When you buy a car, how is the salesperson compensated? Answer: a commission based upon the price of the car you buy. When you buy life or disability insurance, how is the salesperson compensated? Answer: a commission based upon the amount of insurance you purchase. When you buy a new house, how is the realtor compensated? You get the picture. Almost all commissions are based upon the quantity of goods or services you purchase. When you buy something in one of these categories, you have essentially approved that model of compensation for the salesperson and recognize that they may not be acting in your best interests, after all, the more you buy, the more money they make. Not a big deal because both parties are aware this is happening.
What about fee-only financial advisors? By definition, they are required to only receive a fee for service rather than a commission and (when acting as a fiduciary) always put the interests of their clients ahead of their own. Sounds simple, right? If we take a closer look at how most fee-only advisors determine their fee, you will see the classic “Assets Under Management” (AUM) method. In this case, the advisory fee is based upon the amount of assets that the advisor is managing. The typical fee quoted for a $1 million dollar account is roughly 1.00%. One percent…sounds like something I might find in my couch cushions when in reality, for a $500,000 account, that’s $5,000 per year before you consider the additional money YOU will add through contributions, and the long-term trend of the stock market, which is to increase in value (otherwise, no one would ever invest). What if you invested $800,000? The fee would be $8,000. What about $1,000,000? You do the math. But stop and think about this? How is this any different than a commission? If you invest more, the fee goes up. Commission. Even worse, if the account value goes up because of the market, so does your fee…a commission-based salesperson’s dream!
Now imagine if you’ve gone to this “fiduciary” financial advisor with your $1,000,000 of investment assets and they offer to not only invest your money, but provide your financial planning services. You agree to the paltry 1.00% management fee ($10,000 per year!) for your assets and they in return give you comprehensive financial planning. That may seem like a fair deal and you may find value in the peace of mind that comes with having a professional help you. Fair that is, until your neighbor goes to see the same financial advisor (maybe on your recommendation because we all seek confirmation bias) and they receive the same package of services….but only have $750,000 to invest. Under the same paltry 1.00% management fee, they are paying 25% less than you are – for the SAME services! Welcome to the AUM fee model, delivered by your fiduciary financial advisor. Answer me this: How is this not a commission? It’s based upon the quantity of money you invest. It has nothing to do with the work you need done. Here’s another brain-teaser for you: which client has (likely) made it easier to obtain their goals – the one with more, or less money? Keep in mind, your fee (expressed in dollars) will go up over time as you save money. That 1.00% doesn’t seem so paltry at this point.
Shouldn’t an advisor’s fee be based on the work they perform, not your net worth? Ask your advisor how they calculate their fee, and ask them to express that in dollars, not seemingly marginal percentages. It’s pretty simple when you think about it.