When trying to find a financial planner or advisor, it is important to assess advisor compensation. How is the financial advisor paid? In sales commissions and ongoing mutual fund retrocessions or trailer fees? Salary and bonus from an employer, such as a bank or insurance company? Percent of Assets Under Management (AUM)? Or in fees paid directly by the client for services rendered? Often in a fiduciary capacity.
“My financial advisor provides me with free advice. That must be a good deal, right?”
Possibly. But there tends to be no such thing as a free lunch. There are pros and cons to the free advice business model. The biggest negative tends to be that you end up paying a sales commission on products purchased. As well as ongoing fees embedded in the mutual fund or investment.
“What is this about if I prefer a front, back, or declining load when I purchase this fund?”
That would be the sales commission when you buy a no-load (no commission) product. They can come in many shapes and sizes. Usually with more than one option for a specific investment product.
Which you choose, if any, is usually based on your personal financial situation.
“I have heard the term, ‘retrocession’. What does this mean to me?”
Retrocession and trailer fees also come in different forms. Usually where an investment or fund company pays an ongoing fee to the advisor who sold you the product.
For example, if I sell you a mutual fund, maybe the fund company pays me an annual fee as long as my client owns that mutual fund. Perhaps 0.50% per year of client assets in that fund. That is in addition to any sales commission when you initially purchase (or go to sell) an investment product.
Obviously, some potential issues and conflicts of interest in this area. Is the advisor putting you in the “best” investment product for your needs? Or is the advisor putting you in a fund with the highest fees?
“What is a percent asset under management fee (AUM) model?”
As it suggests, clients pay an annual fee based on the amount of assets held by the advisor. Normally, the greater the assets, the lower the percentage charged. Of course, 1% on $5 million brings the advisor much more in fees than 1.25% on $1 million.
There are also various advantages and disadvantages in this fee model. The big plus is that the fees are transparent. If you pay 1.0% on your $2 million, that is $20,000 per year.
Also, you can often negotiate your fees.
On the downside, you often require a certain asset size to qualify for these models. If you have $250,000 in bankable assets, this may not be an option for you. Also, service quality may differ between those of different asset values. Not in attention given to you by your advisor. But often the more assets you have, the wider the included service offering for the fee.
“My advisor offers a fee-only business model? How does this compare with the others?”
A good question. In a “free” advice model, you often pay a sales commission when you initially purchase (or sell) the investment product. You also pay an ongoing fee to the advisor that is embedded in the fund’s management expense ratio.
In a percent AUM model, you pay an annual fee based on the amount of assets held by the advisor. You may, or may not, pay additional fees for products and services.
In a fee-only model, the advisor directly charges the client for the professional services. Much more like working with your lawyer, tax accountant, dentist, fitness coach, etc. You pay for expertise and that is what you get. There is no incentive for the advisor to push any products, because there is no fee received. In either sales commissions or ongoing trailer/retrocession fees.
That is the big advantage of this model. You get unbiased, independent advise. Often, fee-only advisors act in a fiduciary capacity. Not something you experience with percent AUM nor commission advisors.
There tends to be three potential downsides to fee-only advisors. An up-front fee, potential for padding hours, and the quality of the advisor.
Fee-only advisors charge based on work performed. Clients with less assets may have simpler needs, so less time. But there are still the basics that must be performed regardless of asset size. If you have $100,000 in assets and the advisor wants to charge $7500, that may not be a great match for you.
Not paying anything up front, but incurring an annual fee embedded in a mutual fund, might make more sense at this stage of life. Of course, within a few years, the fees you pay the fund will be much higher in cumulation.
As for padding the invoice, fee-only advisors are paid on an hourly basis. That may be an incentive to add an hour here or there to the file. Or a worry with a client that the advisor is always “on the clock”. That may discourage asking questions or raising issues that arise. A legitimate concern.
In my practice, I usually try to estimate the work necessary up front. Then offer a flat fee for the specified services. If I require additional time and/or issues arise that are outside of the agreed upon scope of work, I discuss with the client before starting. That maintains transparency and manages expectations on costs of the engagement.
Finally, if you are paying directly for an advisor’s expertise, you want someone with strong technical skills and experience. But that is usually true regardless of the advisor model.
“Okay, commissions versus %AUM versus fee-only. Which should I choose?”
