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Asking the Advisors: How to Pay for Investment Advice

When looking for a financial planner and/or investment advisor, one of the most important things to decide is what type of compensation agreement will be the best fit for you. Would you rather pay an hourly fee? A fee calculated as a percentage of your portfolio? Or a flat monthly/quarterly/annual fee?

Rather than sharing my own thoughts yet again, I thought it would be more interesting to hear from three different advisors — one for each of the three business models. So I reached out to three people whose opinions I’ve come to value:

Under what circumstances would an investor be best served with an hourly fee model?

Allan Roth: When someone needs help in moving from complexity to simplicity and is willing to be a hands on manager of their own portfolio. If the client will let me design the portfolio simply enough, I can give them rebalancing rules they can follow and they may never need me again. That is the goal.

[In addition], non-investment related advice such as tax, insurance, financial independence, and estate planning coordination works better on the hourly model as need varies greatly.

Rick Ferri: That’s a two part answer:

Investor 1: Someone who wants investment advice but doesn’t want ongoing investment management. They pay hourly or by the project for a portfolio review and investment recommendations, and then it’s up to the investor to implement. Often investors who have a large amount of wealth in a company 401(k) fall into this category. The adviser doesn’t have access [to the account], so the investor has to DIY.

Investor 2: Someone who has an investment manager but who also needs other financial services. Perhaps they need a full financial plan, or estate planning help, or insurance review, or tax planning. In my opinion, these services should be paid for hourly or by the project even if they’re provided by the same adviser who does the investment management. I believe it’s unethical to lump these other services under a higher AUM (assets under management) fee because that links tax planning to the value of an investment portfolio, which makes no sense. In addition, often the investor only needs occasional extra advice, so why should they pay for it continuously with AUM?

Dylan Ross: An investor seeking specialized help when facing a complex decision with significant consequences may be best served with an adviser that charges by the hour. Some examples might be deciding when to begin Social Security, getting a second opinion before a major purchase, or general guidance on how to best structure their investment portfolio.

While hourly advice is frequently touted as great for one-time or the occasional as-needed help, it doesn’t have to stop there. It can also work well for ongoing, pay-as-you-go services. However, for general, less complex advice, it may be more expensive than paying flat periodic fee. For someone considering purchasing any kind of an annuity with their life savings, hiring a fee-only hourly advisor to look everything over would be a very, very wise choice.

Under what circumstances would an investor be best served with a fee based on assets under management?

Rick Ferri: There are two types of AUM fee advisors — wealth managers and investment managers. The first wraps all financial services under an AUM fee and the second charges a lower AUM fee for investment managing services. [Mike’s note: This second type of service is what Rick’s firm does.]

Many individuals and small institutions do not desire to manage their investment portfolio directly or cannot manage them for legal reasons. They delegate this duty to a legal fiduciary, such as Portfolio Solutions. We work with these clients to come up with a sensible long-term plan for their needs or the needs of beneficiaries, implement their plan with discretionary authority, maintain the plan day-to-day including cash flows, and report on performance versus appropriate benchmarks periodically.

I believe the difference between the DIY investor and adviser investor return is discipline. DIY is the best option from a fee perspective because there is no extra adviser fee. That being said, very often DIY investors don’t stay disciplined. Procrastination and inconsistency in management are common and this lowers long-term returns. An adviser is paid to be disciplined. This keeps a portfolio strategy on course and often leads to higher returns.

If you decide to hire an advisory firm, make sure they have the same strategy ideas that you do. This way your thinking is aligned and there is no confusion on what the adviser is trying to accomplish. Also, fees matter. The more an investor pays an adviser, the lower their returns.

Dylan Ross: I have formed the opinion that charging a fee based on assets under management is only really appropriate for asset management services like portfolio management or mutual funds. So it would be most appropriate for an investor seeking only to have their investment portfolio managed in accordance with a particular investment strategy or philosophy, not for household financial management or financial planning.

