How you pay people for their services is important. It’s certainly just as important as how much you pay them for their services. In the financial services industry, which can largely be divided between advice and sales, incentives play a major role. Understanding how different types of financial advisors are affected by incentives is something all clients need to understand. Transparency is crucial in understanding how your money is put to work.
Financial Planning Fees by Comparison
Let’s assume you’re totally new to the world of hiring a financial advisor. You have needs, and you think a financial advisor is the professional to speak to. How will your needs affect how you pay an advisor? Are financial advisors incentivized to offer certain services over others? The kind of service you are looking for will go a long way in determining how you should compensate your financial advisor. Let’s explore the differences.
Sales, Advice, and Comprehensive Financial Services
Clients interested in the sales side of financial services are looking for products a broker is able to sell them. Commissions are the predominant form of compensation for a broker.
On the advice side of financial services, the dominant form of compensation is calculated as a percentage of your portfolio known in the industry as an “assets-under-management” fee — or AUM fee for short. Clients of investment advisors (as opposed to a broker) are looking for advice on their investments, and financial planning advice in general.
Lastly, clients looking for fully comprehensive financial planning will often end up paying a financial planner (as opposed to an investment advisor or broker) a monthly/annual retainer or subscription fee.
To recap, the three main ways financial advisors (i.e. brokers, investment advisors, and financial planners) are paid are:
- Monthly/annual subscription or retainer fee
Why A Financial Advisor’s Incentives Matter to You the Client
When you pay for financial planning services, the incentives to the financial advisor (i.e. their paycheck) need to align with your best interests as a client. In order for you to feel comfortable that you are receiving quality objective advice, you need to compensate the advice-giver in such a way that they don’t have conflicting incentives (even if they don’t act on those conflicting incentives). The basic building blocks of all transactions is trust, and unaligned incentives undermine that trust.
Avoiding Conflicts of Incentives by Choosing the Right Type of Financial Advisor
If you are looking for someone to help you purchase a mutual fund, or you’re financially savvy client just looking for account management without any ongoing advice, you might want to consider a broker who is compensated via commissions. If you are simply looking for investment advice or management, you may want to consider hiring an investment advisor that charges you a percentage of the portfolio he manages for you. But if you’re looking for fully comprehensive financial planning, I think it makes sense to compensate your financial planner directly on a monthly (or annual) basis. Here’s why.
It’s All About Aligning Incentives
If I want to work with clients and offer fully comprehensive financial planning, defined as financial planning covering the areas of budgeting, education, retirement, insurance, investment, and estate planning, then I have to be able to find a way to fairly charge my clients for my services. It wouldn’t make economic sense for a broker or investment advisor to offer comprehensive financial planning services on a commission or AUM basis in many situations. Thus, many advisors and brokers either set account minimums or only offer a select number of services, i.e. they set a minimum fee or limit the amount of service they are willing to provide so that it makes economic sense for both parties.
If I want to charge a 1% AUM fee for investment management and financial planning I’m going to create unaligned incentives for myself. Consider this example; suppose I work with one client who has $250,000 in a portfolio and another with $1,000,000. Next suppose that aside from their differing account balances, their financial planning needs are identical. This is clearly an unfair situation for the clients and puts me in the awkward position of charging one client 4 times as much as the other even though the amount of work may be the same. Ask yourself, who am I incentivized to focus on more? Remember, even if we don’t act on conflicting incentives, it’s best to avoid them in the first place.
Now it’s true that both clients are compensating me at the same rate with their invested assets, but the scope of work in both cases extends beyond investment management. It seems very natural and logical to argue that all investors should pay the same rate for investment advice as the size of a portfolio is a plausible proxy for the amount of work that needs to be done (e.g. more asset means more accounts, more record-keeping, more complex strategies, etc.). But it seems a little awkward to argue all investors should pay the same percentage of their portfolio (rate) for financial planning services unrelated or indirectly related to the management of their investments. And it’s clear from the example above that it disincentivizes working with certain clients, to begin with (hence the reason some advisors enforce account minimums).
Why uVest Advisory Fee Structure Gives Clients a Fair Hand
For these reasons and a few others outside the scope of this financial planning fee comparison, I’ve chosen to charge a flat monthly subscription style fee. The reason I have chosen to do this is that I found it difficult to economically justify working with the clients with which I wanted to work, i.e. professional millennials like myself. For clients who simply would like to engage uVest Advisory for investment management and advice, they can still pay a simple AUM fee (starting at .85%). But for clients who would like to work with me to address their debt issues, optimize their company’s benefits package, optimize the amount of money they put into various types of tax-advantaged accounts, or even accountability for their budgeting, I charge a flat upfront and monthly fee. ($500 upfront and $100/month after that). This way, I’m incentivized to give all my clients the attention they require.
Erik Goodge is a CERTIFIED FINANCIAL PLANNER™ and the President of uVest Advisory Group. He holds a B.S. in Economics and Cognitive Science from the University of Evansville. Erik is a Marine Corps veteran of the Afghanistan campaign and Purple Heart recipient. He is from Evansville, Indiana, and currently lives in near-by Newburgh with his wife and daughter.