Often it depends on the personal situation. If you have $100,000 in assets, you may not be able to even find a percent AUM advisor. And you might find the price of a fee-only advisor does not make sense. That may leave only the commission model or figuring it out on your own.
If you have $50 million, then you may actually want the AUM model. As you can pay a relatively low fee schedule. And, with that level of wealth, receive a high level of personalized service. Or, you could hire in-house expertise. Instead of paying a fee-only advisor $500 per hour, you could hire that person full-time in a Family Office arrangement.
That said, the video looks are a variety of cost scenarios for some idea on what my be best for your own financial situation.
It is always interesting to calculate how fees impact compound returns and wealth accumulation over time. Well worth seeing how your fees create lots of wealth for others, much less so for you.
In episode 21 on the Wilson Wealth Management YouTube channel, we continue with how to find the best financial planner or advisor for your requirements. Today the focus is on the financial advisor’s personal fit and service offering. Both should match your unique needs, client type, and personality.
Now that you have found a potential advisor with proper training and experience, you need to assess the match. Is there a strong personal fit between you and the advisor? Does the advisor’s service offering meet your needs? Clients often intuitively assess the latter. But often do not consider the personal fit.
Questions to consider:
“What type of clients does the advisor typically work with?”
If a financial planner usually works with retirees on their investment and cash flow planning, is that a good fit for a 30 year old client? Perhaps. But maybe the advisor’s focus is on fixed income and other low-risk (low return) investments, where stability and consistent cash flow is important. Will they also be proficient in recommending more volatile investments for clients with 40 year time horizons?
The same applies to other areas. Life insurance. Child education funding. Entrepreneurial advise for small business owners. Not necessarily a deal breaker. But consider the type of clients an advisor typically deals with. That may give an idea of the fit with your needs.
“What is the typical size of the advisor’s clients?”
This has two aspects.
One, if I am primarily working with clients who have bankable assets of $10 million, I will implement different strategies, tactics, and investment products than I would for someone with $100,000.
The higher dollars allows for more non-diversified assets, such as individual stocks and bonds. Because the assets exist to properly diversify the overall portfolio. Whereas, for the client with $100,000 in assets, low-cost, well-diversified index funds tend to be the more prudent strategy.
Also, with more wealth to diversify, often it can be useful to invest in more niche markets or alternative assets. Private equity, for example. Or more tactics involving derivatives and hedging. Again, areas that are not cost-effective (nor usually necessary) for someone with much less capital.
The size of clients the advisor tends to work with may give you an idea of their experience and investing approach with someone of your asset value.
Two, who pays the bills? If the bulk of an advisor’s clients average $5 million in assets and you have $100,000, where do you fit in the advisor’s priority list? Usually not intentional. But in a volatile market, with a finite number of hours in the day, where will you fit in the returned phone call or email strata?
“What is the advisor’s investment philosophy?”
Another key consideration that is often overlooked to some extent.
This includes the overall approach to investing? If you want to day trade, you and I will not be a good fit. I focus on longer-term investing and achieving identified financial objectives. There are other advisors who are happy to advise on high-frequency trading approaches.
Another overall philosophical area may be technical versus fundamental analysis. I do not perform technical analysis in my own practice. I believe in fundamental as the better approach. If you want to spend your time tracking trading volumes and price trends, we will not be a good fit.
The investment process is also part of the philosophy. A buy and hold strategy tends to be my preference. For many clients, investing in passive, index funds. Minimize costs, match the market return. My focus is heavily on the investor profile and target asset allocation. Not trying to time the markets on a weekly basis, jumping in and out of stocks. If you prefer to invest in the latest hot stocks and short-term trends, with much more active trading, then we may not be a great match.
Risk tolerance is another part of the overall philosophy. If you are a low risk investor, based on your investor profile and personal risk tolerance, then recommending derivatives and venture capital is not a good fit. The wrong investments for someone with a lower risk investor profile. But also, for the stress and emotional toll that comes with a portfolio full of assets you do not understand or like.
Conversely, if you are in your early 30s, with lots of excess cash to invest, then less liquid investments may be warranted. And you will not be happy if I try and get you to invest in a 60-40 balanced fund or a 2060 Target Date investment product.
In general, I think advisors do a decent job of matching clients to suitable investments. However, if the advisor is compensated based on product sales or works in a specific sector (e.g., venture capital), there may be a potential issue.
