Figuring out your financial plan can be challenging. Having a professional advisor to guide you through the process can make things easier. Many Americans, however, are flying solo when it comes to their finances. Sixty-eight percent of people polled in a Northwestern Mutual survey say they don’t have a trusted advisor who offers comprehensive financial planning.
For some the decision to forgo a financial advisor may be due to worries about cost. Financial advisors can structure their fees in a number of ways, but for what, exactly, are you paying? Understanding how financial advisors determine their fees can help you decide whether it’s the right investment.
Assets Under Management
The most common method financial advisors use to determine their fees is by charging their clients a flat percentage of their assets under management (AUM). Generally, the more assets your advisor manages, the lower the fee is going to be. In 2017, for example, the average advisor fee for $50,000 in assets was 1.18 percent. The average fee for someone with $5 million, on the other hand, was 0.84 percent.
Advisory firms that use the AUM method can also opt to charge a flat fee instead of a percentage. The average annual flat fee for investors with less than $500,000 in AUM was $7,500 in 2017. It was $55,000 for investors with assets of more than $7.5 million.
Fee-Only vs. Fee-Based Advisors
There are both fee-only and fee-based financial advisors. The two may sound the same, but they’re very different.
Fee-only advisors don’t accept any commissions or incentives for advising their clients to invest in certain products. Instead, these advisors earn their fees by charging clients directly, either a flat fee or an hourly fee.
Fee-based advisors, on the other hand, earn fees from commissions associated with specific investment products. They may also charge various fees to their clients. The biggest potential drawback with fee-based advisors is that they may try to steer you toward investments that aren’t necessarily the best fit, because the investments offer the advisor a higher commission.
There are also advisors who only get paid via commission, without charging their clients anything extra. If you don’t buy anything from them, you don’t pay anything, but you may be subjected to a harder sell than you would be with a fee-based or fee-only advisor. In 2017, 55 percent of advisors said they used a fee-only structure, while 45 percent opted for a combination of fees and commissions.
What Else Are You Paying For?
If you’re working with a financial advisor, the fee isn’t the only thing to consider. You also have to factor in the fees of the investments toward which you are guided.
Let’s say you are investing in mutual funds, index funds or exchange-traded funds. Each of those investments has its own expense ratio that must be factored in. The expense ratio represents the annual fee you pay for the fund, and it’s expressed as a percentage of the fund’s assets. Expense ratios cover all of the fund’s operating and management expenses.
Mutual fund fees have on average been declining for the last two decades. In 2017 average expense ratios were 0.78 percent for actively managed mutual funds, 0.09 percent for index funds and 0.21 percent for exchange-traded funds. Adding in those fees can give you a better idea of what working with a financial advisor may cost, based on what is recommended for your portfolio.
Is a Robo-Advisor Better?
Robo-advisors are gaining steam as an alternative to the traditional financial advisory model. Rather than speaking to a human about your investment or financial management needs, you allow a robo-advisor to shape your investment choices using a computer algorithm. Because the human element is taken out of the equation, the fees are generally less than what you’d pay for a traditional advisor.
According to a survey from Accenture, seven out of 10 consumers worldwide said they’d be interested in receiving robo-advice for things such as banking, insurance and retirement. However, a robo-advisor may not be the right choice for everyone.
If you’re torn between a traditional advisor and robo-advisory services, think about what you need most from an advisor. Instead of focusing on just the cost, ask yourself what kind of value each one provides. In a market downturn, for example, a human advisor could help you keep from panicking and selling off assets, whereas a robo-advisor isn’t equipped to do that.
How to Choose a Financial Advisor
If you’ve decided that a traditional advisor is the right choice, take time to compare advisors and their fees before making a commitment. Ideally, prospective advisors should have a transparent fee schedule; you should know right away which method they use to charge their fees and approximately how much you’ll pay.
Also, be sure to ask whether an advisor is a fiduciary. Advisors who follow a fiduciary standard are ethically bound to put your interests ahead of their own. Fee-based advisors are held to a fiduciary standard. If you’re concerned about cost—and getting good advice—a fee-based advisor may be the better option.