Tying the fee to the value of an account almost seems as if the account, not the person, is the client. If you don’t want to manage your own investments or haven’t been capable of doing so, paying a fraction of a percent of your assets to a low-fee advisor like Portfolio Solutions for disciplined investment management would be money well spent.

Allan Roth: [An AUM-based fee is best] when someone does not want to be a hands-on manager of their own money and wants someone else to handle the portfolio. Fees matter, so a great manager for a low price like Rick is right for those clients. I nearly always recommend Rick for those who want someone to do the investing for them.

Under what circumstances would an investor be best served by a flat annual/quarterly/monthly fee?

Dylan Ross: Flat periodic fees are best for folks who want/need general ongoing advice or regular access to advice at a predictable, fixed cost. It’s similar to a level-pay plan from your utility company, or health club membership. It can be a less conflicted solution for those seeking an advisor to manage assets and provide planning advice. For those seeking ongoing help with general personal finances such as cash management, debt liquidation, credit, saving and investing, low-fee access to a financial planner or an automated online service may be the best fit.

Allan Roth: I don’t see a big difference between this model and the AUM model. In reality, most fees I’ve seen in this matter are based on asset size. It does give more flexibility, like the hourly model, to advise on assets such as employer 401(k), pensions, etc.

Rick Ferri: I believe all investors who have smaller accounts and wish to have account managed under a discretionary relationship should pay a flat fee in lieu of an AUM fee. This is fair to the adviser and fair to the client. The flat fee will vary from adviser to adviser as does the adviser’s account minimums. Investors should choose an adviser that meets their needs.

Finally, Dylan Ross provided this summary, which I mostly agree with: “In a nutshell, I think that that folks are best served to pay a financial planner that is a generalist (not a Jack-of-all-trades, but a true generalist like a family doctor is a generalist) a low, periodic fee. Pay financial planners that are specialists by the hour, as-needed for specialty advice. And for specific services like investment account management, pay a portfolio manager or mutual fund company based on assets under management.”

Checking out an Investment Adviser: Form ADV Part II

Editorial note: We discussed this topic a couple years back, but a few reader emails have made me realize it’s time to cover it again.

When researching a registered investment adviser (RIA), in my opinion the single best first step you can take is to read the RIA’s Form ADV Part 2.

Form ADV is a form that investment advisers have to file with the SEC. Part 2 of the form contains most of the important information that you’d want to know about an investment adviser. For example, you can see:

  • How the adviser charges for his/her services (hourly, fee-for-service, percentage of assets under management, etc.),
  • How much the adviser charges for his/her services (e.g., if it’s hourly, what is the hourly rate?),
  • What services the adviser offers (e.g., if you’re paying 1% per year, are you getting comprehensive financial planning? Or is it just portfolio management, and you would have to pay extra for other financial planning services?), and
  • The adviser’s investment philosophy (i.e., how they pick investments and how they allocate between those investments).

What’s nice about this form is that it’s a way to get the relevant information quickly, without having to filter through a bunch of sales talk (as you would often have to do if you visited the adviser’s website), and without having to give the adviser your contact information.

How to Find an RIA’s Form ADV Part 2

Downloading an RIA’s Form ADV Part 2 is easy:

  1. Go to the SEC’s Investment Adviser Search website.
  2. Look up the adviser by firm name.
  3. Click “get details” then “Part 2 Brochures.”
  4. If necessary, click the link for the most recent brochure filed.

How About an Example?

Let’s say you recently read Allan Roth’s book How a Second Grader Beats Wall Street, you liked it, and you’ve decided to include Allan’s firm Wealth Logic as one of several firms you’re considering. But first you want to find out a bit more about his practice, how much he charges, and so on. So you look up Wealth Logic on the SEC site and download the ADV Part 2 brochure.

With regard to how Allan’s firm charges clients, you find the following plain-English statement:

“All fees are hourly or fixed dollar to minimize any conflicts of interest. No additional profits can be made as a result of the advice rendered. The hourly rate is currently $350. This rate is both negotiable and can be capped for a period of time. All fees are due within 30 days of the billing date and a retainer amount may be requested.”

