Navigating Financial Advisor Fees: Are You Paying Too Much?
Many individuals rely on financial advisors to manage their assets, but understanding the fees associated with these services is crucial. A recent query highlighted a couple paying $26,000 annually (0.85% of their portfolio) to their advisor, questioning whether this was reasonable. This article explores the landscape of advisor fees, helps you determine if you're getting good value, and discusses alternative compensation models, including Assets Under Management (AUM) fees.
Understanding the Financial Planning Landscape
The financial planning world is diverse, with some firms focusing on strategic advice and outsourcing portfolio management, while others offer full-service solutions. Whether a fee of 0.85% is reasonable depends on the scope of services provided and the performance achieved. Shopping around is always a recommended approach.
Is Your Advisor Fee Justified?
According to Dr. Jim Dahle, founder of The White Coat Investor, the typical "financial advisor" often provides subpar advice for excessive fees. Many are essentially product salespeople driven by commissions, creating an incentive to promote less-than-ideal products. Even advisors offering sound advice may overcharge, especially when managing substantial assets. While 1% of AUM might be fair for $300,000, it becomes less justifiable for $3 million or more.
AUM Fees Explained
AUM fees are a common compensation model, where advisors charge a percentage of the assets they manage. It's important to recognize that AUM fees are still fees, and fall under the "fee-only" model. Some investors mistakenly believe that fee-only advisors don't charge AUM fees, but this is incorrect. If the advisor only gets paid from fees, they are fee-only.
The "Advice-Only" Model
An alternative is the "advice-only" model, where clients pay solely for advice and implement it themselves. This suits "validators," who need occasional guidance but are capable of self-management. However, this model can be challenging for advisors due to its transactional nature and the need for a constant influx of new clients. Many who require delegation try to be validators, leading to poor implementation and outcomes.
Doing the Math: Calculating and Negotiating Fees
It's essential to calculate your advisor fees annually. Multiply your assets under management by the AUM fee percentage. For example, $700,000 managed at 0.9% incurs a $6,300 fee. As your assets grow, revisit the fee structure. For instance, paying 1% on the first million, 0.9% on the second, and 0.8% on the third can become excessive as you reach $3 million. Negotiate lower fees or seek a new advisor to ensure you're receiving fair value.
Why Advisors Charge High AUM Fees
High AUM fees persist because clients are willing to pay them. From a business perspective, it's advantageous. Clients tend to become wealthier over time, and many are hesitant to actively manage their finances, negotiate fees, or switch advisors. This stickiness makes AUM-based practices highly profitable. The White Coat Investor (WCI), highlights that many practices depend on consistent AUM growth, especially as initial lean years give way to more profitable engagements.
The Defense of Reasonable AUM Fees
While criticism of AUM fees is common, reasonable AUM fees can be justifiable. We all pay AUM fees in the form of expense ratios on investment funds like the Vanguard Total Stock Market Fund. The key distinction lies in the reasonableness of the fee. Managing larger portfolios involves more complexity and risk, potentially justifying higher fees. However, fees should align with the services provided and the value delivered.
Flat Fees vs. AUM Fees
Paying a flat fee for asset management can be suitable, but its fairness depends on the asset size. Managing $400,000 and $3 million might involve similar effort, making a $10,000 annual fee fair for both. However, managing $30 million presents increased complexity, including estate planning and asset protection needs. A tiered approach, such as a base fee plus a percentage above a certain threshold, could be a reasonable compromise.
Key Takeaways on AUM Fees
- AUM-charging advisors are fee-only advisors.
- The AUM model isn't inherently unfair, but it's prone to abuse.
- Reasonable AUM fees are acceptable if you annually assess their fairness.
- Not everyone is a DIY investor; some require delegation.
- Wealthier individuals should expect to pay more for financial planning and asset management due to complexity and increased risk.
Ultimately, understanding the fees you're paying, evaluating the services you're receiving, and negotiating when necessary are crucial to ensuring you're getting good value from your financial advisor.
