One of the most important factors people consider when deciding whether to hire a financial advisor is cost. But costs can vary significantly from advisor to advisor. Here’s what you need to know about the costs of hiring a financial advisor and how the different fee structures work.
Types of Compensation Structures for Financial Advisors
How much you pay for a financial advisor depends on their fee structure. Some advisors charge a fee based on the amount of money they manage for you, while others charge a flat annual rate or an hourly rate. It’s important to understand how your advisor’s fee structure works so you understand how much you’re actually paying for their service.
Here is an overview of the different fee structures that financial advisors use to charge clients.
Assets under management (AUM)
One of the most common fee structures used by financial advisors is assets under management, or AUM. It is a percentage of all the money they manage for you, also known as your total assets. You can expect an AUM fee of 0.25 percent to 1 percent. That may not sound like a big difference, but higher fees can seriously erode the returns of your portfolio as it grows over time.
A traditional human advisor typically charges about 1 percent of assets, but that number can be higher or lower depending on the advisor and the services offered. So if you had $100,000 with a financial advisor who charged 1 percent, you would pay an annual fee of $1,000.
Robo-advisors, which use an algorithm to build portfolios for clients based on their goals and risk tolerance, charge a lower AUM fee than human advisors. Robo-advisor fees typically range from 0.25 percent to 0.50 percent and you can often get started with small amounts of money, while human advisors typically want to see at least $100,000 or more before working with you.
Per hour
Financial advisors may also charge by the hour, with rates ranging from $200 to $500 and up. Hourly rates can be used for specific projects, such as developing an overall financial plan or estate planning. An advisor may spend several hours preparing a plan and then schedule a one-hour meeting with you to discuss the details of the plan.
Fixed
Some advisors may work with a fixed fee structure, meaning the fee is stated upfront and does not change based on the amount of assets a client has with the advisor. For example, an advisor might charge an annual fee of $7,500 for his services. This may sound like a lot of money to pay, but for someone with $1 million in assets, this translates into an AUM fee of 0.75 percent, which is less than the typical advisor fee. Typically, the fixed rate decreases as the customer’s assets continue to grow.
On a commission basis
You should be especially skeptical of advisors who earn commission-based compensation. It probably won’t cost you anything to meet with an advisor who works on a commission basis, but that’s because he or she is being financially compensated by an insurance company or a financial firm to sell certain investments or policies – even if those products are expensive and not be so good. are not in accordance with your best interests.
If possible, you should avoid hiring an advisor who earns commission-based fees and try to find an advisor who is a fiduciary, meaning they will put your interests ahead of their own.
Performance based
Some advisors may earn additional compensation if your portfolio outperforms certain benchmarks, such as the S&P 500. These are additional fees that negatively impact your investment returns, but because they are performance-based, you will only pay them if your advisor helps you generate excessive returns. However, make sure you check whether the thresholds for earning the fees actually correspond to outperformance.
Why Financial Advisor Compensation Structures Matter
It’s important to understand the different fee structures that financial advisors use because fees limit the investment returns you ultimately earn. You could end up paying hundreds of thousands of dollars in financial advisory fees over your lifetime. So understanding why you’re paying them can help you determine whether a financial advisor makes sense for you.
Sometimes the compensation structure itself can be a red flag, such as with commission-based compensation structures. You want an advisor who makes recommendations based on what’s best for you, not based on how much he makes in commissions. Fee-only advisors do not earn commissions based on the types of products they sell, which reduces the potential for conflicts of interest.
Other financial advisor fees to consider
While it’s important to consider the fee you pay to a financial advisor, it’s not the only fee you need to worry about. Once you select an advisor, they will recommend and help you invest in mutual funds or ETFs that also charge their own fees. Some funds may have an additional 1 percent annual fee, while others, such as index funds, typically have a fee of 0.10 percent or less.
Be sure to ask your advisor about fees for the funds they recommend and ask if there are any index funds that can be used to build your portfolio and can keep costs low. Keep in mind that, all else being equal, the higher the fees you pay, the lower your returns will be.
Is it worth paying for a financial advisor?
There are pros and cons to using a financial advisor, but if you’re unsure about how to manage your finances, working with an advisor can be beneficial. They can help you develop an overall financial strategy and give you confidence that you are on the right track or identify areas that need improvement.
If you’re just starting out, consider getting started with a robo-advisor. You can build an investment portfolio tailored to your overall goals, and you can always switch to a traditional human advisor later if that makes sense for you. Until then, you can save costs by working with a robo-advisor.
More experienced investors or investors with a financial background may not need to work with an advisor at all and can save costs by managing their finances themselves. But good advisors earn their fees over time by helping you stick to your plan, especially during market downturns when it’s easy to panic, and by thinking about risk so you don’t have to .
Bankrate’s financial advisor matching tool can help you find an advisor near you.
How Much Should You Spend on a Financial Advisor?
As a general rule, you probably shouldn’t pay more than 1 percent to an advisor unless they provide additional services.
If you’re just starting out, a robo-advisor may be your best bet to keep costs low while you build your portfolio. High net worth investors can benefit from a fixed fee that remains constant as their portfolio grows, while a percentage fee based on AUM will increase along with their portfolio.
In short
How much you should spend on a financial advisor depends on your unique circumstances. Most advisors charge a fee of 0.25 to 1 percent for managing your assets, although some charge an hourly rate of $200 to $500, and others offer an annual retainer of $7,000 or more. Be sure to be wary of advisors who earn commissions based on the products they let you invest in. You want an advisor who stands up for your interests.
