Episode 22: Advisor Compensation

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.

We look at all that and more in this Wilson Wealth Management YouTube episode.

Questions we discuss, include:

“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.

For additional information on financial advisor compensation considerations, please read “Commission Based Advisors: Part 1”, “Commission Based Advisors: Part 2”, and “Fee-Only Financial Advisors”.