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How to Choose a Financial Advisor
Measuring the Cost of a Financial Advisory Relationship
By Robert Klosterman
President, White Oaks Wealth Advisors, Inc
Selecting a financial advisor is a lot like choosing a contractor. Cost is just one of the
factors. Picking the lowest or the highest bidder won’t guarantee you the best value
or service for your situation.
The only compelling reason to work with a
financial advisor is the assumption that they
will help you to manage your financial
outcomes better than you could on your own.
They will provide improved results, greater
simplicity, or both!
Several factors determine the value of this
financial advisory relationship: the skill and
expertise of the advisor, the up-front costs of
products and services provided, and hidden
costs that are not immediately apparent. All
of these must be taken into consideration to
find the advisor who will bring the greatest
worth to your assets in the course of your
relationship.
The purpose of this paper is to identify the
various levels of cost in a financial advisory
relationship so that the consumer can gain a
better understanding of the total costs and
benefits of working with a financial advisor
and financial institutions in general. By
understanding these costs, the consumer
can ascertain how these expenses relate to
the results they may receive from working
with an advisor or a financial institution.
First, let us identify the various levels of
costs that can be a part of a financial
relationship. They include:
Planning Fees
Management Fees
Sub-Manager Fees
Sales Charges
Transaction Costs
Performance Fees
Mortality Expenses (Annuities)
12 B-1 Fees (Mutual Fund Expenses)
Operational Expenses (Tax & Audit)
Surrender Fees
Planning Fees:
It is not unusual for a financial advisor to
charge a planning fee for developing an
overall strategic financial plan that will deal
with issues such as retirement, wealth
transfer, income tax planning, and overall
investment strategy. These fees can be
charged on an hourly, flat fee or retainer
relationship model. There will be a wide
range of fees regardless of the model used.
It’s wise to check with at least three to five
planners, gathering information about how
their capabilities relate to your needs as well
as how their fee schedules compare.
Hourly Fees
As with other professional
services, hourly fees can range from as low
as $50 per hour up to several hundred
dollars per hour. Two factors are important
in determining how much planning fees will
cost: the rate per hour and the number of
hours worked. It is very important to
understand what is included in the scope of
the financial strategy project and the
advisor’s estimate of the number of hours
that will be necessary to complete the project
satisfactorily. Unfortunately, it is not unusual
for an estimate to be exceeded. Additional
work that was not included in the original
scope of the agreement can add to the cost
of an hourly project. Care must be taken to
understand the scope of the project so that it
will provide you with the information you
need when comparing it to other models and
methodologies.
Flat Fees
Some advisors charge on a flat
fee basis. After initial discussions, the
advisor will quote a fee that will be payable
either one-half up front and one-half on
delivery, or, in some cases, all up front or all
on delivery. Clearly, having some paid at the
end of the project gives the client more
power in the relationship. These flat fees
also range from a few hundred dollars to
several thousand dollars for a project.
Quarterly Retainer
There are still
other advisors who charge a
quarterly retainer to work in an
ongoing financial services
relationship. These fees also have
a wide range from a few hundred to
maybe a few thousand dollars per
quarter. These fees often are
based on the complexity of the
relationship, such as the size of
assets involved, income, and
planning issues that need to be
addressed.
Management Fees
The amount that is charged for
managing an investment portfolio is
known as the management fee.
Most often this fee takes the form of
a percentage of the assets under
management by the advisory firm.
The amount varies as widely as the
fees of other relationships, most
often ranging from 0.75 percent to
as high as 3.0 percent. We have
observed that most firms charge
between 1.0 and 1.25 percent of
the assets they manage. Some
firms also have a lower fee
schedule for larger amounts of
money under management.
It is not unusual to have a minimum
fee associated with the relationship
as well. This increases the costs
for smaller accounts and provides
the management firm with a
minimum level of revenue for
managed accounts.
In some cases, there is also a profit
sharing fee in addition to the base
flat fee. For example, a manager
may have a management fee
schedule of one percent for assets
under management and receive 20
percent of the profits over a certain
level of return such as the 5 Year
Treasury Note, or some other
specific index or benchmark.
Sub-Manager Fees
Firms rarely discuss the costs of
sub-manager fees and most
consumers are not aware of these
charges. Many advisors make use
of mutual funds and separate
account managers to implement the
advice in their portfolios. These
mutual funds and separate account
managers also have costs
associated with them. As with
every example used in this paper,
the fees vary widely, from index
funds that can be as low as 0.18
percent to actively managed mutual
funds that could be in excess of 2.0
percent.
In our experience, we find that
prospective clients very seldom
know to ask about the sub-manager
fees. In fact, when we bring up the
topic—as we feel it is important to
do—the conversation often gets
turned back to what our fee is in the
process, rather than considering the
total relationship. We have yet to
understand why potential clients
consider one to be more important
than the other.
