an investor’s account size.
The charges usually range between $1000-$5000.
Whether the investor makes a big profit or huge loss, the advisor will still get the retainer fee agreed upon at the beginning of the contract.
Financial advisors may also choose to charge a flat fee when offering a comprehensive financial plan.
For example, an advisor may charge you a flat rate of $2,500 to develop a financial plan that will help you save for your retirement.
Since many flat fee advisors are not earning anything for suggesting particular investment products, there are high chances that their recommendations are unbiased.
Their advice is based on your situation and investment strategies that will help you reach your financial goals.
Some investment advisors choose to charge hourly for their financial services.
An hourly fee is a great option if you need financial advisory services for a one-time project.
The hourly fee often ranges from $100-$400.
When Should You Choose a Fee-Only Advisor?
We are clear on how fee-only advisors make money.
Why would you choose (or not choose) a fee-only financial planner for financial services or investment portfolio management?
Let me walk you through the advantages and disadvantages of this model of payment.
Advantages of Fee-Only Financial Advisors
Financial advisors operating under the fee-only model are fiduciaries.
Under the fiduciary standard, advisors are required by law to act in the client’s best interest.
This means they offer financial advice based on the client’s needs.
Since they are independent, there is no conflict of interest when recommending the best investment strategies or financial products to help clients reach their investment goals.
When working with a fee-only financial planner, you stand to get unbiased advice for your specific investment goals.
But that’s not all.
Fee-only advisors stand out because their fee structure is clear.
From the onset, you’ll know how much you’ll pay an advisor, whether the fee is hourly, flat rate, retainer, or a percentage of the assets under management.
And it doesn’t stop there.
Financial planners charging fee-only help clients reach their financial goals by creating a comprehensive financial plan that holistically addresses their financial needs.
Their financial services go beyond helping a client implement and manage the financial strategy for maximum returns.
The advisors also readjust the financial plan according to the prevailing market situation for a better outcome.
Disadvantages of Hiring a Fee-Only Financial Advisor
Yes, the fee-only financial planner rates are straightforward.
However, the fee can be expensive for new investors.
The AUM fees are on an ongoing basis.
And so, a new investor with limited assets might find working with a fee-only advisor costly.
On top of that, there’s the risk of an advisor overlooking simple investment strategies.
They may recommend long-term, complex ones to increase the value of the services offered, hence charge more.
This could also be a trick to have consistent long-term income.
Fee-Based Financial Advisors
Fee-based advisors differ from fee-only as they charge a management fee and also get a commission from the insurance products and investment products they sell.
A fee-based advisor may charge an hourly or flat rate for financial planning services they offer.
If they offer investment management services, they can either charge a retainer or go for an AUM fee.
Apart from that, fee-based financial advisors get a commission if the client buys the products they recommend in the financial plan.
The different commissions that an advisor gets include:
- Brokerage commission: An advisor doubling up as a broker-dealer receives a commission for selling securities.
- Selling a company’s mutual funds share is another avenue where a financial advisor earns money.
- The commission payment model poses a conflict of interest.
The commission payment model poses a conflict of interest.
Since broker-dealers are not held to fiduciary standards, an advisor may recommend a product that is not necessarily in a client’s best interest.
The offers may be tied to the money they’ll make if a client chooses the life insurance, mutual funds, or annuity recommended in the plan.
Despite that, fee-based advisors are most likely to give recommendations based on the investment products that suit your goals.
With that said, many financial advisors are fee-based.
Matter of fact, some firms operate as fiduciaries and broker-dealers, changing the hat when necessary.
Fee-Only vs. Fee-Based: Which Way to Go?
When it comes to choosing the right advisor for your financial needs, it boils down to your personal preference.
Generally, all the fee structures involve you exchanging your money for financial guidance.
Besides, the cost for fee-only and fee-based advisors doesn’t differ widely.
So, what then can help you determine which financial advisor to settle for?
Read on to find out how financial advisors make money using this strategy.
Fee-based advisors offer a more hands-on approach to investment management, which can be ideal for small investors.
Additionally, if you want to stick to one advisor for all your financial needs, a fee-based advisor will be a great fit.
Suppose they helped you with your estate planning, and now you need insurance products.
They can sell you an insurance policy that best fits your needs.
Fee-only advisors offer unbiased advice to help you achieve your goals.
Since their pay solely comes from the client’s fee, registered investment advisors go above and beyond to grow a client’s portfolio.
When the account is strong, their compensation also increases.
It’s a win-win for everyone.
Commission-Based Financial Advisors
A commission-based advisor earns a commission every time a client buys a product or investment they recommend.
These products may include loans, real estate, insurance policies, mutual funds, or annuities. An advisor would also get a commission for a new account opening.
The commission is usually between 3%-6% of the product the client buys.
Suppose a client invests $2,000 into a mutual fund.
A financial advisor stands to earn $80 if their commission is 4%.
Though the commission-based model is prone to bring conflicts of interest, that’s not always the case, as not all advisors are driven by their personal gain.
In addition, commission-based advisors operating under fiduciary are expected to act in the client’s best interest even though they’ll get a commission from the products they recommend.
Is It Worth It Paying an Advisor?
With the AUM fee at one percent, it begs the question if it’s really worth it to pay an advisor.
