Is your financial advisor providing adequate value?

If you’re working with a financial advisor, it’s important to know whether that person is actually providing sufficient value for the money you’re paying. In this post I’m going to give you some insights and questions to help you figure that out.

Determining value can be difficult for clients because the financial advice industry thrives on a knowledge gap between what clients perceive advisors are doing, and what they are actually doing. This is most true when it comes to managing client assets. You might be surprised to know that fewer and fewer advisors today play an active role in managing client accounts, despite charging clients fees on that basis. Instead, these advisors typically do one of the following:

1.       Outsource investment management to a third party. That third party can be their direct broker-dealer/custodian, or an outside entity available through their broker-dealer/custodian. This can have value if the third party is performing specialized investment management, however, much of the time it's nothing more than generic mutual fund/ETF models.

2.      Use a paint-by-numbers approach where advisors themselves simply plug certain funds/ETFs into generic allocation models.

In either case, clients end up paying a hefty premium for something they could easily replicate elsewhere for next to no cost. The advisors know this but clients often don’t.

With that in mind, you can use the following steps to help determine the kind of value your advisor or prospective advisor is offering.

Identify how you’re paying

The first thing you must do is understand the various ways your financial advisor can make money from working with you. Keep in mind that many advisors are limited in the billing options they offer clients because of their preference or employer. Those that offer multiple options are rare.

Commissions – commissions are far less common than they used to be on things like traditional investments, but they are still quite common in areas of annuities and insurance. And no, commissions in general are not some evil thing as certain marketing ploys would suggest. Depending on the product and terms, commissions may not even come out of your money, but can be paid to the advisor directly by the issuing company. Always feel free to ask your advisor for details if they are earning commissions.

Percentage fee on your assets – As mentioned, this involves an advisor charging you a percentage based on the total assets they manage for you. This is the most common way clients pay their advisor(s). This fee is typically deducted automatically from your accounts.

Hourly or fixed/flat-fee rates – You pay an hourly rate for the specific hours of work, or you pay a flat fixed-fee that the advisor predetermines for the agreed upon work. Either of these will most likely require you to write a check or charge a credit card.

Determine value for each payment method

Now that you know the ways your advisor can make money, let's dive a little deeper into each one.

Hourly Rates - This is probably the easiest of all to gauge value, because the amount you pay will depend on the amount of work you require. However, it’s important to know up front what you should expect your bill to be. After you’ve shared your circumstances, goals, etc., ask your advisor to make a best estimate as to the number of hours it will take him or her to prepare your financial/investment plan. You can expect hourly rates to range from the low $100s (low-end), to $350-$500 (high-end). Higher absolutely does not mean better, and you need to be careful about paying a premium for name ID, or for advisors who are pricing high to control the amount of hourly work they take on.

Fixed/Flat fees – Much like hourly rates, you will be able to decide if the amount quoted is a price you can afford to pay for financial planning advice. It’s common to see fixed/flat financial plans cost anywhere from $2,500 to $5,000 (or more). This could mean a client with a simpler situation pays the same general price as a client with more complex issues, simply because the pricing is relatively fixed. When paying a fixed/flat rate, be sure to have the advisor explain all of the areas they cover based on the rate you’re paying.

Percentage fees – Make no mistake, percentage fees are not only the most common, but are by far the most lucrative billing format for advisors. In fact, the amount advisors earn this way can be a multiple of even the highest hourly rates. It’s also the easiest method for advisors because of the automatic deduction without any effort or specific attention from the client. Therefore, this is the most important of the three for clients to focus on.

Taking aim at percentage fees (plus questions to ask)

To be clear, percentage fees are not a bad thing and I use them regularly with clients. My issues with percentage fees stem from advisors charging those fees to clients while avoiding the actual work of asset management. This approach is increasingly common, and in my experience it’s hardly ever revealed to clients in a detailed manner by their advisors. That’s because clients would be much less likely to place money with an advisor if they honestly explained “I’m going to put you in a portfolio that my broker-dealer runs for me, it will likely underperform its benchmark because of my fee, and you could easily get the same thing elsewhere without the fee.”

With that in mind, you’re going to have to ask pointed questions if you want to get to the bottom of how your advisor operates. Here are a few that will make your advisor sweat:

1.       Please explain in detail the actual role you play in managing my accounts and what value you bring for the fee you charge.

2.       Do you outsource client account management to any third party, including your own broker-dealer? If so, please explain exactly what their role is versus your role.

3.       What will you be doing for my portfolio that I can’t easily get on my own at places like Fidelity, Vanguard, Schwab, etc.?

4.       ** If they outsource account management, ask the following: Explain why it wouldn’t be in my best interest to work with you hourly given that I could get the same investment approach elsewhere without your fee?

5.       ** If they charge you more than 1% annually, ask the following: Your fee is higher than 1%, please explain the additional value I will receive versus an advisor that charges 1% or less.

Exceptions

As with most things, there can be exceptions in which it makes sense to pay asset fees to advisors even if they outsource or use generic investment strategies.

Cost breakeven – if your account is less than $100,000 and you have unlimited access to your advisor, plus receive ongoing financial planning services, it could work out to be less costly than hourly or fixed-rate billing. It will depend fully on the quality/quantity of service your advisor gives you at this account size level.

You’re willing to pay a significant premium for convenience – convenience is a great thing, but you have to decide how much it’s worth. Are you willing to pay thousands extra per year for the convenience of having an advisor keep your accounts? If so, this exception applies to you.

Complex circumstances – if you have exceptionally complex circumstances that require truly specialized (and rare) knowledge, as well as frequent involvement from your advisor, this exception may apply. However, people in this circumstance should probably be receiving specialized investment management as well.

Special connection – perhaps your advisor is a close friend or family member and you don’t mind paying a premium for that level of closeness and/or trust.

Hopefully this post has armed you with some important information and tips to better understand your relationship with your financial advisor. If you'd like our help to determine the value being offered by your advisor, feel free to contact us.