The Actual cost of Hiring a Financial Advisor

When people think about hiring a financial advisor, the cost of that person is often one of the considerations that goes into the decision making process. 

There are several ways that advisors can be compensated for their time, and it usually depends on things like how they are registered (which governmental body/bodies have jurisdiction over them)  and what incentives they have to sell products.  

In a previous blog (What Makes a Financial Advisor Independent) I discuss the confusion around the different types of people that call themselves financial advisors.

For the purpose of this discussion, I will disregard insurance agents who call themselves “Financial Advisors” and focus on two main types of financial advisors;

• Financial Industry Regulatory Authority (FINRA) registered advisors with broker/dealers and;
• State or SEC registered advisors with Registered Investment Advisors (RIAs).

To make things a little more confusing, there are advisors that switch “hats” between these two types of arrangements, making it even more difficult to understand how they are being compensated.

The most prevalent type of advisor is one that works for a broker/dealer; these would be places like Merrill Lynch, Morgan Stanley, UBS, Edward Jones–just to name a few.

In reality, there are hundreds of broker/dealers including insurance company BDs.  These advisors sell products like mutual funds, variable annuities, individual stocks and bonds and are paid a commission for selling that product.  

An RIA does not charge commissions for trades and transactions.  Instead, there are two prevalent ways clients pay for investment advice, with a third option gaining popularity among younger clients.

The first, and most common way is through an Assets Under Management (AUM) arrangement.  The advisor charges a percentage of the assets in exchange for the expectation that the client’s accounts will grow over time.  The desired outcome (a higher balance) aligns the client and the advisor. The only conflict with this type of fee is that the advisor, being paid on AUM, is incentivized to make recommendations that keep more money in your account.

Second, a client and advisor can agree on a financial planning fee (a set dollar amount, or hourly charge) based on either a comprehensive financial plan or a modular (specific aspects of the client’s financial situation) plan.  The cost is agreed upon up front and the client knows exactly what they will be paying for and what they can expect the output to be.  The conflict here is that the advisor is incentivized to take longer to create the plan and bill for more hours to increase the overall fee paid.

Finally, as younger clients begin to work with advisors, the first two approaches don’t make much sense.  With less assets available to manage and less complex planning required, a third approach has emerged where the client pays a regular fee (typically monthly, quarterly, semiannually or annually) and the advisor provides ongoing advice as needed. 

This allows the parties to negotiate an agreed upon fee that serves the needs of the client while compensating the advisor for their time.

As you investigate a relationship with a financial advisor, one of the questions you should be asking is “how do you get paid”?  It is also reasonable to discuss all of the ways that an advisor can be paid and find one whose value aligns with yours in terms of compensation.  Having the clarifying conversation upfront will lead to a more fulfilling experience and better outcomes.

Blaise Stevens

CFP®, AIF®, CLU®, ChFC®

Managing Member

(336) 790-2560