A Guide to Financial Advisor Fees: Understanding What You’re Paying
“There are risks and costs to action. But they are far less than the long range risks of comfortable inaction.”
When I was going through my most recent job transition, I interviewed and talked with quite a few financial planning firms.
While there was usually a slight difference in the planning approach, there was always a difference in the fee structure: what they charged, how they charged it, why they charged it, and - most importantly - how they presented the cost to the clients (or potential clients) they meet with.
This widespread approach to financial planning fees was tough enough for me - a financial advisor - to wrap my head around, and I can only imagine how it must seem to someone who is unfamiliar with the finance industry, who is trying to determine if they are paying a fair price for the services they are getting and ensuring they are doing all they can to preserve and grow their wealth.
So I’m here to say: the concern is valid!
The way an advisor structures their fees can have a significant impact on long-term wealth, so it's crucial to be informed and ask the right questions.
That being said, I’ve also noticed that this uncertainty - whether it’s trust-related or simply information-related - can keep people from taking that next step toward finding a financial planner who can help them.
Therefore, I wanted to take some time to break down the different ways financial advisors charge, what is considered ethical (and not ethical), and leave you with a few questions you can ask when you begin interviewing potential advisors.
Types of Financial Advisor Fees
Financial advisors can charge in several different ways. Here’s an overview of the most common models:
1. Fee-Only
How it works:
The advisor charges a set fee for their services, which can be structured as an hourly rate, a flat fee, or a percentage of assets under management (often referred to as “AUM”)
Hourly Rate: Similar to the way many lawyers and accountants charge. You pay for the advisor’s time. This is often used for one-time consultations and/or a specific financial planning project.
Flat Fee: Similar to the way a doctor’s office charges. You pay a predetermined amount for a specific service, like creating a financial plan or managing your portfolio for a year.
Percentage of AUM: The advisor charges a percentage (the typically range seems to be somewhere between 0.5%-2%) of the total assets they manage for you. This is usually automatically deducted from your investment account and for that reason, can make this type of payment structure feel less transparent, since it fluctuates based on the balance of the account and isn’t always laid out in terms of actual dollars. (Note: This doesn’t mean it’s inherently bad, and is by far the most common payment method used within the fee-only model).
Ethical Consideration:
Fee-only advisors do not receive commissions for selling financial products, which can mean that there are less conflicts of interests (reasons why they might suggest a certain financial product in order to get a better payout for themselves). They are often held to a fiduciary standard, meaning they are legally required to act in your best interest.
2. Commission-Based
How it works:
The advisor earns a commission for selling a financial product - things like mutual funds, insurance policies, or annuities. This commission typically includes an up-front payout to them, based on the size of the contract they sold, and also potentially an on-going payment to them monthly or annually, as long as the contract is in force. These commissions can eat into the client’s investment and/or returns, which is why it’s important to fully understand the embedtded costs and to be confident that the product is absolutely the best option for your circumstances.
Ethical Consideration:
As you can probably tell by reading the above, this model can create conflicts of interest. Advisors may push certain products because they stand to earn a larger commission, rather than because it's the best option for you. While the products themselves can certainly be helpful when matched with the right person for the right situation, commission-based advising can lead to biased recommendations, making it essential for clients to be aware of potential conflicts and work with a professional they trust.
3. Fee-Based (Combination of Fees and Commissions)
How it works:
These advisors charge a combination of fees (like a percentage of AUM or a flat fee) and also earn commissions on the products they sell. This is a very common model in financial services, because it allows for more flexibility and for the advisor to provide a “comprehensive” approach to financial planning, where they are able to deliver insurance planning, estate planning, tax planning, and other services “in-house.” With a trusted professional, this can be an ideal situation; however, more flexibility and more services can also mean more opportunities to take advantage of clients.
Ethical Consideration:
The fee-based model can be tricky because the advisor may be providing fiduciary-level advice for certain services while still making commissions on product sales. It's important to ask about these potential conflicts of interest and how they are managed, and how you can be sure you are receiving unbiased advice.
4. Retainer-Based
How it works:
You pay the advisor a monthly or annual retainer, often in exchange for ongoing access to financial planning advice or management of your assets.
