Demystifying What It Really Costs to Work with a Financial Planner
Understanding how much financial planners cost, and how they are paid, can be complicated and murky territory if you don’t have a higher degree in wealth management. But how much you pay a financial planner comes down to the type of financial planner you choose, as this is what drives the planner’s cost and ultimately determines the services you receive.
To get down to brass tacks, below are explanations of the three primary financial planner models and how each type translates to money out of (or in) your pocket.
THE BROKER (COMMISSION-ONLY FINANCIAL ADVISOR/PLANNER)
Brokers are paid by investment companies when they sell you investment products. When you invest with them, a percentage of your investment (usually starting at 5.75 percent) goes toward paying the broker and his/her firm. So if you invest $500,000 with a broker whose commission is up to 5.75 percent that means that $28,750 of your $500,000 investment goes toward paying the broker and the investment firm. This fee is known as a “sales charge.” In addition to the upfront sales charge, the advisor generally receives “trails” on your investment. These are typically 0.25% per year.
Brokers can also receive commissions from insurance companies, which pay them commissions for selling their products. This is why brokers often sell life insurance, long-term care insurance, annuities, disability insurance and other insurance products to their clients.
The commissions received from insurance and investment products may not be disclosed upfront, and they can vary significantly, so it’s important to always ask for a breakdown of the commissions you are paying on any given product. Your broker should be able to provide you with the percentage of commissions you are paying and the total amount you are paying.
A word of caution: Be wary of brokers that sell you new investments or insurance products often. For example, if your broker is frequently changing the investments in your account, you are most likely paying excessive, unnecessary fees to the broker. This is because the commission is charged every time the investments are purchased. This practice is known as churning, and it is an illegal and unethical practice that violates SEC rules and securities laws. Most brokers do not practice churning, but it’s something to look out for as churning generates excessive fees that can significantly diminish the growth of your portfolio.
THE FEE-ONLY RIA
On the other end of the spectrum is the “fee-only” RIA (Registered Investment Advisor). Fee-only RIAs are paid directly by their clients, and they are not allowed to receive commissions or any other forms of payment from other parties.
Fee-only RIAs generally charge an upfront planning/onboarding fee, which can range from $1,000 to $10,000. This fee pays for the front-end meetings and time invested by the financial planner to build you an investment and/or comprehensive financial plan. Traditionally, fee-only RIAs also charge on a percentage of assets under management (AUM), usually at a rate of about 1 percent of assets under management. So if the RIA is managing $500,000 in assets at a 1 percent AUM fee then the client would pay $5,000 per year.
Some fee-only RIAs are beginning to work with clients using other payment models. For example certain fee-only RIAs offer hourly services and/or annual retainer models. These financial planners typically do not manage assets for clients and they are able to charge lower fees as a result. Expect to pay between $200 and $400 per hour for a good hourly financial planner and $3,000 per year and up to work with a financial planner on an annual retainer model.
To get a comprehensive financial plan with an hourly planner you will pay upwards of $1,000, and you will also need to pay anytime you use the planner. Hourly and retainer models are both great payment options if your financial picture is fairly simple, but you would like to work with a financial planner and cannot yet afford the full service of an AUM planner.
The downside to fee-only RIAs is that they can be expensive. This is because you are typically paying for wealth management and comprehensive, ongoing financial planning and advice, which includes cash flow analysis, tax planning, estate planning etc. If you are not receiving these comprehensive-planning services with a fee-only RIA then you’re missing out on a majority of the value that a fee-only RIA can provide. If you are not receiving comprehensive financial planning then you’re probably better off with a cheaper “robo-advisor” such as Betterment or Wealthfront.
THE FEE-BASED RIA
“Fee-based” RIAs are a hybrid between brokers and fee-only RIAs. They are able to charge fees and sell commission products. Like fee-only RIAs, their AUM fees typically start around 1 percent of assets under management.
The commissions paid to the fee-based RIA by investment and insurance companies are usually the same as the fees charged by a commission-only broker (generally starting at 5.75 percent). Like brokers, the cost of commissions is sometimes not disclosed upfront so it’s important to ask a fee-based RIA if you are paying any commissions and how much those commissions are.
Your total cost can appear lower with a fee-based RIA (when compared to a fee-only RIA), but in reality the costs may actually be subsidized indirectly through commissions. For example, the fee-based RIA may not charge an upfront financial planning fee. S/he also may not charge an AUM fee on some assets, as those assets may be commission products.
One problem with fee-based RIAs is that their clients sometimes don’t know when they are paying commissions and when they are paying the fee. We’ve come across many who are paying both commissions and fees on the same investments. It can be very complicated, and it’s not always disclosed clearly by the financial planner. Make sure to ask a fee-based RIA how much you are paying in commissions and how much you are paying in fees in order to get a better sense of what you’re actually paying under this model.
A lot of folks come into our office without a full understanding of how their current financial planner is paid. We’ve even worked with quite a few people who were under the impression that their financial planner was not charging them but instead doing them a favor because they’re an old family friend. After some digging and analysis they were surprised to learn that they were, in fact, paying a hefty amount.
If you’re currently working with any type of financial planner and you don’t know how much you’re paying her/him then ask immediately. You may be surprised by what you find. And if you’re currently searching for a financial planner, make sure you find one who is clear and precise about how and what s/he is paid. Otherwise you may end up paying a lot more than you realize.
Ryan Sterling Cole is a Personal Financial Planner at Citrine Capital. He founded Citrine Capital to help Gen X and Gen Y professionals make prudent financial decisions for themselves and those who depend on them. Ryan is a Certified Financial Planner™ Professional.