Lots of people hate the financial services industry. One of the biggest sources of confusion and dissatisfaction is how advisors charge their fees.
I know because before I started in the industry, I used financial planners myself. Back in the day, I wasn’t a financial planner and had questions about how to handle my personal finances. Although I had money to invest, I didn’t know the best way to go about it. I had had an education in finance, but there was a lot I didn’t know. I thought I knew what I needed: an asset allocation and specific funds to invest in.
But I didn’t have time or energy to try to figure out what the best asset allocation was, much less which funds would best suit my needs.
The Commission Model
So I used a financial planner who was a good friend of mine at the time. She charged commission, which I didn’t really like. I suspected commission advisors tend to recommend mutual funds that pay them more, not necessarily what is best for the client.
Commission advisors will argue that for people without a lot of assets, there isn’t much financial help available. The commission model helps a lot of people get some advice, even if it is biased.
In my case, this was my friend and I trusted her to give me un-biased advice. She and I figured out an appropriate asset allocation. She then suggested the funds for me to invest in and filled out all the paperwork to implement the recommendations.
At the time I had about one hundred thousand dollars. Because I was paying using the commission model, I didn’t have to pay her anything out of pocket. Under the standard commission agreement, the mutual funds that I bought would have paid her approximately $5000. Presumably these fees lowered my investment returns.
Things went along fine for a few years, until I found out about some personal problems she was having. Although we remained friends, I decided to to find a new advisor.
Fee-only AUM model
While my commission advisor used an old-school model to charge clients, another model sprung up in the 1980s called fee-only. Fee-only advisors are upfront about their fees. They charge clients directly rather than getting commission or kick-backs for making recommendations.
The problem from my point of view was that many fee-only advisors charge based on the assets that they manage. This fee model is known as Assets Under Management or AUM.
Most AUM advisors require clients have a minimum of $500,000 in assets before they will proceed. Like most people, I didn’t have that asset level.
Because of my thriving tax practice, I could call in favors with financial planners serving the wealthy to answer my questions. Instead I decided to do what tax clients of mine had to do and find a planner myself.
Fee-based model
Seeing the success of offering financial planning for a fee, American Express and other commissioned broker-dealers pioneered another model. They charged clients for a plan AND recommended their own commission and kick-back laden investments.
When they christened the model “fee-based,” advisors in the fee-only community let out a collective groan. Fee-only advisors felt that commission advisors were co-opting their fledgling brand and confusing consumers.
Fidelity offered people with my asset level a free consultation. When I called to set up the consultation I specifically asked, “Do you only recommend Fidelity funds?“ They assured me they could recommend anything. I went through the somewhat time-consuming process of having them analyze my investments. They recommended five funds. Four funds were Fidelity funds. The advisor was really excited about the non-Fidelity fund. “This bond fund made 20% last year! That’s three times the industry average.”
Knowing that the only way that bond fund can make so much more than other bond funds was by taking more risk, turned me off.
I have worked with clients who use Fidelity since this experience. Fidelity has some great offerings. Their 401(k) programs lead the industry. I don’t have a big problem with Fidelity; I have an issue with their misrepresentation of their bias in my encounter with them.
Fee-only Hourly Model
I knew that somewhere there had to be fee-only advisors who had figured out how to create a viable business working with some people with less than $500,000 in assets.
Finally I found out about fee-only advice other than AUM.
I talked to a couple different fee-only advisors who I heard about. He charged based on a retainer, which made sense to me. Unfortunately I didn’t like his personality.
When I met with the second advisor, something didn’t feel exactly right either. She was clearly competent and would give me good advice. She charged on an hourly basis and the cost was a fraction of the $5000 I previously paid. I would have to pay her out of pocket instead of through some mysterious method that I didn’t fully understand.
This all seemed reasonable, but I had a few problems. First, there was implementing the changes. It didn’t make sense for me to pay her hourly to do that job and frankly I didn’t want to do it either.
I gave tax advice on an hourly basis and felt like—why are you charging hourly? I hate charging hourly!
And, maybe I want to be doing your job not mine! This meeting was one of the key elements in deciding I wanted to broaden my business to help people with personal finance, not just taxes.
I’ve since seen this advisor at professional events and referred clients to her who wanted hourly advice.
The major advantage of hourly planning is that it’s easy to figure out the charges. However, there is no incentive for a planner to be efficient and take less time. Hourly planning also doesn’t focus on the value that a planner can provide—only on the number of minutes it takes to figure out a plan.
Implementing recommendations is often a time-consuming hassle that only a few people enjoy. It doesn’t make financial sense to pay hourly to have someone help with these tasks. It’s up to the client to implement the changes. This is okay if the client is that special person who enjoys it, but often recommendations don’t get implemented.
Also I knew that when a client is paying an hourly basis, they don’t air all of their concerns. They focus on issues where they think the advice is going to pay off. The problem is, the client doesn’t know what they don’t know. So there are missed opportunities with hourly advice.
Fee-only Retainer Model
When I started my business I found the fee-only retainer model. The way I help clients is twofold. First I offer a Financial Strategy Session with new clients. We go over the three most pressing question a client has. We then develop a strategy for how the client can best handle each concern. This costs $950.
I love Strategy Sessions because, for a lot of people, this is enough. They can get in-depth financial advice about their investments, insurance, social security, taxes, real estate or whatever else is on their mind for a fee that works for both of us.
For clients who can benefit from a more in-depth relationship, we work on a retainer basis together. When I work with clients on a retainer basis, I don’t just help them with investments, but also with tax planning and preparation, retirement planning, estate planning, insurance, cash management, and goal setting. We work collaboratively and discover ways to create and preserve wealth together. The cost varies from client to client and is calculated on net worth, income, and complexity of the client’s situation.
Here’s a table that lists out the pros and cons of the different models. The most important thing is that you know what you’re paying for.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.
by Bridget Sullivan Mermel