For many people, working with a financial advisor conjures up images of expensive suits and high-pressure sales tactics. In reality, the relationship you have with your advisor will very much depend on the fee structure you have. Financial advisors use a wide range of pricing structures, including Assets Under Management (AUM), commission-based services, and an emerging flat fee model for financial services.
Though AUM is the most common pricing structure offered by advisors, flat-fee financial advisors may be a better solution for those seeking more affordable financial advice. These advisors charge a flat fee for their services, a set amount per year, without any additional fees. This pricing structure is more transparent about what you pay and provides the same level of services as traditional AUM advisors. This article will review the various compensation structures for financial advisors and why you should consider working with a flat fee financial advisor.
Why AUM Does Not Always Align with the Client's Best Interests
AUM is a type of financial advisor where the advisor charges a percentage of the assets they manage for their clients. So, if a client has $1 million in assets, the financial advisor can charge 1%, meaning they would make $10,000 in fees that year. The advantage of this type of fee structure is that it aligns the financial advisor's interests with their client since the more assets the client has, the more money the advisor will make. However, since AUM fees are based on a percentage of your assets, your financial advisor may be more focused on growing your account than giving you comprehensive advice that takes your whole financial life into consideration.
AUM advisors typically require a minimum investment amount, which can be prohibitive for some people. On the low end, these net worth minimums can be as high as $250k and do not include home equity or “held away” accounts such as employer 401k and 403b accounts. Furthermore, over time AUM fees add up and eat into your investment returns. As your portfolio grows so will your fees. Under the AUM model, a client with $2M will pay 10X more than a client with $200k. Being that most advisors will passively diversify your assets across low-cost ETFs, the steep price difference just isn’t justified.
Finally, since Assets Under Management fees are based on a percentage of your assets, your financial advisors may be biased toward advising you to invest more into your managed portfolio and away from other opportunities like paying down debt or investing in real estate.
For these reasons, it's essential to understand all the fees and incentives associated with using an Assets Under Management financial advisor before you decide to work with one.
Commission-based Services Can Incentivize the Wrong Type of Advice
While AUM financial advisors may encourage their clients to save and invest in their portfolios, others, such as commission-based financial advisors, may have different motivations. Commission-based financial advisors are compensated based on the products they sell, including stocks, mutual funds, insurance products, and annuities. While some financial advisors work on commission but still act in their client's best interest, this type of financial advisory has a greater potential for abuse.
"Consider the planner’s pay structure. You typically want to avoid commission-based advisers. Planners who work on commission may have less than altruistic incentives to push a certain life insurance package or mutual fund if they’re getting a cut of that revenue.” -WSJ Guide to Managing Your Money
With many of the products commission-based advisors sell, the kickback they receive may vary. A commission-based advisor may present a client with two similar products but be biased towards the one that earns them a higher commission, that is if they choose to show both options. Furthermore, commission-based financial advisors may even push products that their clients do not need to begin with.
Commission-based advisors are not held to the same fiduciary standards as other advisors. This means they are not legally bound to act in your best interest. Instead, they only need to justify their recommendations to meet a loosely defined “suitability obligation” that the product is suitable for your situation rather than in your best interest. If you're thinking about working with a commission-based financial advisor, ask them about their conflicts of interest and how they are compensated. It's important to work with an advisor who is transparent about their fees and is in alignment with your investment goals.
Flat Fee Financial Advisors: A More Affordable & Transparent Option
When it comes to financial advice, you want to be sure that your advisor has your best interest in mind. With a flat fee advisor, you’re charged a transparent price for their expertise across your entire financial life. Flat fee advisors offer the same services and level of care as an AUM advisor without the conflicts of interest discussed above. Because their pay is set upfront, there is no pressure for you to invest a certain amount or purchase a particular product.
Flat-fee financial advisors can offer more affordable and transparent pricing for their clients and are a much better option for those looking for comprehensive services at a fair price. As your portfolio grows, your fees will not increase therefore allowing you to keep more of your money and reap the full benefit of your compounding investments. Further, most flat fee financial advisors don't require a minimum net worth. This means that anyone can access quality financial advice regardless of their financial situation.
Key Takeaways
There are a few different pricing models that financial advisors use. Commission-based advisors have a conflict of interest that could lead them to give bad advice. While AUM advisors better align their interests with their clients’, the model is not without its conflicts and the fees that come with it will grow with time and eat away at your returns. Flat fee financial advisors have no conflicts of interest, charge a transparent fee for their expertise and typically don’t have net worth barriers like most AUM advisors. If you're looking for affordable and trustworthy financial planning services regardless of your net worth, flat-fee financial advisors may be your best bet.