“Does the advisor give me the warm fuzzies?”
A client-advisor relationship is best served when both parties are open and honest with each other. It definitely helps if you like the advisor on a personal level. Or, at least, respect them enough to open up about what is happening in your world that may impact your wealth plans, investing patterns, etc.
When I worked in public accounting, you would often see clients come in during tax season. After the year end was closed. “Oh, we did this and that during the year. Can you help with the tax impact?”
But, by then, it is usually too late. Having that relationship where you can discuss things before they happen can make the partnership much more effective.
“Will this advisor be a partner I collaborate with in reaching my goals?”
Another area that differs between advisors. Also, in what the client may prefer.
I believe the client-advisor relationship should be a partnership. A collaboration. Where the client is fully part of the process, understands what is being done, contributes, and buys-in on the actions taken.
Other advisors (and clients) prefer more of a one-way street. “I have a problem. What should I do?” The advisor provides a recommendation and it is implemented. Not a lot of time on the reasoning as to core concepts such as diversification, risk-return, asset correlations.
And some clients do not want to invest their precious time to be educated or be a part of the process. They hired an “expert” to make the best decision. They just want to know what they should do, not necessarily why. Which is fine if that is your personal way of doing things.
However, if you prefer a true partnership, seek out advisors with the same mind set.
On the actual service offering, you should consider the following questions:
“Do the products the advisor offers meet my needs?”
If you require life insurance, does the advisor directly, or even indirectly, offer those products?
If you subscribe to low-cost, passive investing, can you get the best products through this advisor? Or does the advisor only provide in-house products? That may, or may not be, the best in class.
If “free” advice does not get you access to the best products for your requirements, is the cost worthwhile?
“Does the service offering also meet my needs and expectations?”
If you need tax advice or estate planning, can your fund salesperson provide as well?
Who does the actual work on your file? The high end advisor you met initially, with all the experience and qualifications? Or one of the junior staff, just starting out? If the latter, what controls are in place to ensure quality of work?
Is all work performed internally, or is some completed by third parties? Again, what assurance can you receive as to the quality of work performed?
Does the advisor receive any fees for referrals to third parties for additional services?
For work not performed by the advisor’s firm, is that part of the engagement fee? Or will you have to pay extra for work done by third parties?
Many issues revolve around the fee structure for work performed. And that is without even discussing the advisor’s remuneration. Something we will consider in episode 21.
In episode 20 on the Wilson Wealth Management YouTube channel, we discuss how to assess a potential financial advisor’s experience level.
In episode 19, we considered a financial planner or advisor’s technical qualifications and professional designations. But without relevant experience, to a level that meets your needs, qualifications do not mean much.
In this episode, we consider the following questions:
“How do I compare skills and experience between advisors with different designations?”
That is a challenge. Especially in today’s world where advisors often develop skills and experience in multiple areas, but may not possess official credentials in all.
You can search the internet to find the core competencies of each designation an advisor possesses. That should provide some information on their main skill sets. But then you need to discuss the specific expertise that you require. And ensure that advisor can adequately meet your unique needs.
“How can I compare the skill level within an individual designation?”
That can also be a challenge. Especially if you are not familiar with the financial services sector.
In some ways, financial services can be like the medical industry. Your General Practitioner handles your daily needs. Some or relatively better or worse than others. Some may have interests or focal areas that make you a good fit. For example, if you are young and into sports, maybe a GP who deals with a lot of sports injuries in his/her practice.
But if you have an emergency, you go to the ER. If you need specialty assistance, your GP refers you to someone who is an expert in that area of need.
Again, you should discuss your needs with your advisor. What can he/she provide? What is outside their expertise? Or what may be within their base knowledge, but not offered as a service.
In my case, I have decent Canadian tax knowledge. Something that is required in daily financial planning or investing work. But I do not provide tax services (e.g., tax return preparation, estate freezes, etc.), because I do not have my tax specialization. Nor do I consider myself an expert in the field. I explain up front what I do and do not provide clients. If their primary need is tax planning, then we are not a good fit.
Of course, some advisors do claim expertise in areas where they should not. So do not automatically assume they are completely on the level. Ask questions, do a proper review before committing.
“Should I select the most skilled advisor? Or should I try and minimize my costs?”
