Understanding advisor compensation models

There are ultimately four different financial advisory fee models:

Commissions – In my opinion, this is the most tainted of the models and is typically the compensation method for insurance salespeople and securities brokers who masquerade as advisors. You generally don’t directly pay the salespeople for their services. Instead, they get paid a commission from the company whose product they sell to you. If they’re paid solely from selling you something, you can imagine how their “advice” will almost certainly end up being a recommendation to buy something they peddle. Is that the type of advice you want???

Percent of Assets – Otherwise known as percent of assets under management, or “AUM.” This is probably the most common fee method. Under this model, advisors typically charge around 1% per year of the assets they manage for you. Advocates of this form of compensation boast their interests are aligned with yours because they only do better when you (i.e. your investments) do better. In other words, if your accounts go up in value, they make more, and vice versa. But the inherent flaw with this model is that it often overcharges you if you have accumulated a sizable amount of assets. I’ll let you in on a little secret - it’s rarely twice as much work to advise a client who has $2,000,000 than it is to advise a client who has $1,000,000. Yet under the percent of AUM model, the first client would pay twice as much as the second client.

The other flaw of this model is that advisors are more likely to make recommendations that involve keeping your assets with them. Picture this scenario - you ask your advisor if it would be a good idea to take $300,000 out of your account to pay off your mortgage or buy a vacation home. At 1% of AUM, the advisor would lose $3,000 per year of recurring revenue from you if that money were to leave your account. Do you think that advisor can give you a truly unbiased answer??? 

Flat Fee – Also known as a “Retainer” or “Subscription.” The fee is generally fixed and is agreed upon prior to entering a relationship with the advisor. You may have the option to pay on a monthly, quarterly or annual basis. The fee is typically based on the complexity of your financial life and therefore the amount of service and resources necessary in providing you ongoing advice. Some advisors charge a flat fee for financial planning services and separately charge a percent of AUM fee for investment management. Other advisors (such as yours truly) charge a flat fee that includes both financial planning AND investment management. This compensation structure is rare but becoming more popular.

Hourly – As the name implies, some advisors charge hourly for their time and advice. This model doesn’t lend itself well to investment management or ongoing financial planning as the hours will really start to add up during the course of the year. But if you have some very specific questions whose answers won’t depend on a broader analysis of your whole financial picture, a little bit of hourly advice here and there may be all you need. Most advisors don’t offer their services on an hourly basis but there are nonetheless some who do (again, yours truly is one of them). 

To be fair, no fee structure is perfect or completely free from potential conflicts of interest. However, in my opinion, flat fee is the fairest method for ongoing investment management and/or financial planning relationships. For one-off financial questions, the hourly structure is obviously the best.

I think it was Warren Buffet who said, “price is what you pay, value is what you get.” In other words, regardless what fee structure your advisor has, make sure you feel like you’re getting enough value for what you’re paying. The fee itself isn’t necessarily what matters…it’s what you get for that fee.  But some fee methods make a lot more sense than others!