In an ideal world, everyone would have a financial advisor they could call with questions about what to do with their money. Should they pay down debt or invest their latest windfall? Is it a good idea to buy a house right now, or would they be better off saving for retirement?
Unfortunately, if you want a professional to answer these questions, you’re going to have to pay. That fact alone deters many from ever seeking financial planning services. While you will have to pay something for professional advice, it can be well worth the price — depending on the fee structure.
Fee Structure Options
Financial advisors typically operate under five different fee structures. Some may use a single type of fee structure, or operate using a combination of the five.
- AUM Fees: Advisors using this structure charge a fee based on the percentage of your “assets under management” (AUM), or a percentage of the total market value of the assets they manage on your behalf.
- Fixed Fees: Advisors using this structure charge a flat fee for their services — usually between $1,000 and $3,000.
- Hourly Rates: Usually used by consultants for clients with specific questions or special requests.
- Commissions: Often used in conjunction with one of the fee types listed above, this is when advisors earn extra compensation when they buy or sell your funds.
- Performance-Based Fees: Advisors take an extra cut of your investment money if the fund outperforms previously set goals.
Each of these fee structures are quite common, but some are more beneficial to the average investor than others.
The Traditional AUM Fee Advisor
Many financial advisors charge a fee based on the percentage of the assets under management, or how much of your money they are in charge of. Usually, this percent is between 1% and 2% of the portfolio they’re managing, although that percentage may vary based on the amount of assets you have.
While a 1% to 2% fee may seem like peanuts on paper, it can actually take quite a hefty toll on your ability to accumulate wealth. Taking a long view, let’s say you had $250,000 to invest in the market today. Next, let’s assume that you were going to leave that money untouched for 30 years under the management of a traditional financial planner charging a 1.5% AUM fee.
As your money grows, so does the fee your investment advisor charges — that is the nature of percentages, after all. Assuming an 8% annual return on your stock market investment over the course of a 30-year period, your initial $250,000 would be worth $1,737,000. That’s more than six times the amount of your original investment, which seems impressive. That is, until you look how much you’ve paid in management fees over that same period: $362,000.
We would generally recommend shying away from financial planners with AUM fee structures given the hefty fee structure. However, if you have a significant amount of wealth to invest over a long period and can negotiate an AUM structure under 1%, you can consider them for full service asset management and ongoing advice.
Much like a traditional financial advisor, robo-advisors also charge a fee based on the percentage of your assets under management. The main differences between a robo-advisor and a traditional advisor are two-fold:
- A robo-advisor is, well, not human. Instead, you invest your money with a company that uses advanced algorithms and sophisticated software to manage your investment portfolio.
- Robo-advisors charge a fraction of what a traditional human advisor would. In fact, the majority of companies that offer robo-advising services charge an annual management fee between 0.25% and 0.89%, although most charge less than 0.5%.
The difference in fees can have a drastic impact on your net worth over time. Going back to the scenario we explored in the previous section, let’s again say you invest $250,000 in the market today with the same assumptions. However, this time, you decide to use a robo-investor with a 0.25% AUM.
In this scenario, your initial $250,000 would be worth $2,536,000 at the end of 30 years. That’s almost $800,000 more than if you were to use a traditional AUM financial advisor, which is largely due to the much lower portfolio management fees: just $77,000 compared to $362,000.
Robo-advisors are best if you’re comfortable investing automatically and have a relatively simple financial picture. Obviously you won’t have a dedicated human to speak to consistently about your wealth, but that doesn’t mean you won’t be getting sound financial advice.
In fact, robo-advisors like Wealthfront or Betterment adhere to Modern Portfolio Theory, which is the same investment thesis that any human financial advisor worth their salt will also follow. This means your robo-advisor will automatically rebalance and manage your investments in a similar way to a traditional financial planner, but at a much lower cost.
Many robo-advising companies often offer additional features like tax loss harvesting and direct investing, which are usually only offered to high wealth clients at traditional financial advisory service firms. In the end, such services can save (and make) you money in the long-run.
Hourly Rates and Fixed Fees Explained
In contrast to the AUM fee structures previously discussed, financial planners that charge a fixed fee or an hourly rate are usually best for those who need financial advice on a specific topic — such as estate planning or financial management — or help creating a one-time, full financial plan.
A fair hourly rate for a financial advisor usually ranges between $100–$300 per hour. If you prefer to talk to someone in-person about more complicated financial matters on a one-off basis, this is the option for you.
On the other hand, if you’d like access to a financial advisor year-round, you can pay an annual fee to have them on retainer. Usually, this ranges from $1,000 to $3,000 per year, depending on how much money you have to invest.
Returning one more time to our $250,000 investment thought experiment, you can see that over time, if you were to use a fixed fee advisor your money would reach a much healthier sum after 30 years than it would with a traditional AUM fee-based advisor.
And while that $1,000 to $3,000 a year might give you sticker shock at first, it ends up being much less expensive than an AUM advisor over time. As you can see, with a fixed fee structure you would only pay $60,000 over three decades, as opposed to $362,000 with an AUM advisor.
If you feel more comfortable having someone to speak to, or if you have deeper financial topics beyond investing you’d like to discuss on an ongoing basis, we recommend working with a fixed fee financial advisor.
How to Pay Less for a Financial Advisor
When it comes to building wealth, fees can have an immense impact on your investments over time. Luckily, deciding which of these fee structures is right for you is something you can easily control.
Once that decision is made, there is another layer to consider: commissions. This is a common investment management cost, but it could set you back a few thousand (or hundreds of thousands) dollars if you’re not careful.
An expense ratio is another fee you’ll have to pay to your advisor if they decide to invest your portfolio in a mutual fund or an ETF. They are designed to cover operating expenses, including administrative and management costs. Usually, these fees range between 0.2% for ETFs and index funds to 2.0% for some actively managed mutual funds. We highly recommend making sure you are invested in investments with a low expense ratios. Like the AUM fees, high expense ratios can have a dramatic impact on your portfolio over time.
Keep a particular eye out for mutual funds with 12-b1 fees. These are touted as service fees, but really, most of this fee is given back your broker when you buy the fund (and then every year you keep it).
That’s problematic for several reasons. First and foremost because it means you are paying your broker twice — once as an AUM fee and once in kickback commissions. Secondly, when a broker works on commissions, he or she is incentivized to push you toward investment opportunities that could be more expensive than a similar investment. In other words, there is a conflict of interest between what is best for their bottom line, and what is best for yours.
To get around this problem, look for a fiduciary that will only make recommendations that are in your best interest. They don’t take 12-b1 fees or kickbacks from selling you investment products, so you know that what they recommend is actually better for you, and not just better for their pocket.
Some Fees — But Not All — Deliver a Worthwhile ROI
When it comes to building wealth, fees can have an immense impact on your investments over time. Luckily, this is something you can control.
As we’ve seen with the examples above, financial advisor fee structures can dramatically impact your bottom line. Traditional advisors that charge AUM fees are extremely expensive in the long run. As such, fixed fee advisors that are fiduciaries or robo-advisors are best — although the choice between the two will depend on your financial situation and your financial goals.
Some fees are necessary — and even worth the money — but it is best to keep any fee you pay for financial advice as low as possible. While personal finance can be a daunting topic to many, understanding how and when a financial advisor can help you reach your financial goals is a gigantic step in the right direction.