It’s clear and to the point. And if, for example, Wealth Logic instead charged a fee based on the amount of assets under management, there would be a table showing exactly how that fee is calculated.

With regard to what types of investments Allan’s firm recommends to clients, you’ll find the following statement:

“Minimizing expenses and emotion, and maximizing diversification, are core methods Wealth Logic applies in designing portfolios. Broad index funds of mutual fund and ETF categories are those most often used in the practice, as well as Bank and Credit Union CDs going directly to those institutions insured by the FDIC or NCUA.”

Again, it gets right to the point with very little fluff.

Looking up a registered investment adviser’s Form ADV Part 2 should certainly not be the only research you do on an adviser. But it’s an excellent first step to quickly check for things that would eliminate the adviser from consideration (e.g., an important conflict of interests, fees that you think are too high, a minimum asset level that you don’t meet, or an investment philosophy that’s markedly different from your own).

Professional Financial Advice: How Much Should Investors Pay?

I recently had email discussions with two different financial advisors regarding how much investors should be willing to pay for financial advice.

  • The first advisor asserted that an annual fee of 1-1.5% is justified because advisors are likely to improve their clients’ investment results by at least that much by helping them build better portfolios and avoid mistakes.
  • The second advisor argued that, based on simple economics, if customers are willing to pay a given fee, that means that his services are worth that amount of money. (In other words, if the market will support a given fee level, it’s justified by definition.)

Those arguments might make sense from the perspective of an advisor trying to set his/her fees. But from the perspective of the investor, the answer is more obvious: Why pay any more than you have to?

The Do-Everything Advisor

Many financial advisors charge annual fees of 1% (or more) of your portfolio balance per year. In exchange, they provide portfolio management services as well as ongoing financial planning advice.

Such an arrangement can make sense if you need both services. Otherwise, it’s often less expensive to break the services out and pay for them separately.

Help Building a Portfolio

If all you need is help with putting together a portfolio, it’s hard to beat Vanguard’s financial planning service. If you have more than $500,000 in assets with Vanguard, the service is free once per year. If you have $50,000-$500,000, it costs just $250.

If you have less than $50,000, it costs $1,000. At that level, I think that most people who don’t want to build a portfolio on their own would probably be better off just using a simple all-in-one fund rather than paying the $1,000 fee.

Hands-Off Portfolio Management

If you don’t need comprehensive financial planning, but you’re looking for a professional to handle the actual management of your portfolio for you (e.g., rebalancing and tax-loss harvesting as necessary), you’ll want to find somebody who offers exactly that service, without charging you for services you don’t need.

For investors with $500,000 or more, I’m not aware of any lower-cost providers than Rick Ferri’s firm Portfolio Solutions, which charges 0.25-0.5% per year depending on account size.

For investors with $100,000-$500,000, Betterment could be a good choice, charging 0.15% per year for their service. (My understanding, however, is that they do not tax-loss harvest, so their service may make less sense for investors who have a significant portion of their portfolio in taxable accounts.)

For most investors desiring a hands-off solution who have portfolios of less than $100,000, my suggestion would again be a simple low-cost all-in-one fund rather than professional portfolio management.

As-Needed Financial Planning

If you’re seeking help with tax planning, estate planning, or retirement planning, but you don’t really desire assistance with the day-to-day management of your portfolio, the least expensive option will typically be to find a professional who provides advice on an hourly or fee-for-project basis. That way you will only be paying for the advice you need, and you’ll only be paying for it in years that you need it. (For example, you probably don’t need to do a thorough estate planning session every single year.)

One good place to look for such professionals is the Garrett Planning Network.

In short, depending on the circumstances, the typical 1-1.5% annual advisor fee may be justified, or it could be a very poor value. When seeking the services of a financial professional, the best way to get a good value for your money is often to determine what service(s) you need, pay a reasonable price for those services, and not pay for any services you won’t need.

How to Leave Your Broker

A reader writes in, asking:

“I have a few accounts with a broker at Edward Jones. He was recommended by a family member, and he hasn’t tried to cheat me in any way. But I don’t think the service I’m receiving is sufficient to justify the commissions I’m paying. Having read about Vanguard and index funds, I think that’s where I’m headed.