Ethical Consideration:
Retainer fees can provide a steady income for the advisor and reduce the pressure to push products or rack up hourly charges, which can mean that you (the client) receive high-level unbiased, personalized advice on demand. Just be sure to regularly evaluate for yourself and your situation whether the advisor is providing enough value to justify the retainer.
What is Ethical? What is Not?
Fiduciary Duty vs. Suitability Standard:
Advisors who are fiduciaries are required to act in your best interest. This is the gold standard for ethical advice. Non-fiduciary advisors, like many commission-based advisors, are only required to meet the "suitability standard," meaning their recommendations must be suitable for you but not necessarily the best option.
Think about it like this:
Imagine you are hosting a dinner party, and decide to consult a chef who specializes in fine dining. They take the time to understand your guests’ dietary restrictions, preferences, and your cooking skills. Based on this, they recommend a complex but rewarding dish, like a gourmet risotto with seasonal vegetables, that will impress your guests and align with your abilities. They genuinely want you to succeed and have a great dinner.
Now, picture a cooking show host promoting a particular brand of frozen dinners. They tell you it’s a quick and easy option that will suit your needs for a last-minute meal. However, they benefit from promoting this brand because they receive a commission for every purchase made through their recommendation. While it might be "suitable" for a quick fix, it doesn’t elevate your dinner party or showcase your cooking skills.
Similarly, the fiduciary advisor is incentivized (legally and compensatorily) to ensure your success and satisfaction, while the non-fiduciary advisor is legally allowed to suggest a quick, profit-driven solution as long as it still “checks the box,” which means you could end up with something that might not be the best for your specific situation.
Full Transparency vs. Hidden Fees:
Ethical advisors disclose all fees upfront and explain how they are compensated. This is important, because many financial products are rife with hidden fees: sales loads on mutual funds, surrender charges on annuities, high expense ratios on investments, trading costs, manager fees, and more.
Avoiding Conflicts of Interest:
It is considered unethical if an advisor recommends products that benefit them more than you. For example, suggesting an investment because it pays a higher commission, even though a lower-cost option is available, is a red flag. “Churning” - a process in which an advisor, for example, frequently sells mutual funds in a client’s account, in order to make cash available to buy new mutual funds in that client’s account (so they can benefit from the commission on the new mutual fund), is both unethical and illegal. If you suspect at any point that an advisor is making a recommendation or decisions regarding your money, that do not feel like they align with your financial needs, take action: ask questions, get a second opinion, or file a complaint with FINRA and/or the SEC.
Key Questions to Ask When Interviewing Advisors
When you begin interviewing financial advisors (yes! Interview more than one!), it’s essential to ask questions to ensure they are transparent about their fees and any conflicts of interest.
Here are a few questions you can ask to dig deeper:
1. How do you charge for your services?
This question will help you determine if the advisor is fee-only, commission-based, or fee-based. Understanding their structure is the first step in determining potential conflicts of interest.
2. Are you a fiduciary?
A fiduciary is legally required to put your best interests first. If the advisor says they aren’t, ask why not.
3. Do you earn commissions from the products you recommend?
This will reveal if the advisor has any incentives to recommend specific products, which could create a conflict of interest.
4. Can you explain all the fees I will be paying, including any third-party fees?
Advisors should be willing to break down every aspect of what you will be paying, including hidden costs like fund expense ratios or trading fees.
5. How do you mitigate conflicts of interest?
No advisor is entirely free from potential conflicts, but ethical advisors have systems in place to minimize them. Ask how they manage conflicts that could arise from their fee structure or product recommendations.
Final Thoughts
Choosing a financial advisor is one of the most important decisions you’ll make in managing your wealth. Understanding how they are compensated and asking the right questions will help you find someone who is both ethical and aligned with your financial goals.
By clarifying fees, asking about fiduciary status, and understanding potential conflicts of interest, you can feel confident that you’re receiving fair and unbiased advice.
Remember, transparency is key, and an advisor should always be willing to discuss how they are compensated and how that aligns with your best interests.
~Jess
P.S. I am *extremely* happy with where I landed and so proud to be a part of the Lake Ave team. If you haven't already, check us out here!
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