Your Financial Advisor Charges WHAT???

According to a 2011 study that was jointly conducted by Cerulli Associates and Phoenix Marketing International, over 60% of all individuals either did not know how they paid for the financial advice they received, or thought the advice they received was free!

Now, I can understand being confused as to how financial advisor’s are compensated. Aside from this not being a very openly discussed topic, there are a multitude of different ways financial advisors can be paid. However, your financial advisor should always be up-front and explain to you how they are compensated for the financial planning services they provide.

To quote Heath Ledger from The Dark knight, “If you’re good at something, never do it for free.” Good financial advice is hard to come by, and those of us that provide good advice get compensated accordingly.

Clients should never be confused about how their advisor is compensated for the financial services they provide. To help shed some light on this issue, below are the three primary ways in which financial advisors are compensated.

1. Commissions and 12b-1 fees

   This is by far the most common, and misunderstood way in which financial advisors (brokers) are compensated. When you buy and sell a stock, the broker charges a commission for completing the transaction. This commission can range anywhere from $10 or less using online brokerage firms, to as much as several hundred, or even thousands of dollars at a large wire house. This charge usually shows up on your statement and is typically communicated to you when the trade is entered.

   12b-1 fees, on the other hand, are much more hidden and often not communicated to you in any way. 12b-1 fees are payments made by a mutual fund company to the financial advisor. These fees can range anywhere from a one-time payment of 5% of the invested amount (called a front-load), which is often the case for class “A” shares, to an annual charge of 1% of the invested amount on class “C” shares. Whichever option is chosen, this fee is typically not communicated to the client, as you never actually see this amount being debited from the account. This also explains why 1/3 people believe they are receiving their advice for free.

2. Fee-Based Financial Planning

   Fee-based compensation is the second most common payment arrangement between a financial advisor and a client. This model works by combining fee-only financial planning (discussed below) with commission based financial planning. An advisor will typically charge a percentage of the assets that are being managed, as a fee-only planner would, but still leave the door open to receive certain compensation from mutual fund companies or other sources besides the client.

3. Fee-Only Financial Planning

   Fee-only financial advisors receive compensation only from the client, whether that be in the form of an hourly fee charged for creating a financial plan, or by charging a percentage of the assets that the advisor is managing for the client. Fee-only advisors often charge a fee to create a financial plan for a client, and then either implement and manage the recommendations directly, or leave it up to the client to implement the different strategies recommended (often providing some guidance along the way).

   Instead of investing in class “A” or class “C” shares mentioned above, fee-only advisors usually invest in class “I” shares, or what are called load-waived class “A” shares, both of which do not pay 12b-1 fees to the advisor. Because the 12b-1 fee is not paid, the performance of a class “I” share will usually be slightly better than that of a class “C” share of the same mutual fund.

   In addition to being much more straightforward and eliminating the potential for hidden fees, this fee arrangement also removes conflicts of interest that arise when an advisor is making his investment selection, specifically when the advisor is faced with two similar investment options, one of which pays a larger 12b-1 fee than the other. Because fee-only advisors do not receive 12b-1 fees, they are much more inclined to choose the investment option that is in the best interest to their client.

Apple Tree Wealth Management provides independent, fee-only financial planning services to clients. Most clients come to us to consolidate their assets and create a long-term strategy to achieve their financial goals. We charge a predetermined fee to complete the plan, adjust it as necessary, and communicate this plan to our clients.

For those clients who do not have the financial acumen, time, or interest to implement the plan themselves (which most don’t), we also take the time to implement and monitor the plan over the course of the year, charging a percentage of the assets that we manage for that client to pay for the services. We are never compensated via commission, and are never conflicted when choosing the most appropriate tools to implement the plans we recommend.

NOTE: For clients who give us the opportunity to manage their assets on an on-going basis, the fixed-hourly financial planning fee is rebated to the client over the course of the year. Going forward, the financial planning fees are included in the percentage fee we charge on an annual basis.