Sales Charges
The front-end sales charge mutual
fund has all but disappeared, but a
few still exist in the marketplace.
Thirty years ago it was not unusual
to have a front-end sales charge in
a mutual fund as high as 8.75
percent. Better educated
consumers and increased
transparency through the financial
press have driven these costs down
to a much lower level, and many
mutual fund groups now operate on
a low-load or no-load basis. Today
consumers can choose from an
abundance of no-load mutual funds.
True no-load funds without 12 B-1
fees and/or a surrender charge can
be found with great performance.
We see little reason for anyone to
pay a front-end sales charge in
today’s environment, yet these
funds still exist. Consumers should
be cautious and examine all sales
materials and prospectuses for
relevant information on the costs of
purchase.
Transaction Costs
Mutual fund transaction costs are
also not widely disclosed to
consumers. These costs vary
widely and do affect performance.
In a typical mutual fund these costs
will vary from 0.15 percent to as
high as 0.5 percent. Of course
these costs are a necessary evil in
effecting the work that a mutual
fund or separate account manager
needs to undertake. What is
difficult to ascertain is whether
these transaction costs can be
lowered effectively for the benefit of
the consumer. The financial press
has written a lot about ‘soft dollars.’
Soft dollars consist of research,
software, trips, and other costs that
the advisory firm may have.
Brokerage firms pay soft dollars to
the management firms of mutual
funds and separate account
managers in order to attract their
business. There are requirements
by the SEC to disclose these soft
dollars, however they are not
disclosed in mutual fund
prospectuses and or annual
reports.
If you want to find out if a firm
receives soft dollars, you can get a
copy of the firm’s Form ADV which
is filed with the SEC on an annual
basis.
Performance Fees
See Management Fees above.
Mortality Expenses
Mortality and insurance expenses
are another level of fees commonly
associated with variable annuities.
This fee pays for the costs
associated with providing monthly
annuity payouts for the variable
annuity contract. It also provides
funding for the death benefit
associated in the variable annuity
contract. This fee can be as high
as 2.0 percent of the contract value.
It is in addition to the management
fee, sub manager fee, transaction
fees, and any other marketing
costs. These costs combined give
variable annuities the high cost
reputation that they often deserve.
To be fair, there are some very lowcost
annuity products on the market
today. Investigation is required to
ascertain whether a low cost
contract is actually being used.
12 B-1 Fees
These fees were instituted several
years ago to allow mutual fund
companies to charge an additional
level of expense over and above
their management fees for
marketing costs. This would allow
previously marketed front-end load
funds to be marketed in a manner
which would allow consumers to
purchase shares at net asset value,
deducting the marketing costs from
the ongoing operations of the fund.
In order to be able to pay the
salespeople or brokers their
commissions, a surrender fee was
also made part of the agreement.
This was to assure that customers
who had not stayed long enough to
pay their fair share of the
commission would compensate the
fund for doing so. Most 12 B-1 fees
range from 0.25 percent to as high
as 1.0 percent of the value of the
fund. Again, this is in addition to
the other fees associated with the
fund.
Another variation of this is a no-load
fund that is marketed as a “no
transaction fee” or “NTF” fund.
Discount brokerage firms often tout
these funds to avoid a transaction
cost to purchase a fund and hold it
in their brokerage account. In
reality, the “NTF” collects 12 B-1
Fees and is more expensive for
most consumers than the
transaction fee fund.
Operational Expenses
Of course to run an organization,
there are other expenses that need
to be paid. These include the costs
for prospectus printing, tax return
preparation and 1099 distribution,
and an annual audit. These
expenses are also part of the
expenses of running a mutual fund
and are not disclosed or part of the
management fee. These fees,
depending in the size of the fund,
can range from a very small amount
up to as high as 0.20 percent.
Surrender Fees
Surrender fees have been dealt
with in the 12 B-1 section of this
paper. They are very common in
the ‘B’ share environment and in
variable annuities. Surrender fees
can last as long as 10 years,
providing a significant disincentive
to switch from an underperforming
asset to better performing assets.
Surrender fees can range from as
high as 10 percent of the value of a
fund to as low as 1.0 percent.
Summary
The phrase “you get what you pay
for” should be a consideration when
evaluating potential financial
advisory relationships. You
shouldn’t choose the lowest or
highest fees without considering the
value of the services provided.
Always make sure that you are
selecting from advisory firms with
the background and skills to give
advice on the issues that are
relevant to your situation, then
compare the fees charged by the
these firms..
Only after a thorough process of
evaluation, including checking with
client references, asking for and
reviewing cost information, and
becoming reasonably satisfied that
the expected outcomes will meet
your specific needs, should an
individual begin an advisory
relationship.
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