But I don’t actually know how to move my money. Do I just call my Jones guy and tell him I’m leaving? I don’t relish the thought of that conversation.”

To transfer an account from one brokerage firm to another, you don’t actually have to call your current advisor/broker first. In fact, you may not have to call him at all. And to the extent possible, I’d suggest avoiding it. The receiving brokerage firm (in this case, Vanguard) has an incentive to be as helpful as possible, whereas the company you’re leaving has an incentive to make things difficult and/or give you a sales pitch to get you to stay.

What you’ll want to do is originate the process at the receiving brokerage firm. Either open an account online (choosing during the application process that you have an account you want to transfer over), or give them a call and explain what you want to do.

The receiving brokerage firm will give you the appropriate paperwork to sign. Once you sign it and send it back in, they forward it to your old brokerage firm and handle the process from there.

Getting a Medallion/Signature Guarantee

Some brokerage firms (including Edward Jones) will require a “signature guarantee” (sometimes called a “medallion guarantee”). This is not the same thing as having your signature notarized, as it has to be done by certain employees of a financial institution such as a bank or brokerage firm. Most places will only provide a signature guarantee if you have an account with them, but I’ve heard of some credit unions offering to do it for anybody.

Before heading to your bank, I would suggest that you call ahead, because it’s often the case that only a certain manager can provide a signature guarantee, and you wouldn’t want to make the trip only to learn that the right person isn’t at work that day.

Transfer “In Kind” or Liquidate Everything First?

As part of the transfer process, the receiving brokerage firm will typically ask if you want to:

  1. Bring things over “in kind,” or
  2. Have your old brokerage firm liquidate everything and send it over as cash.

If the account is an IRA and there are no fees to sell any of the holdings, it’s probably simplest to have everything liquidated and moved over as cash.

Conversely, if the account is an IRA and there will be fees to sell any of the holdings, it’s usually best to compare the cost at each brokerage firm and do it wherever it will be less expensive.

Finally, if you’re transferring a taxable account, you’ll probably want to bring things over “in kind,” because liquidating everything would result in capital gains/losses. After everything is transfered over, you can go through the holdings one by one to see which ones should be sold immediately, which ones should be sold later (after a short-term capital gain has become a long-term capital gain, for instance), and which ones should be kept.

When to Use a Financial Advisor

Jeff writes in,

“Until recently, I had a financial advisor who I’d used for several years. He helped me create and manage my portfolio. At least that’s what I thought he was doing. After having my eyes opened by a few books, I now see that he was just recommending expensive investments that paid him a fat commission.

I’ve since moved my portfolio to Vanguard and invested in what I think is a sensible asset allocation.

But given how simple it is to manage a passive portfolio, I’m starting to doubt that I need an advisor at all. What do you think, for passive investors is there really any need for an advisor?”

I think Jeff is right that, at its most basic, the implementation of a passive portfolio is rather simple:

  1. Choose an asset allocation that fits your risk tolerance,
  2. Create a portfolio that meets that asset allocation in the lowest-cost way possible, and
  3. Rebalance every once in a while.

If you’ve taken the time to educate yourself about these things, then it’s likely that you can handle them without an advisor.

Still, you may want to use one.

For instance, you might be having trouble settling on an asset allocation. Or perhaps you have settled on an allocation, but between you and your spouse, you have so many different accounts that you’re having trouble determining the lowest-cost, most tax-efficient way to implement that allocation.

It may be worth sitting down with an advisor who charges an hourly fee or a flat fee-for-service sort of advisor to get some help with either of those questions.

Help Implementing the Plan

Alternatively, you may have no difficulty creating an investment plan, but still find it worthwhile to have somebody else handle the actual implementation of that plan.

For example, if much of your portfolio is in a taxable account, it’s beneficial to have somebody checking regularly for tax-loss harvesting opportunities. If you don’t want to take the time to do that yourself, it may be worth using an advisor.

