There is a common misconception among many that you cannot seek a financial advisor’s advice without having substantial assets.
This is not true.
Some advisors may require a minimum amount of investable assets to work with them, sure. But many don’t today, and many more advisors are tailoring their practices to be more attractive to those that may not have $1 million to invest right now.
Today I’m going to write about the different types of fee structures that advisors may employ. I’m not here to tell you which method is best, nor to make a recommendation. Each person’s situation is different, so you choose what’s best for you.
Should You Pay for an Advisor?
In a world of easy access to just about any piece of information at nearly any time, many people are questioning whether they need an advisor in the first place. Give them a robo advisor with low-cost index funds and they’re set.
I vehemently disagree here.
Financial advisors are not stock jockeys. That’s the sort of reputation some get because of the information asymmetry that used to exist but no longer does.
Back in the 1980s, financial advisors had access to data, financial reports, trading technology, etc. that was not as readily available to their clients. It was easy to call up a client, convince them to buy XYZ stock based on the advisor’s “research” he or she just completed, and charge a 7% commission to do it.
That’s not what financial advisors do anymore.
These days, FAs possess a boat load of knowledge spanning many different topics. Investments still play a large part in client conversations, but there are many other bases to cover.
- Tax planning
- Estate concerns
- Health care planning
- Stock option/equity compensation strategies
- Education planning
- Many more
If FAs were still only concerned with investments, then I’d say there aren’t much use for them. But when you include everything else, most are well-worth the cost of a professionally done financial plan.
Payment Option #1: Upfront Commissions
Yes, these still exist!
Paying your broker an upfront trading commission has lost quite a bit of popularity in today’s day and age. That’s due to several reasons, but it mainly boils down to the availability of trading technology becoming more widespread, as well as regulations clearly discouraging advisors from being compensated in this way.
Personally, I don’t think paying an upfront commission is as bad as many people make it out to be. In some cases, it can be cheaper to pay a 5% upfront commission for each purchase you make rather than paying an annual fee of 1% of your assets over an extended period.
Strict regulations are in place around this method of payment today. In the past it was easier for some sleazy advisors to have their clients pay multiple commissions upfront at different times. It’s much more difficult to do this today with the regulations in place, plus investors are far more cautious of paying commissions upfront.
Payment Option #2: Charging a Fee as a Percentage of Assets
As briefly mentioned just above, the most popular way to pay for a financial advisor today is to pay an ongoing fee on your assets. This payment method has caught fire over the last 20 years. Just like new regulation is discouraging upfront commissions, it is heavily accelerating advisors being compensated on their AUM, or assets under management.
It’s a good selling point, too. An advisor would be compensated based on their client’s account value, say 1% of AUM for example. When the client’s portfolio value increases, the advisor gets paid more for managing that account. And the advisor takes a pay cut when the account value decreases.
The incentives are aligned in this method. The advisor is clearly incentivized to increase his/her client base’s account values.
Regulators – attempting to put the client’s interests ahead of an advisor’s – like this model much more than option #1.
The payment options discussed so far dominate the industry in terms of popularity today. The next two methods are newer but gaining in popularity.
Payment Option #3: Paying a Subscription Fee
You pay a monthly subscription fee for Spotify and Netflix. Why not for your financial advice as well?
Some advisors like this train of thought. It is advantageous from their point of view for a few reasons, namely:
- It’s reliable, recurring revenue.
- The advisor doesn’t have to worry about market fluctuations impacting their income.
- The client knows exactly how much they pay in fees and can spread it out over time.
- It allows the advisor to focus on other aspects of financial planning that he or she may have otherwise skipped over due to compensation concerns.
I believe this sort of payment method will catch on quick with Millennials and Gen Z. These age groups regularly pay subscription fees for multiple services and appreciate their transparency and reliability.
Not only that, but this sort of method also opens the door for different discussions around financial planning.
In a subscription fee arrangement, the client can manage their own assets away from the advisor. This is impossible to do in the first two payment structures. This is extremely advantageous for more DIY investors.
As I mentioned above, revenue that is recurring and agnostic to investment performance can allow the advisor to focus on other aspects of planning. It can be easy to get caught up focusing solely on a client’s investment performance when that determines the advisor’s compensation. But what about budgeting? Employee benefits at work? Tax management? The list goes on.
This sort of structure can more heavily align clients’ needs with the advisor’s compensation, especially if the clients are not interested in investment management.
Payment Option 4: Upfront Flat Fee
The last financial advisor payment structure to discuss today is an upfront flat fee.
It’s self-explanatory here: an advisor charges $X for his/her services and the client pays it upfront, or maybe over a series of 2-4 payments. Those services can be specifically tailored to the advisor’s strengths or focused on a specific client need.
This sort of relationship is very similar to option #3, but there is less reliable, recurring revenue. A client may choose to pay this advisor one time and never engage with them again. To compensate for this possibility, most advisors will charge a higher fee at engagement than a subscription model would cost over time.
An advisor may have different packages with different fee amounts that a potential client can choose from. Again, this makes the fee transparent for the client and ensures the advisor does not have to be compensated solely from investment performance.
The best payment structure for you will depend on the needs of your family and what makes you comfortable. There are no right or wrong answers, and there is a reason all four structures are in use today: because at least someone prefers to pay that way!
The purpose of this article is to inform you about what structures exist and to give you an idea of what works for you.
If you’re in need of a financial planner’s services, reach out to us here and let us know how we can help. At Watchdog Capital, we allow our financial advisors to charge the payment structure that works best for them. We can match you up with an advisor that suits your needs – both with your financial planning as well as the way you prefer to compensate them for their time.