It all depends on your needs. If you have a simple tax return, for example, do you need a tax partner from Ernst & Young? He/she might be the most skilled person, but you will pay a huge premium for expertise you likely do not require. The tax kiosk in your shopping mall may meet your needs.
On the other hand, I do see people try to save as much money as possible on advisors. Often, it comes back to cost them much more in the long run. We will cover this a little more when we look at “free” advice from mutual fund representatives.
“Should I only worry about today’s needs? Or should I also consider my future requirements?”
Within reason, individuals should probably work with advisors they can grow with over time. The client-advisor relationship is often one of trust, comfort, and knowing each other. That helps improve planning and working together. If you have to move to another advisor in three years, as you have outgrown your current partner, then there is a learning curve involved.
In episode 19 on the Wilson Wealth Management YouTube channel, we start our look at how you should assess potential financial advisors. There is such a wide range of technical skills, experience levels, and a multitude of professional designations amongst advisors. It can be difficult to find the right financial planner or other advisor to best meet your wealth management or investment needs.
One area requires assessing an advisor’s technical qualifications. We consider the following questions:
“What is a financial advisor? Is this different from a financial planner?”
A financial planner is a financial advisor. But not all financial advisors are planners. You need to determine what skill sets you require, then begin searching for professionals with relevant qualifications.
“There too many financial designations. How do I wade through the alphabet soup of advisor credentials?”
Yes, it is difficult. There are many different specializations, most with their own individual credentials.
If I require tax expertise, perhaps I seek out a CPA who has completed the in-depth tax program. If I require detailed investing advice, perhaps a CFA is best.
But even within an area, there are often many designations. In Canada, CPAs merged financial, managerial, and general accountants a few years ago. Now, when I meet a CPA, I need to ask for specifics on their training. Much different in skills whether the accountant was trained in audits and tax work as CAs. Versus if they have a cost accounting background by going the CMA route.
Or, Canadian financial planners. Technically, one does not require a professional designation to call themselves a “financial planner”. But there are actually three different certifications for financial planners who do pursue credentials. Certified (CFP), Registered (RFP), and Personal (PFP). Given the nature of financial planning, there really is no difference between the designations. Yet when you are assessing potential planners to hire, you will have three options to ponder. Four if you do not care about certifications.
“Does a credential equal competence? If so, why? If not, why should I care about letters after an advisor’s name?”
A credential does not guarantee competence. However, with so many available certifications out there, I would like to see my advisor have at least one. In the specific skills I require. If an advisor cannot be bothered to attain even one certification, how much effort will they take to ensure their skill set is strong.
And most members or professional organizations are required to take a certain number of education hours each year in order to retain the designation. That may provide some comfort that the advisor remains current in their expertise. Or not.
“Will any credentialed advisor meet my needs? Or do I need to dig deeper?”
You definitely need to dig deeper. We will discuss relevant experience in our next episode.
“What does it mean if an advisor is ‘in good standing’? Is this good or bad? What, if anything, does this tell me about them?”
If an advisor maintains a professional designation, you do want to ensure it is current.
Many professional organizations maintain databases that people can search to assess if an advisor is in “good standing”. If not, the advisor should be able to provide documentation to prove that there are no issues with the designation.
In contrast with commission based financial advisors are the fee only advisors.
Today we will look at the pros and cons of this group.
As a reminder, I provide fee only service in my business. So read my analysis with that in mind.
Fee Only Financial Advisors
As you might expect, a fee only advisor charges fees directly to clients.
Fees may be charged a few different ways.
They may be based on an hourly rate. Flat fees may be charged for a specific service, regardless of time involved. Or they could involve a combination of the two.
For example, an advisor may charge $300 per hour for wealth management advice. The advisor may also provide a flat fee quote of $3000 to prepare a comprehensive investment plan after estimating the work involved for a client. In areas of uncertainty as to effort required, the advisor may quote $1500 for a retirement plan, plus $150 per hour for any time exceeding 20 hours. Or, perhaps $200 per hour up to a maximum of $2000 for a personal budget.
Advantages
(Hopefully) Unbiased Advice
In this era of Bernie Madoffs, you would be crazy to blindly assume that your financial advisor has your best interests at heart. I strongly recommend that you perform proper due diligence on any professionals – investment or otherwise – before developing relationships. And, even then, be careful.
However, I believe that on average there is a greater probability that a fee only advisor will provide unbiased advice than one whose income is derived from selling products.
