Financial Advisor Fees — How They Really Work
There are 3 ways that financial advisors or retirement advisors can charge in the US:
They can charge commissions based on transactions. For example, when you buy or sell a stock or a bond. The typical fees to a full service firm ,e.g. Merrill Lynch, where you value their research and recommendations, maybe 2% for a transaction. So if you buy $10,000 of stock, your financial advisor fee is $200. The same transactions can be made through any discount broker for $9.99 so you better feel that their advice is worth the commission paid to a full service broker. At least when you buy an exchange listed stock, the financial advisor fee is transparent and printed on the confirmation. (This is not true if you buy a stock in which your broker is also a dealer–the markup on your purchase is similar to a bond purchase described below). By the way, your Merrill Lynch broker gets 35% of the commission he generates and Merill keeps the other 65%. If your financial advisor is independent and does not work for a large firm but works with an independent broker dealer, then he keeps typically 90% of commission generated.
Not so if you purchase a load mutual fund or a bond. In the case of a load mutual fund, the financial advisor fee is set by the fund and buried in the prospectus. Typically, this fee will be 4% of the initial investment (i.e. $400 on a $10,000 transaction) or 1% annually. if you don’t read the prospectus, you won’t see the financial advisor fee printed on the confirmation. In the case of a bond, the fee is not disclosed. Guidelines allow the brokerage firm to buy bonds, mark them up as much as 5% and then sell them to you for the 5% profit. The profit is not disclosed to you. You may be shocked that this is the way financial advisor fees work on Wall Street. Welcome to your education.
The second way that financial advisors assess fees is a non-transaction based system. Foe example, they may manage your portfolio and charge you 1% annually of the portfolio value. This system usually requires you have at least $100,000 portfolio and the financial advisor fee is $1,000 annually on such an account. These advisors must have a registered investment advisor certificate (most financial advisors do not as they charge commissions) and with a registered investment advisor, the fee is fully disclosed in a separate management agreement and on your quarterly statement. Your account is held at a discount brokerage firm that earns $9.99 each time there is a transaction in your account. Your advisor gets no portion of that so he has no incentive to make trades. His incentive, based on the structure of his financial advisor fee, is to keep you as a cliert for a long time (so he gets to collect the fee each year) and make your account grow (as that’s the only way he gets a raise).
A registered investment advisor may also charge fees for time. For example, to do a a financial plan that may take 10 hours he charges $1,500. Again, this is fully disclosed in the investment management agreement you must sign. Close to this would be a fee charged for a project. Let’s say you own eight rental houses and want to know which homes are best to sell given the tax implications and cash flow. The advisor can take on a project either for an hourly fee or project fee on which you both agree.
Last, some financial advisors charge incentive fees. However, US regulations only allow wealthy investors to pay incentive fees because the government believes this is a risky way to invest. The typical hedge fund, which requires a $1 million investment (and thus only deals with accredited or wealthy investors) will charge a financial advisor fee of 2% annually plus 20% of profit. The belief is that this financial advisor fee structure incents the advisor to take larger risks because he gets a piece of the profit and thus the government allows such arrangements only when the investor is wealthy.
If you don’t know how you are being charged, ask. Fees could be hidden and you may be shocked to learn how you pay your financial advisor and what you pay for retirement help.
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Tags: financial advisor fees
October 24th, 2008 at 5:14 pm
I idea of seeking advice of financial advisor is very personal. For some people, dealing with financial issues is unpleasant. For these people, the real question will be how to choose the right advisor, rather than whether or not to work with.
Forex Income
April 14th, 2009 at 8:53 pm
I’m an advisor. I pulled my clients out of the market to cash in July of 07. We have also made short moves and made profits. My spread above the S&P has been as high as 60% recently.
So if you have a $300,000 IRA and you lost half of it in the market because you thought your professional was making too much, then how much did it cost you in your Vanguard mutual funds?
The idea is not to worry about fees. It is to seek quality, in a proven audited track record advisor and expect his performance to generate a profitable situation. If not get one that does this for his clients in a proven way over the long term.
If not, I’d start reading some books about the markets, economics, trading, and as much data you can get your hands on. Otherwise your true cost in the market will be even more than outlined above.
April 15th, 2009 at 8:14 am
When retaining a financial advisor, particularly one from the big banks and brokerage houses, be very mindful of their hidden fees. Here are two cautionary tales:
http://investmentscientist.com/2009/04/08/staggering-cost-of-conflicts-of-interest/
http://investmentscientist.com/2009/02/26/david-swensen-on-fee/
May 20th, 2009 at 8:46 am
What’s brutal is when two types of fees are combined. My friend is nearing retirement and has a financial advisor at UBS. He is going mainly into bonds and the advisor wanted .5% a year to manage his account putting it into bonds funds (which tend to be simple and have lower returns in the long run than equity). Yes, the bond funds also had loads.
Mutual Funds with No Loads last blog post..The best of the top no load mutual funds
June 15th, 2009 at 9:52 pm
Most mutual funds and even etfs charge maintence fees. Etfs are lower cost and some closed end funds have low cost. They get set percent every year no matter what the fund does so everyone should look for the fees and how the fund has done for last 5 and 10 years.
Best etf funds lists last blog post..Bond etf.
July 4th, 2009 at 3:53 am
Some funds have a load fee and the annual fee. If the fund does well over the years the fee does not bother me as much. I am willing to pay the up front cost if they have a consistent record of earnings that is better than other funds. Sometimes you do get what you pay for and if you buy a mutual fund you are paying for them to buy and sell stocks to earn you money.
July 31st, 2009 at 2:06 pm
Seven Steps to finding a Good Broker!
1) Just ask for full disclodure of all fees and services to be rendered for the fees in writing
2) Evaluate and compare the track record of Broker.
3) Evaluate your intuition about the broker.
4) Check http://www.nasd.com (Finra.org) under “brokercheck” to evaluate the broker’s work experience and see whether the broker has any disclosures on their record that concern you. (Disclosure = red flags)
5) Interview the broker - remember you are now his employer.
6) Take the best combination of experience, education, and trustworthiness under consideration.
7) Take one step at a time.
(Don’t turn over all your millions in year one) Give him a 50K CD to work with and let him move up the ladder of trust over the years.
CommonCents
August 5th, 2009 at 4:25 pm
Yes, this is one of the most important things to look at when selecting a financial adviser. I agree to an extent with OC Financier. The overall goal would be to make money. Sometimes it is a better deal to go with a adviser with a little higher fee, if the adviser, has the track record to justify it. Overall what really matters is what you net after the fees. What good is having an adviser that charges you a very low fee but under his advisement your portfolio only returns half of what a more experienced adviser may bring in that charges just a little more.
The main thing is for the adviser to fully disclose all avenues of his compensation. If they are shady about that or try to gloss over that, you would have to ask yourself, what else might they be shady on if you become a client. Having a trustworthy adviser is key when they are controlling your families financial future