What "Free" Financial Advice Really Costs You

Many investors believe that financial advice should be free. Although many professionals are happy to oblige with what they call free advice, those who follow their recommendations often pay an unseen price for that guidance -- and the dubious quality of that financial advice can lead to poor results.

The hidden way you pay for financial advice
The money management industry knows that if you have to pay money up front to get an appointment with a stockbroker or financial advisor, you're a lot less likely ever to set up that appointment in the first place. Yet they also know that the brokers and advisors who drive sales in the business need to get compensated, and money managers rely on those salespeople in order to gather assets under management.

To solve that problem, financial professionals have traditionally relied on commissions. Those charges can take a number of different forms, ranging from clear and concise fee schedules for certain services to less obvious means of funneling compensation to advisors. For instance, Morgan Stanley (NYSE: MS  ) and Bank of America's (NYSE: BAC  ) Merrill Lynch unit charge minimum stock commissions well above what you'd get at self-service discount brokers, with Merrill having raised its minimum fees for stock purchases from $50 to $75 last year. Morgan Stanley's Choice Select program has sliding tiers based on the volume of trades you perform, with fees ranging from 0.60% to 2.25%.

With commissions, at least, it's clear that you'll pay for financial advice at the time you make an investment. But other less obvious fees also lurk underneath the surface. For instance:

  • With some advisor-sold mutual funds, front-end sales loads act like commissions, diverting a percentage of your initial investment to cover the cost of paying the salesperson who sold you fund shares. But other classes of funds can tack on an annual charge, some of which can go to compensate financial professionals on an ongoing basis. Over time, those recurring annual charges can exceed what you'd pay on an up-front commission.
  • In addition to mutual fund marketing-related fees, funds often have revenue-sharing arrangements with the financial companies that sell fund shares. Under those agreements, the fund might agree to compensate the selling company for expenses like investment research and subscription services. Such soft-dollar incentives lead the professionals working for you to direct their business to those funds, even when they might not always be the best solution for your particular needs.

Asset-based fees
An arguably better way to pay for financial advice comes from asset-based fee-only arrangements. With these models, you pay a percentage of the total assets your advisor manages for you. As long as the arrangement is fee-only, rather than simply fee-based, you won't see commissions come out of your account.

The benefit of fee-only financial advice is that you know up front what you're going to pay. Yet again, there's not necessarily any correlation between the amount of your fee and the service you receive. One customer might have a tenth the assets of another yet need more guidance with their finances, and in such a case, the less affluent customer would get much greater value for the fee they pay than the more affluent customer.

The old-fashioned way to pay
Paying an hourly rate or fixed dollar amount for financial advice isn't all that common, but when you think about it, it makes the most sense. That way, what you pay is directly tied to the service you get. It also gives you an incentive to build your own expertise so that you don't have to rely as much on the professionals you work with.

For many investors, professional financial advice is something worth paying for. But don't cheat yourself by paying too much without even realizing it. When free advice seems too good to be true, rest assured that you're paying for it somehow.

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Read/Post Comments (8) | Recommend This Article (20)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 14, 2013, at 6:06 PM, lovesdos wrote:

    when reading the headline on this article, i could help remembering that motley fool provides quite a bit of "free" advice

  • Report this Comment On June 14, 2013, at 8:22 PM, herzele wrote:

    Ya get them CHEAP, Ya get them DUMB !!

  • Report this Comment On June 15, 2013, at 10:21 AM, airpurifier wrote:

    Either free advise or paid advise, You decide to take it or not. You have to take personal responsibility for your actions. Motley Fool provides quite a bit of free IDEAS. It up to YOU to do your homework, then you decide. Yes, I have used Motley Fool, Seeking Alpha and others for ideas. Some I wish I had acted upon. Other I am glad I did not. Either way, it is MY decision.

  • Report this Comment On June 15, 2013, at 10:25 AM, JessicaMcMillen wrote:

    Dan, thanks for sharing the reality with us.

    After an unpleasant experience with one of the well-known Wall Street names I decided to find fee-only advisors. My research came up with three large national networks of advisors: Paladin Registry: www.paladinregistry.org, Alliance of Cambridge Advisors: www.acaplanners.org, and Garrett Planning Network: www.garrettplanningnetwork.com.

    These networks have certified financial planners all over the place, most of which are fee-only, some are fee-based.

    Since I live in a remote area I continued my research for a web based, fee-only, financial advice. I found several nice solutions. One interesting site that claims to be fee-only, certified financial planner is Plan&Act: www.planandact.com. Another one I am not 100% sure if they receive commissions is My Financial Advice: www.myfinancialadvice.com.

  • Report this Comment On June 15, 2013, at 11:59 AM, snickerdoodle9 wrote:

    @airpurifier :You have to take personal responsibility for your actions.

    Hello and Amen ...... ! I watched and listened to a popular afternoon tv show and a stock market commentator suggest selling some holdings ( among his recommendations ) of a sector that are in my portfolio . The holdings make up a part of a high yield reinvested dividend sector that are paying me every month . A few days later on an up day he is glorifying a stock that is among the sector that he suggested selling . Through reading and listening to these " talking heads " I have become a good rule breaker with their suggestions and am profiting dearly by doing the opposite of what they are saying . The key is to do the research ( homework ) before and after investing in a potential stock of interest . Over the years I don't believe that any market sector has gone unscathed of getting hammered . A portfolio is diversified across many sectors offers better protection against severe losses .

  • Report this Comment On June 16, 2013, at 1:15 AM, talotu wrote:

    @JessicaMcMillen

    You can also look at www.wealthfront.com they are fee-only and last time I looked they were waving fees on the first 25,000.

  • Report this Comment On June 16, 2013, at 9:46 AM, dickieduck wrote:

    I totally agree that the most reliable advice is that which you pay for. I do not expect someone to give me advice for free. I would much rather pay a fee to an advisor and feel that the advice being given is what is best for me and my situation, rather than being skewered by what profits the advisor the most. But... that is fine if you live in or near an urban area where there are such professionals. If, like me, you live out in the sticks, there are no such people - just not enough business for them to survive on - so you have to rely on the "financial planners" who are getting something for themselves out of the advice they give you. Thanks, Jessica McMillen, for suggesting some alternatives.

  • Report this Comment On July 02, 2013, at 12:51 PM, barbarian312 wrote:

    Are you serious? Most of the "professionals" can't even beat an index fund. Meanwhile I, an amateur, have been beating Warren Buffet's returns for 11 years relying solely on my own research and the free advice of my fellow Fools. Why would anyone in their right mind pay for investment advice from someone who still has a job?

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