When looking for a financial advisor, there’s much to consider: what states they conduct business in, their certifications, whether you enjoy talking with them and trust them, what their specialties are, and, of course, how much they charge.
But just as important as how much they charge, is how they charge it. The wrong payment structure could lead to someone mismanaging your assets, overcharging you, or giving you bad advice.
So don’t hurry through the payment conversation and sign the contract. First, get familiar with the different types of payment structures, and decide which one is the best for you, your goals, and your financial situation.
What it is: Your advisor charges you a flat fee per hour of work.
Typical cost: $100 to $400 per hour
Best for: People with a small portfolio who want a holistic financial plan.
Potential conflicts of interest: Your advisor fudges the numbers and says he works for more hours than he did, or recommends active asset management in order to get more paid hours. This type of payment structure has become more popular recently, and with good reason. It’s the most democratic way of charging for financial advice, because the financial advisor doesn’t care about the size of your portfolio, or even if you have one.
“Because we charge hourly, we’re able to work with clients regardless of wealth, and also not be influenced either by the size of their portfolio, or the products we can sell or the investments we want to have for them,” says financial advisor Martin Poole of HFH Planning in New York. His firm charges $360 an hour for new clients, who he says earn at least $100,000 individually or $150,000 as a couple.
Like most advisors who charge by the hour, Poole comes up with holistic financial plans for his clients. “We have a few clients where we’re not doing a holistic plan, but for most of the clients that come to the door, we assess their financial situation and then decide if investing is right for them. It’s the least profitable method for the firm,” he notes.
His advice could help you with student loans, your mortgage, retirement planning, saving for your kid’s college, dealing with a windfall, and asset allocation. Fairly typical goals for the early to mid-thirties set.
This payment structure is often cited as the least likely to lead to a conflict of interest with your advisor, but it might not necessarily be the most affordable, depending on your portfolio and the level of work you will require from your advisor.
Look for an advisor that is part of the National Association of Personal Financial Advisors (NAPFA) a professional association of fee-only financial advisors.
What it is: Your advisor charges you based on the size of your portfolio.
Typical cost: 0.5% to 1.25% of your portfolio annually, though the fee is broken into monthly or quarterly payments. An advisor will typically charge a smaller percentage as the portfolio gets larger.
Best for: People with larger portfolios ($250,000 or more) who want an advisor to manage their portfolio for growth.
Potential conflicts of interest: Advisor bets on riskier, high growth stocks to increase your portfolio size quickly, or advises against paying off loans in order to preserve the size of your portfolio and keep their fees higher. You know how you’ve heard that financial advisors won’t take anyone with a portfolio smaller than $200,000? Well, that’s not uniformly true, but it’s generally true for this type of advisor. And it makes sense – if you have only $10,000 to invest, an advisor would only earn $50 to $125 on that, and would be limited in how much work they could do for you anyway. There’s only so much diversification you can do with a $10,000 portfolio, and the stakes are much lower.
“I will take anybody, but I will discourage them if it’s less than $250,000,” says Michael Terry, founder and president of MTP Advisors in New York. “I have to charge them a minimum amount and I don’t think it’s good for them if their assets are so low. I encourage them to learn as much about personal finance as they can and call me once a year and see how they’re doing.” For the latter type of client, he will charge hourly.
While Terry prefers charging a hourly fee, he does have clients who like being charged a fee that is a percentage of their assets, because they like to know that he is incentivized to grow their portfolio. In that case he recalculates his fee quarterly based on the current size of the portfolio. “Some clients think that I will do a better job for them, and that when things go up I get more money,” he says. “The ones who I manage assets for, they get the planning as well.”
What it is: Your advisor and/or broker-dealer charges you per financial product you buy and/or transaction you make.
Typical cost: $5 to $200 per trade, varies widely on other financial products.
Best for: Financially savvy clients who are comfortable with their overall financial picture, and will be very involved in their portfolio management.
Potential conflicts of interest: Your financial advisor sells you unnecessary or inappropriate products, hides the commission-based side of the payment from you, overcharges you, or churns through your account (buying and selling unnecessarily in order to earn commissions). This is the type of payment plan often favored by financial advisors at large firms. It can be controversial, because of the large potential for conflicts of interest. For example, your advisor may recommend a mutual fund with high front-load fees, costing you money right away, when they could have recommended a more appropriate no-load fund. So if your advisor says the relationship won’t cost you any money, don’t necessarily take that at face value. “They’re paying somewhere, they just don’t see it,” Poole says of clients who work with commission-based advisors. Also, a commission-based advisor typically won’t do basic planning for you, such as helping you pay off student loans or save up for a home.