Well, whether to get an advisor boils down to the value you are getting from their financial services.
If a certified financial planner (CFP) charges you 1% for managing your $500,000 account and they grow the account by 8% year on year, that’s worth it.
However, if the growth rate is the usual market average, then you might reconsider your options.
More than the return on investment, a financial advisor is worth it because:
- They help you make informed financial decisions that are not clouded with emotions.
- They develop a comprehensive plan that balances your investment portfolio.
- They provide ongoing support throughout your working relationship.
- Therefore, beyond the advisor fees, consider other benefits of working with an advisor to decide if it’s worth it.
Therefore, beyond the advisor fees, consider other benefits of working with an advisor to decide if it’s worth it.
Granted, advisors are not for everyone.
But how do you know if you need one?
Signs You Need a Financial Advisor
You are making losses: The purpose of investing is to increase your net worth.
Therefore, if you are making losses every other year, perhaps it’s time to seek the advice of an advisor.
A financial advisor will check your plan, identify what’s not working, and offer recommendations for better results.
They can also provide wealth management services on request.
Uncertainty of market: Suppose the uncertainty in the market caused by the pandemic is making you stressed.
Or your current financial situations make you scared and even confused; it’s about time you hire an advisor.
Investment options: Your money can only grow if you invest it.
So, if you’ve dumped yours in a bank account, the low interest rate is good, but it’s not enough to take you to the next level.
On that note, a financial advisor can help you put that money to work.
Lack of time: Sometimes, you might be pressed on time.
Or maybe you just don’t know where to start in growing your portfolio.
You guessed it!
A financial advisor can help you get started in financial planning or specific areas, such as retirement planning, tax planning, or estate planning.
Maximum returns: It could be your accounts are strong, but you need an expert to further optimize your plan for maximum results. A CFP will be your go-to person.
Tips to Finding an Advisor that Meets Your Needs
The financial advisory industry has a wide range of advisors specialized in different services.
To find the one that best fits your needs, you’ll need to go the extra mile.
How do you do that?
Let’s find out.
Decide What Services You Need
First off, understand the nature of your financial need.
When this is clear, you’ll know the financial advisor to look for.
- If you are going through a divorce, a chartered divorce financial analyst will help you during and after the divorce.
- Suppose you are planning for retirement. A retirement planning specialist will meet you at the exact point of your need.
- An estate planner will be ideal when it comes to planning your estate for your beneficiaries.
For every financial or investment problem you need help with, there’s an advisor specializing in that particular area.
Understand the Types of Financial Advisors
There are Robo advisors, traditional advisors, and hybrid advisors.
Robo advisors use automated systems to manage clients and keep their investments on track.
A Robo advisor is a good fit if an investor is new in the market.
It’s also a great option if you have little cash to invest since there are no account limits.
Robo advisors’ fee is equally cheap as compared to traditional and hybrid advisors.
Traditional advisors are human advisors you can meet in person.
Depending on your needs, they offer holistic advice to help you better manage your personal finances.
A traditional advisor is ideal if your investment portfolio is complex, with lots of moving parts.
The downside, though, the advisor fee is higher than Robo advisors and hybrid advisors.
A hybrid advisor is a combination of a Robo advisor and a human advisor.
A hybrid offers the in-person relationship that comes with traditional advising and the automated systems of a Robo advisor.
An investor can choose this option if their portfolio is not very advanced.
Know How the Advisor Gets Paid
We’ve covered this already.
But just a quick recap.
Advisors can be fee-only, fee-based, or commission-based.
The best financial advisors are the ones who put your interest first.
They might be affiliated with a financial company or not, but still, the products and services they recommend fit your personal needs.
You’ll want to ask your advisor if they get a commission if you buy the product they recommend.
In addition, ask about the companies they are affiliated with.
Moreover, it will be in your best interest to know if the fee-only advisor charges an hourly or flat rate.
Probe further to find out the asset management fee.
Ask for Referrals
Talk to your friends, family, and colleagues to find out the advisors they are using.
Only inquire from the individuals with the same goals or those in the same financial situation as you.
You’ll get more relevant referrals.
From here, launch a Google search to find out more about the advisors.
Be sure to check the reviews.
Verify the Advisor’s Credentials
The best financial advisors are certified by the relevant authorities.
Since it’s your money at stake, it’s crucial that you only work with licensed advisors.
Ask the advisor about their professional qualification.
Further, there are websites where you can verify advisor’s credentials: AdviserInfo.sec.gov, BrokerCheck.finra.org, and CFP board site.
You can also find out if the advisor has received any disciplinary action in their career.
A licensed advisor ascertains that they have the knowledge and the competency to offer financial advisory services.
It also shows that they abide by the professional code of ethics.
Interview Multiple Advisors
It’s time to make your decision.
But before hiring the right one, talk to several professionals to find the one that best fits your needs.
In your interviews, ask if they can outsource the expertise of other specialists if the need arises.
Furthermore, you’ll want to know:
How has the relationship with other clients worked?
Which approach do they use?
Is it possible for the advisor to customize their approach to match your preference?
How often will they be in touch throughout your working relationship?
The interviewing stage is where you seek clarification to understand the financial advisor’s services better.
It’s also an opportunity to share your financial situation and the goals you hope to achieve.