One of the first questions that I get from most prospective clients is, “What are your fees?” In a world in which you can get the fees, and reviews, for just about every product imaginable on Amazon, financial advisors still work in a world of secrecy. Try going to a financial advisor’s website, assuming they even have one, and try to find what services the advisor provides and the fees they charge. Instead, what you find are stock photos of happy couples sitting across from an advisor dressed in a suit, sitting in a hip office and smiling at a computer screen. Honestly, is anyone that happy going through a financial plan? Evaluating financial advisors is difficult, and many people don’t know the appropriate questions to ask, so “What are your fees?”, comes up in almost every first conversation that I have with a potential client. Unfortunately, “What are your fees?”, is the wrong question, and this post discusses the right question to ask a potential advisor.
My fees + Their fees = Total Fees
The biggest issue with, “What are your fees?”, is that you are only getting half the answer. More and more advisors are becoming “fee-only fiduciaries”, which is a great thing, but fee-only doesn’t necessarily mean low fees. In fact, many fee-only financial advisors charge a higher fee than the old traditional brokers, who make a living on commission. A fee-only financial advisor charges a fee, typically based on total assets that they help you invest, and don’t receive any commissions based on the product they sell. The benefit to you, the consumer, is that you are getting conflict free advice from a financial advisor, without getting hit with high commissions. The problem is that there are typically two fees when you work with a fee-only financial advisor, and the fee you don’t see can be high.
When you ask a potential financial advisor, “What is your fee?”, they will always respond with the fee that they charge you. This is typically based on assets under management (AUM) and usually ranges between 1 to 1.5%. Unfortunately, the fees don’t stop there.
Almost every financial advisor manages your money using mutual funds, ETFs, or even annuities. These products have an additional yearly expense which should be added to the financial advisor fee to get the total fees that you pay. And depending on the product, these fees can be even higher than the fee your advisor charges.
Source: Morningstar 4.16.18
Different investment products charge different fees. For example, if you have a $500,000 portfolio of mutual funds that charge 1% per year, you will pay $5,000 per year for the investments. You never see this fee come out of the account, instead this fee negatively affects the performance of the investment. If you own an investment that earns 10% and charges a 1% annual expense ratio, your investment would only make 9% that year. This is the reason why choosing investments that have lower expense ratios is so important. It is pretty easy to see why low cost index funds have become so popular in recent years.
Fees by investment strategy
Let me give you an example of a fee-only financial advisor who charges 1.25% (pretty normal) and uses mutual funds to manage the clients accounts. On average, mutual fund expense ratios are 1.14%. Therefore, your total fees on an annual basis is over 2%! That’s just crazy. If you are a conservative investor trying to earn 5 to 6% annual returns, your advisor and fund company is taking up to 40% of your profit each year. No matter how good of a financial planner you are working with, you will never make progress on your financial goals giving that much money to a financial advisor annually.
The right question you should be asking
“What are your fees?”, is just not the right question, because you are only getting half the story. Asking “What are the total fees?”, is the right question and allows you to compare advisors on an apples to apples basis. Unfortunately, you probably can’t get this question answered unless you actually sit down and meet with a potential advisor. The ugliest part of the financial industry are all of the hidden fees and how vague advisors are when explaining these fees. My advice is to only work with a financial advisor that posts both their management fees and the investment fees on their website. If a potential advisor is hiding this information, what else are they hiding?