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:
- Rick Ferri, a CFA who runs a firm that manages clients’ portfolios and charges a fee based on assets under management. (More info on Rick and his services here.)
- Allan Roth, a CFP who charges by the hour. (More info on Allan and his services here.)
- Dylan Ross, a CFP who charges a flat monthly fee. (More info on Dylan and his work here.)
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.”