A 2023 Harris Research poll commissioned by Empower found that 71% of Americans have bought a lottery ticket and 24% of millennials have consulted a fortune teller. However, only 33% of Americans have met with a professional financial advisor.
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Excessive fees can erode financial returns, highlighting the value of professional guidance in effectively managing costs. Yet, people still prefer discussing divisive topics like politics and religion over seeking reliable, professional guidance for their financial planning needs.
The number of people seeking advice continues to decline in 2024. The rise in online financial education has emboldened more individuals to manage their own money and save on advisory fees. Simultaneously, high levels of student loan and credit card debt, alongside historically high living costs, have left many with fewer assets, making them less attractive to advisors.
Regulatory bodies, including Congress, the Securities and Exchange Commission and the U.S. Department of Labor, have implemented measures to make fees more transparent and consumer-friendly, with regulations requiring advisors to prioritize clients’ needs over their own. Time will tell whether these actions clarify fees or further muddy the waters.
With the White House changing administrations in January 2025, many of the consumer-friendly initiatives touted by the Biden administration will be in flux as legal challenges continue to unwind from the courts to your household.
Despite these headwinds, reliable guidance is even more essential in limiting the impact from excessive fees:
— Human or robo advisors.
— Compensation structures.
— Financial advisor fees vs. investment product fees.
— Ongoing invoices.
— Deductibility.
— Transparency.
— Starting the conversation.
Human or Robo Advisors
When we think of professional financial advisors, human advisors often come to mind first. However, artificial intelligence has opened new avenues for expert guidance, with AI-driven advice now capable of meeting routine planning needs.
Robo-advisory services enable financial institutions and fintech entrepreneurial businesses to profitably capture smaller accounts. Often viewed as the most affordable professional option, robo advisors appeal to younger investors just starting out, as well as experienced and DIY investors looking for cost-effective solutions. Robo advisors are ideal for those with straightforward needs and a less emotional approach to risk.
Currently, robo advisors rely on standardized investment models, which may fall short for clients who require more interaction, especially when addressing complex issues, navigating the emotional aspects of asset management or the emotional family dynamics around inherited assets. For those with more intricate needs or who prefer personalized guidance, the added fees for advanced robo-advisor services can rival — or even exceed — those of human advisors. In these cases, personalized human advice often offers more comprehensive support at comparable costs.
The rapid evolution of proprietary, predictive AI platforms may reshape the investment landscape significantly in the coming years. At the same time, human advisors are continuously innovating to provide more options for clients with evolving needs.
Compensation Structures
Financial advice is not free. If you are not writing a check directly to a human or robo advisor, then it is important for you to know how these resources are being compensated for their advice and recommendations. There is no superior compensation method. Advisors tout their preferred method as favorably as possible, but every compensation structure has its virtues and drawbacks.
Each client’s situation is unique, and some clients may not have the funds to pay an advisor as they may ideally desire. Compensation structures often change as clients’ needs evolve, but will fall under one of these six compensation structures:
Fee-Only
Registered investment advisors, or RIAs, are compensated by a fee based on their advice. The assets-under-management, or AUM, model is the industry’s most prevalent fee-only structure.
AUM fees are calculated as a percentage of the assets they manage and are payable on a yearly, quarterly or monthly basis as long as the advisor has a relationship with the client. A client’s portfolio value will change on a regular basis. Therefore, the assets will be revalued each year, reflecting the additions or subtractions from market returns, new investments, distributions and other factors. So, while the AUM percentage will remain the same, the actual fee will vary based on the increase or decrease in managed assets. A few advisors are experimenting with an average daily account value in order to smooth out major moves in the market.
A 2023 AdvisoryHQ study averaged three years of wealth management fees across the U.S. and found that, for a client with $1 million in assets, the average human AUM fee has been consistently 1.02%. In this case, the client would pay an annual fee for a $1 million portfolio of $10,200. AUM fees typically decrease as account size increases, and advisors may negotiate their fee with their most affluent clients. Advisors will usually establish a minimum account size as small accounts are labor-intensive and challenging to manage profitably. This can be a barrier for younger or newer investors who have not accumulated significant assets. Robo advisors follow the fee-only compensation structure and may cost as little as 0.2% to 0.35% for standardized models.
Clients should not hesitate to ask for percentages to be converted to actual dollar amounts. All advisor sources must disclose their AUM fee structure and the benefits it covers at the beginning of the client relationship in a Form ADV Part 2A. This document is regularly updated and must be easily accessible to the client throughout their relationship.
Performance-Based Fee
In this method, an additional fee is added to the standard AUM fee when a predetermined benchmark has been achieved.
Commissions
Broker-dealer representatives may earn commissions from product sales. The firm that offers the products compensates the advisor for recommending its financial solutions. The client will not receive a regular bill, but will pay for the representative’s expertise within the product itself or in stiff fees to exit the product early. Product costs may be referred to as expenses, loads or surrender charges. Percentages tend to be higher than an annual AUM fee, but payable for a shorter duration.
Product manufacturers go to great lengths to make complex products easier to understand. An “illustration” is provided to describe features and benefits. Internal costs are detailed in a “prospectus” given to the client at the beginning of the product conversation. Even though the documents are lengthy and rather dry to read, they are important to study carefully. Clients are required to sign a statement acknowledging that the documents were received and reviewed prior to the purchase.
