Financial Advisory Asset-Based Fees: How Do They Work?
Before we begin, first let’s find out what role a financial advisor plays when it comes to managing your finances.
Simply put, financial advisors are specialists that help you come up with a financial plan to meet your goals at a timeline that is suitable to you and advise you on how to best manage your money. They offer services such as investment management, tax planning, estate planning, life-care planning, debt management, etc. Your financial advisor acts as an invaluable source of information for making decisions related to your money, personal finance, and investments.
There are typically two ways financial advisors charge clients. Some advisors work on a fee-only structure wherein they get paid for any services rendered by them by charging their clients fees. Other advisors are fee-based, wherein they are paid for the services they provide while also earning commissions by selling specific products or investments. When making your decision to hire a financial advisor, it is advised to keep their preferred method of payment in mind. While both fee-only and fee-based advisors help with financial planning and wealth management, they differ when it comes to their functioning and principles.
Let’s dive into the world of different kinds of financial advisory service fee models, shall we?
Primarily, financial advisors charge their clients in the following two ways:
Fee-only advisors: As is evident by the name, fee-only advisors charge their clients a fee that may be paid on an hourly rate or a project basis. The fee-only model offers an advantage of uniformity in a financial advisor’s charges for the client irrespective of the size of their investment or assets.
Fee-only advisors can be further classified into:
- Flat fee advisors: Under this model, you will be charged a fixed amount by your advisor for the entire year for seeking his consultation. Generally, the first-year costs are more compared to later years as the advisor may choose to charge a lesser annual fee as the engagement progresses.
- Asset-based fee advisors: Asset-based fees are considered to be the most popular financial advisory service fee model. The advisor charges a fee (generally 1%) based on the value of the assets that they manage. Financial advisors are more hands-on in this kind of model. They help design a financial plan as well as guide you in its execution along with any rebalancing that your portfolio may require.
- Performance-based fee advisors: These kinds of advisors generally employ a two-tier fee structure. One, they charge a base fee dependent upon the assets which are further clubbed with a share of the profits at a defined percentage. Despite being the more economically feasible option, it is also highly risky as advisors may take a higher risk on your portfolio than your portfolio warrants to attain lucrative and higher returns that improve the advisor’s gains.
What is the difference between an asset and fee-based financial advisory service?
|Criteria||Fee-only (including asset-based pricing) Financial Advisory Services||Fee-Based Financial Advisory Services|
|Method of remuneration||Paid upfront by the client for any services rendered||The advisor receives a fee from the client as well as commission from financial firms for the sale of their investment products and services|
|Income sources||The only mode of earning||Multiple sources of income - client fee along with commission earned from the sale of products and services|
|Standard of service delivery||Primarily composed of financial fiduciaries, thereby bounded by law to put the interest of their clients first||These financial advisors are not fiduciaries and their prime focus is the fulfillment of their client’s wishes|
|Degree of risk||Risk is considerably lesser here due to a fiduciary guarantee as well as alignment of interest of both concerned parties||A riskier proposition due to the absence of a fiduciary guarantee. The interest of both parties may or may not be aligned|
It is recommended that one pick a financial advisor who uses an annual asset-based fee model as his remuneration model.
How would one describe an asset-based fee model?
An asset-based fee model refers to a remuneration model wherein a financial advisor charges fees based upon the assets under management (AUM). The present value of the assets or investments managed by your financial advisor on your behalf refers to AUM. Typically under AUM, only those funds are included which are directly managed and invested on behalf of the client. As per the Securities and Exchange Commission (SEC), AUM is defined as those securities wherein the financial advisor offers “continuous and regular supervisory or management services”.
Generally, financial advisors charge a fee of around 1% of the total assets they manage. So, if your financial advisor is managing assets worth $100,000, then you could be paying anywhere between $1,000 and $2,000 as remuneration under the asset-based fee model. However, the exact charge is calculated by taking under consideration other factors such as the experience of the advisor as well as the popularity of the firm you choose to manage your assets.
One advantage of picking an asset-based fee remuneration model is that annual asset-based fees tend to reduce as the value of your assets augment over time. Some financial advisors use a specific benchmark scale that mentions the change in fee percentage upon reaching an asset-value goal. It is also important to note that the pricing model for AUM is calculated differently by each firm.
How is the AUM fee calculated?
As mentioned above, different firms employ different methods to measure AUM. The AUM calculated by some firms is typically based on the inherent structure of their operations. For instance, a mutual fund company will measure AUM fees differently compared to a financial advisory firm, as is the case when it comes to insurance firms or brokerage houses. Many times, it simply boils down to a matter of preference. Ultimately, whichever firm you’re dealing with has full control over how they define AUM. Most firms also update their AUM terms regularly. But, it is the SEC that states certain rules on what can and cannot be deemed a part of the AUM. With that said, since AUMs are defined per the market value of assets, the value of AUM tends to fluctuate daily.
This makes understanding how AUM is defined as per your financial advisor you work with vital as it helps determine the terms in advance. Moreover, if your financial advisor also manages your bank account, mutual funds, shares, etc., he will also include this in the list when ascertaining the fees they will charge you. This kind of remuneration is known as ‘Assets under Advisement’.
Financial advisors may also act as fiduciaries if they follow an asset-based fee model. The fiduciary status indicates that a financial advisor is liable to put the investor’s needs before their own and that they are legally bound to provide them the best of their services. These financial advisors have a fiduciary duty towards their clients that they must fulfill.
