The Hidden Costs of Financial Advisors

If you hear the term ‘fee-based’ financial advisor, what comes to mind?  If you’re like most people, you think it means financial advisors who charge clients a fee for their services, and chances are that any fee-based advisor is not going to put a lot of emphasis on setting you straight.

Why?

Because the hidden costs associated with hiring a fee-based advisor can be astronomical, meaning more money in their pocket, and potentially far less in yours.

When dealing with the financial services industry, most consumers don’t realize that there is a very important distinction between ‘fee-based’ and ‘fee-only’ advisors.

While fee-only advisors are not licensed to receive third-party commissions on the investments they choose to allocate their clients’ money to, fee-based investors are privy not only to commissions on the earnings they secure for you, but also potentially to incentives and signing bonuses offered by various brokerage firms, mutual fund companies and other institutions that are trying to convince them to invest your money with them.

There are a few different ways an advisor may charge fees, and it’s essential you understand the fee structure before engaging any advisor to handle your money.

A Percentage of Your Overall Account Value

This method of compensation is fairly common and it provides the advisor with the opportunity to receive more compensation as the value of your account grows, which is entirely fair in that it provides them with incentive both as far as increasing your value and keeping losses to a minimum.

The fee itself can range from approximately 1-2% per year and usually the more assets in your portfolio, the lower the fee.

Commission on Products You Purchase Directly from the Advisor

Many advisors offer investment and insurance products that you can purchase directly from them.  There are several different ways these fees can work, and they often take the form of either a front end or back end load, referred to as DSC’s or deferred sales charges.

Front End Load 

A front end load is a one-time withdrawal of up to 5% of your total investment which goes toward compensating your advisor.

Back End Load

A back end load invests 100% of your investment but incurs a penalty for early withdrawal of the investment if you take your money out before the end of the agreed-upon term, normally between 5 to 7 years, depending on the company.  The penalty is normally based on a declining scale, for example in year one the penalty rate may be 5% while in year two it declines to 4% and year three it may drop to 3.5% and so on.

The 0% Front End Load Option

The 0% front end load option is a third option that every investor can use, which entails investing 100% of the investment amount as a front end load but does not withdraw any commission or assign an early withdrawal penalty.  In this situation the advisor will receive an increased Trailer fee for managing the investment on an annual basis without taking away from the client’s investment in any way.

Trailer fees are fees that all advisors are entitled to for managing client accounts.  These fees are based on the size of the account and can be anywhere from .5% to 1%, based on the advisor’s book of business.

If your advisor is compensated in this way, make certain you have a clear understanding of exactly how they are paid before engaging them.

Hourly

There are advisors out there who will charge you an hourly rate for financial advice, generally with the understanding that you will be responsible for implementing their suggestions on your own.

The benefit in this method of billing is that it ensures a high level of objectivity, since the specified rate is not influenced by factors such as the value of your investments or the purchase of any particular investment.

There are a variety of ways that advisors may structure their compensation, and thus finding the right fit for you can take some research and shopping around.  Do your homework and before engaging the services of any advisor make certain that you have had an open discussion around fees and that you fully understand how your advisor will be getting paid.