The prospectus is updated annually with a required notice to the client. An “in-force illustration” can be generated after a product is sold and will reflect the actual performance of the product since the date of sale along with a fresh projection of potential future values. The representative will typically request in-force illustrations as part of an ongoing review with their client.
Hybrid/Fee-Based
Hybrid models may combine AUM fees and commissions. The standard of care required by regulation differs, so the advisor must take extra care to explain which standard applies to each part of the recommendation.
Flat, Hourly or Project Fee
Flat or hourly fees are appealing to younger clients with fewer assets and active retirees who may be drawing down their investments to pay for their living needs. They are also attractive for clients who feel more comfortable with a consistent fee schedule instead of one that changes as their assets rise and fall. As with the other types of fee structures, the advisor must detail what services are covered with these alternate fee structures.
Project fees or per-plan fees align well with unique situations, such as saving for a child’s wedding, where the time frame is a much shorter, specific duration than longer-term life events such as retirement. Project fees may also cover strategic documents, such as a financial plan, created for retirement, estate transfer or a business exit strategy.
Wrapped Fees
Wrapped fees are typically used in employer-sponsored plans, such as a 401(k), where the advisor’s compensation is embedded in the plan costs.
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Financial Advisor Fees vs. Investment Product Fees
When a professional advisory source makes financial recommendations involving products, there is an additional product fee payable in addition to the AUM fee. Financial advisor fees compensate the advisory resource for their expertise, while product fees cover investment costs. A client may pay a 1% advisor fee and a 1% product fee, for a 2% total fee. A client is not paying twice for the same benefit; rather, they are paying all parties to the transaction.
Ongoing Invoices
Advisory fees are invoiced to clients and are payable for as long as the client has a relationship with the advisory firm. Many practitioners calculate their invoices manually. This can lead to errors, especially if the advisor has negotiated fees, revised their fee structure or offers multiple fee structures. To minimize paperwork, some advisors opt for annual invoicing. However, this approach can unintentionally increase the risk of errors if the firm is processing a high volume of invoices during the year-end holiday period. This approach may also restrict clients whose budgets are better aligned with a quarterly or semiannual payment schedule.
The investment product fee is only payable for the period that the client holds the product in their portfolio. These fees are deducted directly from investment accounts, so clients aren’t consistently reminded to review their statements to confirm they’re being charged the agreed amount. Regulators have increased oversight to prevent advisors from overcharging clients, even unintentionally. It’s essential for advisory firms to ensure their invoices align with the fees outlined in their ADV documents.
When errors occur, those funds are removed from the investment, causing clients to miss out on potential market returns on the discrepancy. Being aware of the fees you’re paying for services can help you save both money and opportunity costs. If a client suspects they were charged incorrectly, they have every right to request an account reconciliation. Quality advisors strive to run an efficient operation while providing excellent client service, so any resistance to inquiries about questionable fees should be a red flag.
Deductibility
During the first Trump administration, Congress approved the 2017 Tax Cuts and Jobs Act. The provisions removed individual deductibility for advisory fees through 2025, although some trust and business accounts can still qualify. The loss of tax deductibility under this act is set to “sunset” or expire at the end of 2025. By that time, Congress will determine whether the provision will be extended or revised, or the deduction may be restored partially or wholly.
With the Trump administration returning to the White House, there will be renewed interest in the impact of tax deductibility for investors. Given that taxes can make a sizable dent in financial outcomes, this can be a prime opportunity for clients to discuss this topic with their accountant or tax advisor. It is also an opening for financial advisors to add extra client value by connecting them with vetted accounting and legal professionals to detail how the law would specifically apply in their situation. Often, the tax savings may help offset the cost of working with these professionals.
Transparency
Good advisors provide clear answers when asked about their compensation, viewing this discussion as a chance to highlight their value, unique strengths and firm differentiators.
Advisors who operate under an AUM- or asset-based compensation model often emphasize the alignment of interests in growing assets, which helps avoid potential ethical conflicts. For clients focused on asset growth, the AUM model can closely match an advisor’s expertise.
However, retiring clients may shift their focus to principal management and income distribution to support living expenses. They might also consider large purchases, such as extended vacations or recreational vehicles, and have growing interests in life and long-term care insurance. In these situations, the AUM model may no longer be the best fit for the client or the advisor.
Clients should feel comfortable discussing which fee structure best suits their needs and keeps their advisor engaged with their account. A perceptive advisor may refer a client to another professional if they lack a compatible compensation structure. While clients might initially feel they are being passed along, this is actually a hallmark of the fiduciary standard, as the first advisor is willing to forgo ongoing compensation to prioritize the client’s best interests.
Starting the Conversation
At the end of the day, a client must find an advisor that charges in a way that best aligns with their investment needs, their reliance on the advisor, and their own financial acumen or lack thereof. When evaluating an advisor, consider asking:
— “What’s my total cost for working with you over the next year, and what will I receive in return?”
— “If you only do better when my account grows, what is your plan if the market drops unexpectedly?”
— “I understand that you will make a commission on this sale. Will your fee structure incentivize you to manage my funds on a long-term basis?”
Once the client understands and accepts how they are paying for professional services, it is then up to the advisor to ensure that the value they bring to the table exceeds the compensation being rendered.
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What to Know About Financial Advisor Fees & Costs originally appeared on usnews.com
Update 11/18/24: This story was published at an earlier date and has been updated with new information.
