Everyone likes a bargain, but most people don't really know if the financial advice they seek is worth the price they pay. More than half of those who use financial advisors either thought the advice they received was free, or weren't able to say how much they paid, according to a survey conducted by Cerulli Associates and Phoenix Marketing International.
In reality, the amount that people pay for financial advice is often far higher than they imagine, and it takes some work to dig through all the costs that you might be paying to your advisor without even realizing it. Below, we'll run through the common fees that financial advisors charge, and how you can learn more about what your actual costs are.
How commissions cost you
You shouldn't count on getting a bill that will list all of the money that your financial advisor collects in fees and other charges. Most of the time, you can expect that your advisor will get compensated either by collecting commissions on the investment transactions done in your account, or through an arrangement based on a percentage of the amount of assets you have under management.
With advisors who make money on commissions, some arrangements are more visible to the customer than others. For example, some financial advisors charge fixed amounts every time you buy or sell a stock, and those amounts typically appear on brokerage statements.
However, if your advisor recommends that you buy a mutual fund with a sales load that gets paid back to the advisor, then a statement won't always be clear how much that sales load was. Instead, you'll have to calculate the amount yourself, based on your initial investment and the rate of the sales load. The good news is that sales loads are becoming less common, with most mutual funds offering shares to new investors without an upfront charge.
Fees that are based on assets under management involve fewer conflicts of interest than commission-based fee schedules, because your advisor doesn't have the same incentive to make unnecessary transactions simply to generate commissions. Instead, asset-based fees align incentives for both you and your advisor because the more successful you are in growing your investment accounts, the greater the compensation that the advisor receives. This goes a long way toward getting you and your advisor on the same page in terms of your financial goals.
Indirect investing costs many people don't notice
Even with an asset-based fee, investors still have to be diligent about the potential impact of layering in indirect costs for financial advice that often go unnoticed. For instance, some advisors use mutual funds or exchange-traded funds to implement your investing plan, and you'll often have to pay the associated costs that those funds incur in addition to the asset-based fee. Most funds simply take their fees directly from their asset base, leaving investors with a reduction in performance without any explicit statement specifying the dollar amount taken out of your account.
These indirect costs can be particularly egregious if they go back into your financial-advisor's pocket. Many fund companies, insurance companies, and other providers of investment products arrange to offer compensation for the professionals responsible for selling their products. If you combine an excessive asset-based fee with high indirect costs, you can end up paying all-in costs of anywhere from 1.75% to 2.5% each and every year. Moreover, it can be exceedingly difficult to unearth these relationships, and not every financial advisor is upfront about revealing those potential conflicts of interest to their clients.
What you can do
Fortunately, you're not powerless when it comes to fees you pay your financial advisor. All it takes is knowing the right questions and getting the right answers. So be sure to ask your advisor:
- How are you compensated for giving financial advice?
- Where on my statement can I see the fees you charge?
- How can I figure out how much I'm paying in total fees for your advice?
- Do you have any indirect compensation arrangements with investment providers or other associates?
No professional should be offended by these questions, and all advisors should freely answer them. If you don't get the answers you want, then the odds are higher that you wouldn't like the answers if you knew them -- and that warrants looking for a new financial advisor.