Millions of Americans utilize financial professionals to help them save and invest, but how much does a financial advisor cost, and what fees does the client pay them? That answer can be trickier than it sounds.
Tricky or not, clients need to know the fees charged by financial advisors, so if you use one yourself, make sure you know how they’re charging you. That means knowing both the broad strokes and the fine print.
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Because often, the devil is in the details. And so, all too frequently, are the hidden costs.
The mainstream financial advisor business models. “Most advisors charge a percentage of assets under management,” says Larry Miles, principal at AdvicePeriod, a financial advisory in Los Angeles. You’ll often see this referred to in abbreviated form as AUM, and the typical financial advisor charges around 1 percent of AUM, Miles says.
Whether your financial advisor dings you for commissions on top of that depends on if they have a fee-only structure or a fee-based structure. They sound awfully similar, but they couldn’t be more different.
In a fee-only structure, advisors can’t collect commissions on products they sell you. Examples of this business model would include charging a percentage of AUM, hourly fees, retainers or flat fees.
Fee-based financial advisors, however, charge clients commissions based on the investments they sell. This can mean they’re commission only — in which case they only make money when they sell you something — or they make money on both commissions and a percentage of assets under management.
While you’d assume fees would be minimal in today’s age of Vanguard funds and robo-advisors, some products can carry hefty costs, and they aren’t always clearly illuminated.
Where to see how, and how much, financial advisors charge. “To understand what a potential advisor is going to charge you, you should ask them for an itemized list of fees, including commissions, third-party fees and management fees before you sign anything,” says Benjamin M. Greenfeld, chief investment officer of Waldron Private Wealth in Bridgeville, Pennsylvania.
“Registered investment advisors are required to file a Form ADV annually with the SEC, which lists out potential conflicts of interest and other compensation,” Greenfeld says. “The ADV is provided to each new client at the time of signing an agreement with the advisor and offered annually.”
Quarterly statements also reveal the general structure of how you’re compensating your advisor, though they’ve been criticized for being unreasonably dense and lengthy.
“It’s as if the financial industry is purposely trying to make it difficult for the client to tell what is going on,” Miles says. “Statements are a nightmare.”
Hidden costs. Generally speaking, how much your financial advisor costs should be well-laid out and understood at the beginning of the client-advisor relationship. But there can also be hidden expenses that perniciously drag down portfolio returns.
Frankly put, these hidden fees rip clients off.
While technically disclosed in the fine print, mutual funds can carry with them a range of expenses for investors, ranging from kickbacks to the advisor selling you the fund and 12b-1 fees to back-end costs that get assessed when the fund is sold.
Bonds can also be a way to subtly siphon money away from clients, Greenfeld says, with advisory firms using either end of the transaction to shave off 1 to 2 percent of the bond value.
“Individual investors normally do not see these costs unless they dig into the details of the transaction,” Greenfeld says.
But the most shocking hidden fees charged by financial advisors may not technically be fees at all. They come under the guise of so-called proprietary products and alternative investments. These are products created by the investment sponsors that aren’t traded publicly. Because they aren’t publicly traded, they’re incredibly opaque.
“It’s very difficult to see what they are, what their risks are. There is no historical performance data,” says Nejat Seyhun, professor of finance at the University of Michigan’s Ross School of Business.
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These proprietary instruments, marketed as no-fee, no-commission investments, often provide downside protection with a guarantee that the product won’t lose value. As the sponsor, “I can say that there are no fees and no expenses,” Seyhun says.
But there’s a catch: The upside is also capped — dramatically. “And that’s how I’m going to get paid,” Seyhun says. “Everything is hidden.”
So, the $64,000 question is: What do these products actually cost? How do you find out? Is the only way to discover to simulate their performance yourself?
“Yes, to go to someone with a Ph.D. and ask them to evaluate this product,” Seyhun says. The fees, then, are hidden in the return structure.
In an upcoming research paper entitled “How Should Retirement Plans Be Organized?” to be published in the NYU Journal of Law and Business, Seyhun, along with S. Burcu Avci and M. P. Narayanan, simulate those returns a million times.
Over 10 years, a $100,000 investment in the Standard & Poor’s 500 index, assuming average returns and volatility, became $215,113, according to the paper.
A $100,000 investment in a representative proprietary product turned into just $129,114. Even Treasury bonds, the paper concludes, are a historically better product. That’s a huge invisible fee.
Know what you’re paying for. Finally, financial advisor fees vary with the services they provide.
It sounds obvious, but mere investment management should cost less than investment management combined with tax planning, estate planning, and other financial planning services like lifestyle assistance and cash-flow management.
In fact, if your financial advisor is essentially only doing asset allocation for you, much of that can be achieved far more cheaply nowadays through low-cost Vanguard funds, target-date funds and ETFs.
Advisors using the AUM model charge fees on the cash in your account too. Cash, of course, can sit around free of charge — and even earn a little interest — in your own account.
Trust and diligence. Yes, it’s important to do your due diligence when trying to understand how much financial advisors cost. But it’d also be nice to simply trust your financial advisor on top of that, wouldn’t it?
New legislation from the Department of Labor known as the fiduciary rule aims to put trust at the forefront, requiring any financial professionals working with retirement accounts to act in the best interests of their clients.
Although many advisors already abide by the Labor Department fiduciary rule, its implementation has been delayed, so until it’s actually enacted, it’s important to ask if your financial advisor is a fiduciary.
[See: 7 Dividend Stocks to Benefit From Trump Tax Changes.]
Saving for retirement is one of the most important financial decisions of your life. Make sure you know exactly how you’re paying the person who’s supposed to guide you there, that they’re acting in your best interest, and that hidden fees don’t cost you a small fortune.
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Financial Advisor Fees: Rarely Clear-Cut, Occasionally Invisible originally appeared on usnews.com
