For decades the status quo in the financial advisory world has been to charge clients around 1% of assets under management. This fee arrangement has many advantages. Unfortunately, most of those advantages are enjoyed by the advisors, not the clients. But since accounts in excess of $1,000,000 provide advisors with such huge profit margins, you can bet that your advisor will be happy to renegotiate your fee to keep you on as a client. This article will certainly give you some leverage to do so.
Why Financial Advisors Charge a %
Charging fees as a % of your investments lacks salience, i.e. it’s not very noticeable. For one, you rarely, if ever, discuss or agree to the dollar amount you will pay. If your portfolio is $1,000,000 and your advisor charges 1%, he doesn’t ever bring up that 1% of $1,000,000 is $10,000 per year. And since most advisors debit the fee quarterly from investments accounts, rather than sending an invoice, the fee is just swept under the rug.
Of course, this is great news for your advisor. Who likes talking about fees? Especially when they are often in the tens of thousands? Saying 1% sounds so meaninglessly small. Plus, every other advisor charges essentially the same way.
Another advantage of % fees is that they tend to go up over time due to additions to the account, as well as from market appreciation. As the assets in the account grow, so does the fee. Paradoxically, the actual level of service doesn’t change. Who wouldn’t like to be in a business with ever increasing revenue for the same level of work? Another win for the advisor.
Why Charging a % Fee Isn’t Good Business
I discuss some of the reasons why charging a % can lead to some biases and conflicts in the advice advisors give here. Certainly, conflicts of interest are something you want to avoid as much as possible. But for this article I want to focus on the business aspect of this fee method.
First, let’s look at how most other professionals are compensated. When you go to the doctor for an operation, they don’t ask you for your net worth and then base your fee on that number. They decide what procedure you need and charge you for that procedure. Most professionals charge either hourly or a fixed fee for service.
In fact, in most states it is illegal for estate planning attorneys to charge based on their client’s assets.
The reason for this is simple, you hire a professional for their expertise. The fee you pay should be relative to the level of expertise of the professional you hire, and the difficulty and/or duration of the service being provided. It shouldn’t have anything to do with your income or net worth.
Financial Advisors’ Businesses Look Different
Financial advisors’ businesses don’t look like the businesses of other professionals. Because they are compensated on a % of your portfolio, they often have two clients receiving the same service, but paying very different fees. I can tell you from experience, the level of assets you have has little to do with the level of service you need.
Because of this disconnect between services provided and fees paid, financial advisors often have a large number of clients who are completely unprofitable. Often these are old clients that the advisor sold insurance or other products to on commission. When the advisor moved to a % of assets business model they kept these clients hoping they will one day receive an inheritance or rollover a large 401k. But until then, these clients are subsidized by the larger accounts.
Another bulk of clients provide a reasonably normal profit margin of 20-40%. They have portfolios between a few hundred thousand and a million. For these clients, the % of assets model actually works fairly well since the fee they pay ends up being a reasonable hourly rate. For these clients, the main downsides to the % of assets model are the conflicts of interest inherent in the model.
And then there are the handful of clients with portfolios in the millions who provide advisors with unconscionable profit margins of 50-80% or even more.
Market Price or Market Power?
Now, I’m a believer in capitalism. I own a business. I don’t think there is anything wrong with trying to make a profit, even a substantial one.
But what I have a problem with is price discrimination, especially in an industry as complex and high-stakes as financial planning. Charging one person $5,000 and another $50,000 for the same service just doesn’t seem right.
One reason that advisors have been able to operate this way is that choosing an advisor is not a simple matter. There is no clear-cut path to becoming a “financial advisor” like there is a doctor or a lawyer. In fact, offering a lower fee could actually lead consumers to assume an advisor is less qualified or “discount”.
Because of the confusion, people tend to just go with whoever their sibling or neighbor or co-worker uses. Since consumers have a hard time distinguishing one advisor from another, financial advisors have never had to compete on price. And so, the 1% of assets model has stuck for a very long time.
But you don’t have to settle for the status quo.
A Reasonable Rate For Expert Financial Advice
First, I recommend reading ”The 19 Questions to Ask Your Financial Adviser” by Jason Zweig and asking the questions to your current financial advisor. Or if you are in search of one, use it in your initial meeting. These questions will help you determine if you are even dealing with a professional advisor or a salesman. You want to first establish that you are working with a professional, then you can negotiate a fair fee for the services provided.
Second, if your portfolio is over $1,000,000, you should have a heart-to-heart with your advisor, or prospective advisor.
Ask them “How much time do you (expect to) spend working with me and on my portfolio on an annual basis?”
The answer should be somewhere between 10 and 30 hours (since most advisors have between 70 and 150 clients, and there are 2000 working hours in a year).
Then you can break down your fee as an average hourly rate. For example, if your fee is $30,000 per year and your advisor says he spends 20 hours on your account, then the average hourly rate is $30,000/20 = $1,500/hr! Even if he claims to spend 30 hours, which would be on the high end of believable, that’s still $1,000/hr.
For comparison’s sake, the average attorney in the U.S. charges $350/hr.
Bottom line, you should be able to get high-quality financial planning and investment management from a competent professional for less than $15,000 per year. Even if your portfolio is $5,000,000.
Negotiating with Your Financial Advisor
A word of caution. It is possible that your advisor will refuse to adjust your fees significantly, if at all. There are two reasons why.
First, the advisor would love to call your bluff. Finding a new advisor will take effort on your part, and your advisor knows you’d rather just leave the account where it is. He knows he’s likely to keep the account, and the huge profits, by simply standing his ground.
Second, if your advisor adjusts your fees, he knows he is going down a slippery slope. It is likely you have friends or family who use the same advisor. Does he have to make them all the same deal? Because the top clients are essentially providing the advisor his entire profit margin, he can’t afford to reduce fees on many of them and stay in business.
Sadly, if your advisor is unwilling to negotiate your fee to a reasonable level, then he is probably more interested in the revenue your portfolio generates than he is in providing you a valuable service at a fair price.
Conclusion
Charging fees based on clients’ ability to pay is quite unique to the investment industry. In my opinion it’s one of the things that is keeping the industry from being viewed as a profession, rather than a sales industry.
Because sorting professional advisors from salesmen is so difficult, and because % fees are so invisible to clients and lucrative to advisors, it is unlikely we will see sweeping changes to the industry any time soon. But if your portfolio is over $1,000,000, you are likely paying your advisor an unreasonable rate for the services being provided. Likely far more than you pay other, potentially even more-qualified professionals like doctors, lawyers or accountants.
Don’t settle for the status quo. Do some research on what a professional advisor looks like. And find someone who will provide you honest, expert advice for a reasonable fee.
Continue Reading:
Sorting the Professionals from the Salesmen
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