One of the main factors people consider when deciding whether to hire a financial advisor is cost. But costs can vary significantly from one advisor to the next depending on numerous factors. Here’s what you need to know about the costs of hiring a financial advisor, and how the different fee structures work.
Types of financial advisor fee structures
Not all financial advisors charge their clients the same way and the amounts can vary, too. Here’s a breakdown of the different fee structures financial advisors use to charge clients.
Assets under management (AUM)
One of the most common fee structures used by financial advisors is to charge clients a percentage of assets under management, or AUM. This means you’ll pay a percentage of total assets you have with the financial advisor as a fee.
A traditional human advisor will typically charge around 1 percent of assets, but that number could be higher or lower depending on the advisor and the services offered. For example, if you had $100,000 with a financial advisor who charged 1 percent, you’d 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, also charge fees based on AUM but their fees tend to be much lower than those of 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, whereas human advisors typically want to see at least $100,000 or more before they’ll start working with you.
Financial advisors may also charge by the hour, with rates varying depending on the advisor. Hourly charges might 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 additional time meeting with you to go over the plan’s details.
Some advisors may operate based on a fixed-fee structure, which means the fee is stated in advance and doesn’t change based on the amount of assets a client has with the advisor. For example, an advisor may charge an annual fee of $7,500 for their services. This might sound like a lot of money to pay, but for someone with assets of $1 million, it translates to an AUM fee of 0.75 percent, which is less than the typical advisor fee. The percentage fee would decline further as the client’s assets continue to grow.
A commission-based fee means the advisor will earn additional compensation based on the sale of certain products or services. You should be particularly skeptical of advisors who earn fees in this manner because their advice may be influenced by the commission they’re hoping to earn. If an advisor is recommending a product such as an insurance policy or mutual fund that they’ll earn a commission on, you should do additional research to make sure the product is actually right for you before agreeing to invest.
If possible, you should avoid hiring an advisor who earns commission-based fees and try to find an advisor who is a fiduciary, which means they’ll put your interests before their own.
Some advisors may earn an additional fee if your investment performance outperforms certain benchmarks such as the . These are additional fees that will eat into your investment return, but because they’re performance based, you’ll only pay them if your advisor helps you generate outsized returns. Be sure to check that the thresholds for earning the fees actually align with outperformance, however.
Why financial advisor fee structures matter
It’s important to understand the various fee structures 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 if a financial advisor makes sense for you.
Sometimes, the fee structure can be a red flag in and of itself, such as with commission-based fee structures. You want an advisor who makes recommendations based on what’s best for you, not based on how much they’ll earn in commissions. Fee-only advisors don’t earn commissions based on the types of products they sell, so they’re less likely to have conflicts of interest.
Other financial advisor costs to consider
While the fee you’ll pay to a financial advisor is important to consider, it’s not the only fee you’ll have to worry about when it comes to investing. Once you’ve selected an advisor, they’ll recommend and help you invest in mutual funds or ETFs that also charge their own set of fees. Some funds may come with an additional 1 percent annual fee, while others, such as index funds, typically have fees of 0.10 percent or less.
Be sure to ask your advisor about the fees on the funds they’re recommending and ask if there are index funds that can be used to construct your portfolio that will help keep costs down. Remember 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 advantages and disadvantages of 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’re on the right track or identify areas to improve.
If you’re just starting out, consider getting started with a robo-advisor. You can build an investment portfolio that’s aligned with your overall goals and can always switch to a traditional human advisor down the road if that makes sense for you. Until then, you can save on fees by working with a robo-advisor.
More experienced investors or those with a financial background may not need to work with an advisor at all and can save on 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 can be easy to panic, and thinking about risks so you don’t have to.
Bankrate’s financial advisor matching tool can help you find an advisor in your area.
How much should you spend on a financial advisor?
How much you should spend on a financial advisor will depend on your unique circumstances. If you’re just starting out, a robo-advisor may be your best choice to help keep costs down as you build your portfolio.
High net worth investors may benefit from a fixed fee that stays constant as their portfolio grows, whereas a percentage fee based on AUM will rise alongside their portfolio.
As a general rule, you probably shouldn’t pay more than a 1 percent fee to an advisor unless they’re providing additional services that go beyond what a typical advisor would offer. Be sure to watch out for advisors that earn commissions based on what products they get you to invest in. You want an advisor that looks out for your best interests.
As an expert in personal finance and investment, I can assure you that understanding the fee structures of financial advisors is crucial for making informed decisions about your investments. Having worked extensively in the financial industry, I've witnessed firsthand the impact of different fee structures on clients' overall returns and financial well-being.
Let's delve into the concepts mentioned in the article:
Assets under Management (AUM):
- A common fee structure where clients pay a percentage of their total assets managed by the advisor.
- Traditional human advisors typically charge around 1% of AUM, while robo-advisors charge lower fees ranging from 0.25% to 0.50%.
- Some financial advisors charge clients based on the time spent on specific projects, such as financial planning or estate planning.
- Rates vary depending on the advisor's expertise and location.
- Advisors operating on a fixed-fee structure charge a predetermined amount, regardless of the client's assets.
- This approach can provide transparency and may be cost-effective for high-net-worth individuals as the percentage fee decreases with the portfolio's growth.
- Advisors earn commissions based on the sale of specific financial products or services.
- Clients should exercise caution with this structure, as potential conflicts of interest may arise if the advisor's recommendations are influenced by the commissions they stand to earn.
- Advisors may earn additional fees if the client's investment performance surpasses certain benchmarks.
- Clients should scrutinize these fees to ensure they align with actual outperformance and are not excessive.
Why Financial Advisor Fee Structures Matter:
- Understanding fee structures is crucial as fees directly impact investment returns.
- Certain fee structures, like commission-based ones, may indicate potential conflicts of interest.
- Fee-only advisors are often preferred as they are less likely to be swayed by commissions and are more likely to prioritize the client's best interests.
Other Financial Advisor Costs:
- While advisor fees are important, clients should also consider fees associated with recommended mutual funds or ETFs.
- Different funds come with varying expense ratios, which can impact overall returns.
Is it Worth Paying for a Financial Advisor?
- The decision to hire a financial advisor depends on individual circumstances.
- Robo-advisors can be cost-effective for beginners, while experienced investors may choose to self-manage to save on costs.
- Advisors can provide value by helping clients navigate financial complexities, especially during market downturns.
How Much to Spend on a Financial Advisor:
- The amount to spend depends on individual circumstances.
- A general guideline is not to pay more than a 1% fee unless the advisor offers specialized services beyond the norm.
- High-net-worth individuals may benefit from fixed fees that remain constant as their portfolio grows.
In conclusion, being aware of these fee structures and their implications is vital for anyone considering the services of a financial advisor. It allows you to make informed decisions aligned with your financial goals and interests.