What benefits can you reap if you hire the services of an asset-based financial advisor?
Let’s go through some of the most important benefits of hiring an advisor who provides asset-based fees financial planning service:
- Promise to serve in your best interest:
- Provide transparency in financial services:
- Navigate major life phases with their support:
Since asset and fee-based financial services professionals are duty-bound to perform a fiduciary duty, you can be rest assured that your money is being handled by an advisor who has your best interest in mind. They are compelled to put your interests before their own and investments undertaken by them are to your advantage.
As mentioned previously, asset-based fee advisors have a fiduciary responsibility towards their clients. Since they are registered with the SEC, you have complete access to their qualifications, certifications, remuneration methods, and more. Moreover, the advisor stands to be legally sued if he cannot maintain 100% transparency in their actions and objectives and fails to honor the relationship between him/her and the investor. Also, if your investment portfolio suffers a serious decline in value, the advisor’s license can be revoked by the SEC. The advisor may even be permanently banned from providing any financial services.
Asset-based financial advisors state the terms and fees that’ll be charged by them, divulge the method of calculation for AUM under different situations, as well as how the fee will change over the years. They are upfront with you from the start and make you aware of all possible areas of conflict that may arise to prevent any chance of disagreement in the future. Furthermore, since these advisors cannot use your assets and investments to favorably assist any other client, the level of trust tends to be higher in the advisor’s loyalty.
An asset-based financial advisor, who is also a fiduciary, acts as a source of relief due to the trusted financial support that they provide you. With them to guide you, you can navigate important life stages like marriage, childbirth, divorce, retirement, etc easily as they come up with an updated financial plan that can be formulated and executed with their help. Hence, with their help, you can face life’s uncertainties knowing that you have a financial plan that has been prepared especially for you.
If you compare an asset-based pricing model against the standard fee for a financial advisor, which fee model would you pick?
First of all, there is no standard or ‘normal’ fee charged by financial advisors. Each advisor charges a different fee depending upon their level of expertise, fee structure, certifications, services offered, and the location they operate in. Therefore, it is difficult to accurately calculate how much you should pay a financial advisor for their services. For instance, a CFP (Certified Financial Planner) might offer limited services compared to a money coach but may end up being more expensive than the latter.
Therefore, your needs and your budget become the single most important factor when it comes to hiring a financial advisor. Say, for example, you’re running a small investment account, and only need basic investment advice, it would be more prudent to pay a flat fee or an asset fee worth $1,000 or more. However, if you have a larger investment portfolio, you’d be better off hiring the services of an expert having sound financial knowledge and fiduciary standards to take your portfolio to the next level.
Lastly, you also have the option of using the services of a robo-advisor or an online investing platform, that offers automated, algorithm-driven financial services given they fit your investment needs and purposes. These robo-advisors have limited to no human supervision.
Tips to ensure transparency in advisor fee costs
Once the final fee model that best suits your financial needs has been selected, make sure that you take the following three steps to be well informed of your advisor’s fee costs. when it comes to advisor fees:
- Don’t be shy about asking questions on charges:
- Be cautious about your investment choices:
- Don’t hesitate to negotiate with the financial advisor:
The first step is to make yourself aware of the fee structure used by the financial advisor. Ensure that you’re clear about their charges and whether they follow a flat fee or an asset-based fee model. If they follow an asset-based model, learn more about the size of their AUM along with their calculation methods. Don’t be shy about asking questions and ensure that you understand the answers given by them.
The world of investment is an intricate one. There are additional charges that you may have to end up shelling out if you’re not careful beforehand. For example, investing in mutual funds invites payment of add-on charges. When such cases crop up, ensure that you are clear about who will bear these charges with your financial advisor. Also, try to be on the same page with your financial advisor and work with them to identify more economical investments that suit your risk appetite and monetary goals.
Before you choose your financial advisor, ensure that you’re clear about all the contractual terms and the conditions of the relationship. Do your homework, evaluate alternatives and ensure that you are aware of fee terms for each of your shortlisted financial advisors.
Which fee model best suits your financial needs?
Financial advisors get paid in several different ways and it is of utmost importance that you understand how your advisor is making their money. The fee model that they use reveals their interest alignment, transparency, and loyalty. Generally speaking, fee-based advisors tend to rank low on the above-mentioned three parameters and are more likely to offer you advice that may not be in the best interest of your financial needs.
Thus, when it comes to finding the most suitable financial advisor, you’d be better off engaging the services of an annual asset-based fee advisor. These advisors are comparatively more economical than their counterparts, follow a fiduciary standard, guarantee you transparency, financial advice that is in your best interest, as well as loyalty in their services.
Choosing the perfect financial advisor is easier said than done. You need to be able to thoroughly understand the way they work, their areas of expertise, and their experience. Even though budding investors keenly research and do their homework on the amount financial advisors charge, they forget to do similar due diligence when it comes to the advisor’s method of payment. However, as enumerated in this article, an advisor’s preferred mode of payment is vital when it comes to the kind of financial service they deliver. It is advised to pick an advisor after evaluating several options and select the one that best meets your financial needs, budget, and charges you in a way that is comfortable for you. Don’t forget that your financial advisor is the gatekeeper of your hard-earned money, so be careful who you choose to entrust your money to.
If you need guidance in managing and growing your finances, consider hiring a financial advisor. Our free match service connects you to 1-3 Financial Advisors who fit your financial needs and goals and can be contacted for a free initial consultation before you make a decision to hire.