More Likelihood of Fiduciary Duty
I would also look for advisors that act in a fiduciary capacity. If the advisor is obligated to act in the client’s best interest, there is less chance of problems aligning your interests with the advisor’s.
Note that a fee based advisor is not necessarily acting as a fiduciary. Nor does it mean that all commission based advisors do not act as fiduciaries. A lot comes down to the service performed, the employer, and advisor’s professional governing body. But a fee only advisor may more likely be acting in a fiduciary role than a commission advisor. If for no other reason than you are paying directly for a service whereas a commission based advisor is compensated by another party.
Fiduciary duty is a hot topic in the investment industry. Some believe that all advisors should act in a fiduciary capacity. I think this may be a bit of overreach as the investment industry covers a lot of ground. As long as the advisor discloses in advance whether he acts in a fiduciary capacity, as well as what that means, I am fine with not forcing everyone to become a fiduciary.
This is becoming more common anyway. In my own case, the three governing bodies for Chartered Financial Analysts (CFA), Canadian Chartered Professional Accountants (CPA), and Canadian Certified Financial Planner® professionals all require their members the duty to put their clients’ interests first.
But I would ensure that the advisor you use acts in a fiduciary capacity. It will give you a little more peace of mind.
Competent Advice
Providing financial expertise is the job of the fee only advisor.
They do not earn income by selling products. They make their money by their knowledge. If they provide quality and perceived added-value for their clients, they will grow their practice.
If you undertake adequate due diligence, you should be able to find an advisor that is highly qualified.
Additional Services
A big advantage of fee based advisors is that they usually also provide non-investment specific services.
If you want more comprehensive wealth management or financial planning support, a fee based advisor will be preferable.
Comprehensive advice might include estate and succession planning, tax support, and sophisticated wealth management.
Of course, skill sets differ between advisors, so find a match that serves your needs.
Disadvantages
Direct Cost
First, by having to directly pay your advisor, you may feel the expense more than one hidden in a product commission or annual operating expense.
Writing a cheque for $2000 may have more mental impact than having an extra 25 basis points deducted annually on a mutual fund. Even if those accumulated lost basis points exceed the cheque over time in total cost.
Second, fee only advisors can be expensive.
Like other professions, rates will differ between advisors.
Those advisors with better reputations will charge more than lesser known advisors. The same is true for technical skills, experience, etc. The “better” advisor will charge more.
For an investor with relatively simple needs, the direct fees of a fee only advisor may approximate or be higher than a commission based advisor for a similar service level.
And for small investors, a fee only advisor will likely be more expensive than in using a commission based advisor.
Additional Services
While many clients desire more financial assistance than simply investment advice, it comes at a price.
These additional services can be quite lucrative for fee based advisors. So if you use a fee based planner, be wary of costs for non-investment related advice.
A Caveat on Costs
While you want to be prudent in spending money, you get what you pay for in life.
Try not to take shortcuts. You and I both know many horror stories of the person that “saved” on legal, tax, accounting, medical, etc. advice and ended up paying for it ten-fold over time.
Combination Commission and Fee Based Advisors
Please be aware that some advisors charge fees to their clients, yet also accept commissions or other income on product sales or business arrangements with third parties.
The pros and cons are still applicable as relates to each.
In many professional organizations, advisors are required to inform clients of any relationships where they receive money from third parties. This is also true with disclosing potential conflicts of interest, something that may be present if they are both charging fees to clients and accepting commissions or retrocessions from investment issuers.
You should also watch out for referral fees paid to advisors when directing business elsewhere. For example, if your advisor, fee based or commission, does not perform tax work but sends you to someone for assistance. Often, there is some kind of monetary relationship involved for referral business of this nature. So be on guard.
To be safe, always confirm in writing with a potential advisor as to how they are compensated.
Conclusion
A fee only advisor may be preferable if you meet any of the following criteria: have a sizeable investment portfolio; want a more comprehensive and long-term financial plan; have needs that impact your financial life, but are outside traditional financial investments (e.g. owner-managed business; rental properties; tax shelters, more complex investing strategies).
A fee only advisor may also be preferable if you have concerns about advisor objectivity.
Regardless of fee only or commission based, use an advisor who is required to put your interests first.
In the short run, you may pay more for a fee only advisor. But, if you find a competent professional to work with, you may save money in the long run.