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.