Why Financial Advisors Charge a 1% fee
Charging fees of 1% of your investments is a very sly method of billing, i.e. it’s not very clear. For one, you rarely, if ever, discuss or agree to the dollar amount you will pay. He might as well tell you the fee is 25 marshmallows.
If your portfolio is $1,000,000 and your advisor charges 1%, most won’t ever bring up that 1% of $1,000,000 is $10,000 per year. And since most advisors debit the fee quarterly from investments accounts, rather than sending an invoice, the fee is just swept under the rug.
Of course, this is great news for your advisor. Who likes talking about fees? Especially when they are often in the tens of thousands? Saying 1% sounds so meaninglessly small. Plus, every other advisor charges essentially the same way.
Another advantage of 1% fees is that they tend to go up over time due to additions to the account, as well as from market growth. As the assets in the account grow, so does the fee. But actual level of service doesn’t change.
MOST ADVISORS WANT TO AVOID THIS CONVERSATION:
You – “I pay you 1% on the $200,000 you manage for me, right?”
Advisor – “Correct. That 1% is $2,000 annually.”
You – “”I am getting ready to retire and you want to manage my $800,000 401k balance at the same 1% fee. This would increase the fee I pay you 5 times from $2,000 to $10,000 annually. Explain to me in detail how you will increase your services 5-fold.”
Advisor – …….
Why Charging a 1% Fee Increases Conflicts
I discuss some of the reasons why charging 1% fee can lead to some biases and conflicts in the advice advisors give here. Certainly, conflicts of interest are something you want to avoid as much as possible.
So how are most other professionals are compensated. When you go to the dentist, they don’t ask you for your net worth and then base your fee on that number. They decide what procedure you need and charge you for that procedure. Same with doctors. Hate to make attorneys look good, but they are more transparent than most advisors. In fact, in most states it is illegal for estate planning attorneys to charge based on their client’s assets. Most professionals charge either hourly or a fixed fee for service.
The reason for this is simple, you hire a professional for their expertise. The fee you pay should be relative to the level of expertise of the professional you hire, and the difficulty and/or duration of the service being provided. It shouldn’t have anything to do with your income or net worth.
Wealth Management and Airlines
The wealth management businesses doesn’t look like the businesses of other professionals. Why? Because they are compensated on a 1% of your portfolio. I can tell you from experience, the level of assets you have has little to do with the level of service you need. Most advisors often have two clients receiving the same service, but paying very different fees.
Next time you travel on an airplane, try and imagine what everyone paid for their seat. You don’t think everyone got that $69 fare do you? I recently flew United Airlines to Florida with my family and we (5 of us) paid $89/seat. My father was surprised to see I got such a good price, so I went back to United’s website and pulled up my same flight dates…..$175/seat. This was less than 4 days later. Same airplane, same seats(not first class) and almost double what I paid.
This is how the wealth management world works.
There is a disconnect between services provided and fees paid and financial advisors often have a large number of clients who are completely unprofitable and ignored. (Haven’t heard from your advisor in more than 6 months, then this is you)
Often these are old clients that the advisor sold insurance or other commission products.
When the advisor moved to a 1% of the portfolio business model they kept these clients hoping they will one day receive an inheritance or rollover a large 401k.
So some clients are paying fees of $10,000+ and getting the same level of service as a different client paying fees of $1,500.
Choice
One reason that advisors have been able to operate this way is that choosing an advisor is not a simple matter. There is no clear-cut path to becoming a “financial advisor” like there is a doctor or a lawyer. In fact, offering a lower fee could actually lead consumers to assume an advisor is less qualified or “discount”.
Because of the confusion, people tend to just go with whoever their sibling or neighbor or co-worker uses. And in most cases the cost of services is not made clear. Your brother in-law could be paying $1,500 to the same advisor who is charging you $10,000 for the same service.
And since cost of services isn’t disclosed in a clear fashion (like a bill), the 1% fee model has stuck and continues to be the status quo.
Come Prepared
First, come with questions so you can get clear answers. Here is a great list of questions to ask:
Searching for a new advisor:
Are you always a fiduciary, and will you state that in writing? (Yes.)
Does anybody else ever pay you to advise me and, if so, do you earn more to recommend certain products or services? (No.)
Do you participate in any sales contests or award programs creating incentives to favor particular vendors? (No.)
Will you itemize all your fees and expenses in writing? (Yes.)
Are your fees negotiable? (Yes.)
Will you consider charging by the hour or retainer instead of an annual fee based on my assets? (Yes.)
Can you tell me about your conflicts of interest, orally and in writing?
Do you earn fees as adviser to a private fund or other investments that you may recommend to clients? (No.)
How often do you trade? (As seldom as possible, ideally once or twice a year at most.)
After inflation, taxes and fees, what is a reasonable estimated return on my portfolio over the long term? (If I told you anything over 3% to 4% annually, I’d be either naive or deceptive.)
How often will I here from you?
Evaluate your current advisor (start with the ones above):
Am I happy with my financial advisor’s communication with me? (or has it been more than 6 months since last communication and more than a year since your last in person review)
Does my financial advisor take the time to understand my long-term goals (Do you have a financial plan?)
Does talking with my advisor make me feel more knowledgeable or more overwhelmed?
How is my current portfolio working toward my goals?
How will this affect my taxes now and in the future?
You should be able to get high-quality financial planning and investment management from a competent professional for less than $10,000 per year. Even if your portfolio is $5,000,000.
Let’s Wrap This Up!
Charging fees based on clients’ ability to pay is quite unique to the investment industry and the ER. In my opinion it’s one of the things that is keeping the industry from being viewed as a profession, rather than a sales industry.
But if your portfolio is over $750,000, you are likely paying your advisor an unreasonable rate for the services being provided. Likely far more than you pay other qualified professionals like lawyers, doctors and accountants
Find someone who will provide you honest, expert advice for a reasonable fee.
Smarter Planning. Smarter Portfolios. Smarter Fees.