Wealthramp Back StoryDecember 6, 2016
Are You Still Using Your Ex’s Financial Advisor?March 5, 2017
You know your advisor makes his or her living helping people like you manage their investments. How are you paying for your wealth manager, or broker’s advice? It’s a loaded question because there a lot of ways financial advisors can earn their living, but rest assured, their compensation comes out of your pocket. Whether it’s commissions they get as kickbacks when they sell certain investments, also known as sales charges, or simply advice fees you pay to them directly, or a combination of commissions and fees, it’s now one of the most popular searches on Google. And the more people know, the more they share that knowledge online. Consumers are much savvier today than just five years ago and a lot less shy about asking how much they’re paying for all this advice. Individual investors are also more aware of the conflicts of interest inherent in the commission-based system most big Wall Street firms still rely on. After all, when an advisor works for a big name brokerage firm, he isn’t working for you. He’s a salesman for them.
The take-away for the informed consumer is that the independent advisor who doesn’t get kickbacks for selling investments and charges a fee for advice is by far the better deal for individual investors. And the only real way to know your advisor is truly on your side is to know he’s a fiduciary. In other words, that he's making recommendations in your best interest. When a financial advisor practices as a fiduciary, the fee-for advice arrangement means he’s working only for you and just puts you on the same side of the table. Think of this type of advisor as your financial advocate.
How much am I paying in advisor fees?
Once you know how you’re paying for advice, the question is whether his fees are reasonable. A typical client with a portfolio worth $250,000 can expect to pay an average of $2,675 per year in advisory fees, according to AdvisoryHQ's 2016-17 report.
The report also shows that a client with a million dollar portfolio typically will pay $10,200 per year for advice, not including transaction costs. How do these yearly fees compare to a typical account at a big brokerage firm? Advance Practice Advisors Founder Paul Spitzer finds that same client could easily pay twice that fee at a major Wall Street brokerage firm and never even know it because brokerage firms bake a lot of their fees into the cake—meaning the investment products they sell.
Fee-Based Vs. Fee-Only Advice: What’s the Difference?
Fees are quickly becoming the norm in the wealth management world but it doesn’t mean all fee arrangements are created equal. When you hear that advisors are "fee-based" or "fee-only" in relation to investment advice, it sounds like just semantics, but they are two totally different payment arrangements. Fee-only means that just that. Fee-only financial advisors won’t accept commissions or incentives from the investments they recommend for you. Fee-only advisors work for you directly, and you pay them directly for their advice. The fees can cover ongoing guidance, a one-time consultation or fixed fees you negotiate. They also tend to the most transparent.
A fee-based advisor still takes both commissions and fees, which again, both come straight out of your pocket. The reality is that there's no exact definition for fee-based, and there are no guidelines, so you're flying blind. Since they can receive a combination of fees and commissions, they seem to get the best of both worlds. An advisor can easily claim he's fee-based when, in fact, he gets the vast majority of his income from commissions. It's all a matter of what percentage of their compensation really comes from commission. A fee-based advisor who makes 90% of his revenue from advice fees seems to fit the true definition of fee-based, whereas the advisor who gets paid equally from both commission and fees requires a lot more homework. The point is the combination model feels more like that advisor is double dipping. If you’re interviewing an advisor who says he is fee-based, you’ll need to require full transparency on the part of the advisor in order to openly discuss where there are potential conflicts of interest.
Forget the pinky swear; get it in writing
If your head is spinning, you're not alone. It’s absurd to think investment advisors can get away with such confusing language. The fact is, most advisors now want to distance themselves from the commission-driven model because they know that ordinary investors can see there are blatant conflicts that come into play when financial advice comes from the mouth of a salesperson. The brokerage industry is switching to a "fee-based" model because it gives the impression of the "fee-only" model real fiduciary advisors use. Merrill Lynch and others recently adopted the “fee-based” model so now they too can advertise their advisors are not all compensated by commission.
The problem with the fee-based approach occurs when clients think they're getting pure, unbiased advice—or they believe the advisor is a true fiduciary with no ties to products, when it's anything but that.
How to cut through the jargon
Ask what percentage of income the advisor gets from advice fees versus the percentage they get from commissions. Fee-based in my world means that an advisor earns 90 percent or more of their income only from the advice fees you pay, and that they only earn commission on investments that happen to pay a commission and that you specifically requested, such as a specific mutual fund you insist you want.
Ask this simple question: how much of your compensation comes from fees I pay you, and how much do you get from commissions or other kickbacks? Then ask for it in writing. Keep in mind, there can be unique situations in which this flexibility works in your best interest. The key is transparency.
There are plenty of excellent, trustworthy fee-based advisors and they’re hiding in plain sight but they’re hard to find because of all the noise and confusing marketing by Wall Street brokers. The conversation about who to trust for advice is just getting louder and louder thanks to all the talk about advisors becoming fiduciaries and educators touting the benefits of fee-only advisors. This is all good for consumers. At the same time, it's also making the conversation confusing. So don't be fooled by fee-based versus commission-driven. Make an advisor defend their fee-based claim with numbers, and if they don't do that or the percentage of commission is too high, cut and run.