“If someone is telling me, ‘I need money for my kids education,’ I’m not your guy. ‘I need money to buy a house,’ I’m not your guy,” says Michael Zelvin of Brill Securities in New York. He charges commission for stock trades.
There are instances where this payment structure can be appropriate. First, you need to be very financially savvy and have a solid understanding of the finance world, so you can completely understand where the commissions are, the fees involved with each transaction, and how that will affect your returns. “I spend a long time on the first call explaining what I do,” Zelvin says. “It demands a certain amount of sophistication on the client’s account.” So if any of this is confusing to you, try a fee-based advisor instead.
Second, you should be looking for an advisor who will do a fair amount of research for you on appropriate assets to buy, and work closely with you on growing your portfolio. “If I just hand somebody money and say, ‘Go do what you do,’ I wouldn’t favor commission based,” Zelvin says. He himself is a stock picker, doing heavy research on small-cap companies that he thinks are poised to do well. He even goes as far as calling up the CEOs of these companies. “They’re using me for the amount of time I put in going to find these things,” Zelvin says of his clients. “I could be called a business consultant.”
And he is clear-eyed about the pitfalls of commission-based payments. “I can understand very much why it’s controversial. I’ve asked myself whether I should change my structure. But it isn’t broke so I don’t fix it. My clients see the work I do and are fine with paying me a commission.”
In his case, the brokerage firm he works for charges $25 per transaction before he earns any money. The rest is negotiable, depending on what kind of relationship you want. “I don’t have any template. If it turns out the person has a high risk IQ and wants to be more active in the market, I’ll try to lower those fees. [Ed note: Someone who is more active in the market will have a higher number of trades.] I have a number of discretionary clients who I’ve earned over time that let me do whatever I want. I’ll do a trade and I’ll charge them $80 for it. I’ll own a stock position for a year and if we make a lot of money on that, I’ll charge them more on the way out. On the other hand if it was a bust, I’ll try to mitigate that loss by charging a smaller fee.”
Another important note: because Zelvin is focused on riskier investments, he only holds a portion of many of his clients’ portfolios. They have their more conservative investments elsewhere.
What it is: Your advisor charges you a flat fee, but also earns money on certain products they manage or sells to you, like mutual funds, annuities, and life insurance.
Typical cost: $100 to $400 per hour for the fee, no cost to you for the commission, which is paid by the company providing the product.
Who it’s best for: Clients who want a holistic plan that also includes buying products and managing assets.
Potential conflicts of interest: Your financial advisor sells you unnecessary or inappropriate products, hides the commission-based side of the payment from you, hides that a third-party is giving them a commission for selling certain products to you, overcharges you, or churns through your account (buying and selling unnecessarily in order to earn commission). This might be a more affordable way for you to get a holistic financial plan, since your advisor is making money from the fees he or she charges you, but also is making money (but not from you) if they buy financial products for you. For example, they could charge you a low per-hour fee for planning, but also earn money every time they buy a position in mutual fund for you or help you choose and buy insurance. David Warshaw, CFP®, CHFC®, CLU® a Senior Wealth Manager with Blueprint Wealth Alliance, mainly charges fees, but some of his clients have commission-based products that they bought before becoming his clients, making him a fee and commission advisor. “If someone comes in to me with an annuity, I have to service that,” he says. And he says the broker-dealer he works with for IRAs has a $25,000 investment minimum and works with C-Class mutual funds, which charge a commission, typically 1%, on the back end of a fund when you sell it. If you are thinking about working with a fee and commission advisor, make sure they are clear with you about where and how the commission is charged, both before you become a client, and whenever they are about to buy or sell a product for you.
So, how do you know which one is best for you? You need to be clear going in about what your goals are. Do you want general help in sorting through your financial picture? A fee-based advisor that charges per hour might be best for you. Want to have some fun with a chunk of money and need help researching potential bets? Maybe a commission-based advisor is best for you. You should also do the math on the cost. Ask your potential advisor how many hours they think they will spend on your financial plan each year, if they charge an hourly fee. Calculate what an assets-based advisor would charge per year based on the size of your portfolio. Either one could be higher, depending. In any case, you should understand and feel comfortable with the cost of your advisor before signing anything. After all, you’re trying to get help managing your money. And being a savvy shopper is the first step toward that goal.