For most items or services you purchase, as a consumer, price tends to be pretty straight forward. If you need a gallon of milk you can go to a supermarket, drug store, or gas station and know immediately how much the milk is going to cost you. Understanding how much you are paying for a specific product or service, is usually a straightforward process. Unfortunately, when it comes to hiring a financial advisor, pricing can be complex.
Last week, Betterment, the asset manager I use for my clients, published a “Quick Guide” to compare the costs associated with different asset managers. This is a must read for anyone who invests. While this guide does a great job of breaking down the investment fees you will incur across different platforms, it is only part of the story.
To help you better understand your fee schedule, I have a listed a few questions you should consider asking your advisor:
What services do you provide? Investment management? Financial planning? Insurance sales?
The prices in this guide are for investing only. What this chart outlines is the fee associated with purely investment management, which is only helping you pick stocks, bonds, and make allocation decisions.
Investing is an important aspect of your financial plan, but it is only one part. Comprehensive financial planning is not included as a service in the “Quick Guide” examples.
Can you explain your fee structure?
Once you understand the specific services you are receiving the next step is to understand the associated fees. When I meet with a prospective client and we discuss my fees, I always ask what they are currently paying their advisor.
They usually go back to their current advisor and ask the question, “What is my fee schedule?” Here is where the current advisor explains the management fee (usually 1%) and points them to the account statement to show the funds coming out quarterly.
Now it gets tricky. Technically, the client may only be paying their advisor 1%, however, that is often only part of the fee. If you hold any mutual funds or exchange traded funds in your account, you are also paying the company that manages the mutual fund or exchange traded fund product that you own. The fee you pay these managers is called the expense ratio. According to Morningstar, the average mutual fund expense ratio in 2014 was 1.19%. Investors rarely see these fees coming out as these are commonly paid by a reduction in the fund share price.
In addition, investing in stocks, bonds, or mutual funds will often include transaction costs. These are the costs incurred, by the investor, to buy and sell securities. Transaction costs are not included in the management fee charged by your advisor.
Lastly, how is your advisor being compensated for the planning work and advice they provide? Is it a flat fee amount? Is it an additional % of the assets? Are you being charged hourly?
Do you receive any incentives for selling me specific investments?
I spoke about this topic a few weeks back in my blog post “Incentives Matter.” This doesn’t mean that the investment they are suggesting is wrong for you, but wouldn’t you want to know if your advisor was financially motivated to sell you a particular product?
Anyone who provides financial advice (investment advisors, financial planners, brokers, financial advisors) should be transparent with their fee schedules and the corresponding services they offer.
Clearly understanding your fee structure is a critical part in evaluating the services you receive.