“Fee-Only” in its purest sense means just that: the financial advisor is ONLY paid by fees paid by the client. Some advisors out there market themselves as fee-only, yet receive other payment for their services, usually indirectly. But even within the fee-only community, there are several ways for an advisor to determine the fee, and each of these methods has unique advantages and drawbacks.
Assets Under Management (AUM)
Most advisors who are fee-only charge their fee using what is called the AUM model. This model charges a percent of the assets that they manage on your behalf. This model has the advantage of being really easy for the client. You never write a check and if you don’t look at your statements, you may not even notice that you’re paying for the service at all. It certainly has led to a great business model where average financial advisors have retention rates in the 90% range. (source: PriceMetrix)
The drawbacks of the AUM model are first and foremost that it puts the focus of the advisor and the client on the investable assets. Many financial advisors have minimum asset levels for the clients that they can work with so that the client is profitable. This then shows the client that their focus should be on their investments, despite the fact that many of these advisors offer advice in at least five or six other areas where both the advisor and the client have far more control to affect positive changes.
This is also the heart of the major conflict of interest for the AUM model--if a client receives a financial windfall, the advisor is incentivised to recommend investing the money because it leads to an increase in their own revenues. Additionally, as your investments grow, so does the fee to the advisor. This isn’t terrible in its own right, but I have met many clients who had been clients of an advisor for years and didn’t actually know how much they were paying annually.
The AUM model is a good and respected model for charging for fee-only financial advice. If you choose an advisor with this model, look for these things:
- Reasonable Fee: 1% is the industry average and the advisor should have AMAZING service if they charge any more
- Services: Retirement planning, investment management, estate planning, insurance analysis, and education planning are par for the course. Most financial advisors offer these
- Their Focus: Many advisors market the above list, but then the entire focus is on investments. To try to avoid this, pay attention during your “get to know you” meetings for where their focus is. Anyone who says any variation of “we consistently beat the market” is investments-focused.
- Asset Management: Does the advisor also charge for “held away” assets --those investments you have in your 401(k), 403(b), annuities, etc. that they cannot bring over to their custodian? If so, how much work can they and will they do to help you with these?
For years there has been a push within the financial advice industry to become a financial planning profession. A few financial advisors that were pushing in this direction looked at other professions and decided to copy lawyers who usually charge for each hour actually worked. This model has the huge advantage of putting focus on the actual work done by the financial advisor, which then requires the advisor to provide value to their clients with the work that is done. In addition, the fee paid by the client is transparent so the client sees what work was done and how much time it took when the advisor sends an invoice.
The drawback though is that the amount of time that it takes to do the analysis required to give advice is fairly nebulous. Because of this, and the large price tag for each hour of work, clients usually avoid calling their advisor as much as they can, just like many of us avoid calling our attorneys unless we really have to.
“Hourly fee for service” financial planners are a great resource and usually do a wonderful job of focusing on financial planning. If you decide to work with an hourly advisor, here are some things to look for:
- The Garrett Planning Network: This is a group of hourly-fee financial advisors; they do a great job and I highly recommend the advisors in the network.
- Official Estimate: You should be given an estimate of time and cost at the start of the engagement when you define the scope. If there may be significant overruns, the advisor should notify you before doing additional work.
- Payment: Many advisors who charge this way significantly underbill. It takes most advisors 8 - 12 hours at the low end to do a financial plan.
The retainer model is a similar attempt to make financial planners more like attorneys. In this case the financial advisor charges a set fee for all of the advice that you will receive either annually, quarterly, or more recently, monthly. The major advantage of this is that the fee is completely transparent. The client never has to worry about how much calling the advisor will cost because they’ve already paid the cost. If anything, this model encourages the client to reach out to their advisor more often so they can “get their money’s worth”.
The drawback to this method is two-fold. First, traditionally the fee is set by the advisor based on a seemingly arbitrary internal calculation. So everyone pays an amount, usually within a specific range, based on how complex their situation seems to the advisor at the beginning of the engagement. The second is that the fee, when charged annually at least, is usually a rather large number that is completely transparent to the client and causes some pain to pay, unlike the AUM model where it’s deducted in the background and you don’t have to see it.
However, the retainer model is a great model for paying for advice. If you decide to work with an advisor on a retainer model, here are some things to be aware of:
- Custody of client's accounts: If an advisor accepts more than $500 for work that will be completed more than 6 months away there are some potential custody issues that make running their firm far more cumbersome and expensive
- Services: Know the “menu” of what advice you have available to you and don’t be afraid to make use of the advisor’s time
- Fee: Know that if you take too much of the advisor’s time they may increase your fee in the future, but they cannot do this without your knowledge and acceptance
Income and Net Worth Retainer (INW)
A far less common form of retainer, though it is growing in popularity, is the income and net worth (INW) model. I was first made aware of the model from Jude Boudreaux who founded Upperline Financial in New Orleans, but he copied the model from Marty Kurtz at The Planning Center based in Moline, IL.
INW is the model that I use in my firm. For me, its appeal is that the fee is entirely transparent to my client; they know exactly how much they are paying me each month; and they know how I came up with the amount. In addition, the model is affordable to a wider range of clientele since there is no need to have a certain amount of investable assets before becoming a client. This also removes the conflict AUM advisors have of what to do with a windfall. (Here's a blog post with more about why I chose INW)
The drawbacks of the INW model are that it relies on a certain level of income and/or net worth for an advisor to be able to work with a client (for example, the advisor will likely have some cut off for what makes a profitable client). In addition many INW advisors do not reduce the fee for someone who has a negative net worth. Instead that part of the fee goes as low as $0, but never negative. Additionally there is still a conflict between the advice on windfalls, the advisor is paid the same if they recommend that you invest it or pay down debt; however they are disincentivized from encouraging you to spend the windfall.
I believe the Income and Net Worth Model is a fair way to pay for financial advice, which is why it’s the way that I charge. If you decide to go with an advisor that charges based on income and net worth, here are a few things to keep in mind:
- Fee: The fee will adjust as your income and net worth grow and shrink over time, ask how often the fee is recalculated, and ask if you’ll sign a new fee agreement or if the change will happen automatically.
- Income & Net Worth Definitions: Each advisor defines income and net worth differently, so make sure you understand what is and isn’t included (with my firm I don’t charge on rental real estate or privately owned business under net worth since these both contribute to income, and income is defined as Adjusted Gross Income from the previous year’s tax return)
- Advisor Access: As with the regular retainer model, know that you have paid for access to your advisor, so be sure to make use of your access, and know what types of advice the advisor will be able to help you with