Or perhaps you find it difficult to convince yourself to rebalance into stocks during bear markets or out of stocks during bull markets, despite the fact that your investment plan calls for exactly that. In such cases, it can be helpful to have somebody who is emotionally detached from the portfolio who can handle the rebalancing.

For such services, a low-cost annual-fee advisor could be a good fit.

Help with Tricky Questions

And finally, there are some aspects of investing and retirement planning that can still be rather complicated, even when you’ve made a point of keeping your portfolio as simple as possible.

For example, deciding when you and your spouse should each claim claim Social Security isn’t a very intuitive process. In addition, the change in marginal tax rates that results from starting Social Security can often result in tax planning opportunities. A CFP skilled in such areas could be well-worth his/her fee.

Ditto for the question of how to spend down your accounts in retirement. By strategically planning how much to spend from taxable accounts, tax-deferred accounts, and tax-free accounts every year, you can save a lot of money over the course of your retirement. If that’s not something you want to take the time to research and think through, hiring a tax-savvy advisor may be an efficient use of your money.

In short: Yes, passive investing is mostly straightforward. Still, depending on your circumstances, an advisor may be able to offer you a value that significantly exceeds his/her fee. And remember, it doesn’t have to be an all-or-nothing decision. You can be a mostly-DIY investor, who still meets with an advisor every few years when life circumstances change or tricky planning situations arise.

Where to Find Financial Advice? Probably Not Your Brokerage Firm

Jason writes in to ask:

I met with an investment counselor at my bank. I liked him personally, and he was very respectful of my investment goals.

He came up with a portfolio of five different American Funds offerings–a mix of domestic stock, international stock, and bond funds. The downside is that American Funds requires me to pay an up-front fee equal to 3.5% of my investment.

I’ve read about the advantages of index funds, which I can purchase cheaply through an online brokerage. I am leaning toward that type of strategy, but can online discount brokerages advise me on how to use index funds to put together a portfolio? Or will I be on my own? Or is there somewhere else I should seek advice?

Avoiding Commission-Paid Brokers

American Funds are definitely not the worst thing a person can invest in. That said, I’d generally recommend staying away from sales-loaded mutual funds and the brokers who sell them.

For example, based on Jason’s statement that he’d be paying a 3.5% sales load, it appears that we’re talking about an amount between $100,000 and $250,000. That means that, at a minimum, he’s looking at an up-front cost of $3,500 for this advice. You can get a good financial plan for significantly less than $3,500.

Separating the Advice from the Transaction

Jason raises a good point about discount brokerage firms: They generally don’t offer financial advisor services.

But that’s fine. In fact, even if your brokerage firm does offer such services, I’d generally steer clear. As I’ve mentioned before, brokerage firms have a vested interest in getting you to do what’s profitable for them, rather than what’s profitable for you.

As such, I think it’s usually a good idea to invest with one company (a discount brokerage firm of your choosing) and get your advice from a different company. In my opinion, hourly-fee advice from an independent advisor is the least-biased available.

Exception: Vanguard CFPs

There is one noteworthy exception to my suggestion to avoid advice from your brokerage firm: Vanguard. Vanguard has CFPs on staff who can help with managing your portfolio.

There are two reasons I’d be far more willing to accept investment suggestions from Vanguard than from any other brokerage firm or fund company:

  1. As we’ve discussed before, Vanguard is (indirectly) owned by clients, so there’s not much of an incentive for them to recommend anything other than what they believe is best for you.
  2. Their funds are always among the cheapest in each category (especially if you request that the CFP stick to index funds).

Also, the price is quite affordable:

  • For people with accounts of $500,000 or more, the service is free.
  • For people with accounts between $50,000 and $500,000, it costs a flat $250.

For people with less than $50,000, it costs $1,000, though in most cases a portfolio of less than $50,000 shouldn’t be terribly difficult to manage on one’s own.

My understanding is that it’s a relatively basic plan–not as comprehensive as you could get by sitting down with an independent CFP, for instance. Though at $250, that’s still a bargain. At $0, well, that’s even better. 🙂

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