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Financial Advice: Hourly Fees, Asset-Based Fees, or Annual Fee?

I usually recommend that investors avoid commission-paid financial advisors.  The conflict of interests created by commissions is too great to overlook.

Of course, that still leaves several options:

  • Advisors who charge a fee equal to a percentage of your portfolio,
  • Advisors who charge hourly fees,
  • Advisors who charge a flat annual (or quarterly) fee,
  • Advisors who charge flat fees for specific services,
  • Advisors who use various combinations of the above.

So how should you choose between them?

Consider Conflicts of Interest

Asset-based fees: Advisors who charge as a percentage of assets have an interest in keeping as many assets under their care as possible, even when that’s not in your interests (such as when you would be better served by liquidating some assets and paying down debt).

Also, there’s a conflict of interests to the extent that the advisor’s tolerance for income volatility is different from your tolerance for portfolio volatility.

Hourly fees and fee-for-service: Hourly or fee-for-service advisors have an incentive to “over plan,” that is, to sell you services that you don’t really need.

Flat annual fees: Advisors who charge flat annual fees have an incentive to “under plan,” that is, to do the minimum amount of work possible to keep you around.

Personally, I find the conflicts of interests caused by asset-based fees to be the most concerning, though I’d argue that each of the conflicts mentioned above is far less significant than those involved with commission-paid advisors.

Which One Costs the Least?

An advisor might try to convince you that a fee equal to, say, 1% of your assets is a good value because he (or she) will be able to help you improve your returns by more than 1% per year. Such advisors may be correct about their ability to improve returns by helping you avoid mistakes, minimize taxes, and so on.

But that does not necessarily mean that the fee is justified.

If you’re able to find a low-cost advisor, one whose advice is every bit as good and whose fee would only total, say, 0.5% of your portfolio, wouldn’t that be preferable to using the advisor with the 1% fee?

The value of financial advice is not the degree to which it will improve your results. As with every other good/service produced, its value is the lesser of:

  1. Its benefit to you, or
  2. Its replacement cost–how much you would have to pay another provider for a similar service.

In other words, be sure to shop around!

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Comments

  1. Jan Sackley says:

    You raise some important considerations about fees for services. I do not, however, agree that hourly fees incentivize advisors to “sell you services you don’t really need”. Rather, the client and advisor should agree up front as to what work the advisor will perform. Ongoing telephone consultations about the portfolio should also result in a fee, as should periodic reviews by the advisor. The important point is that the client and adviser should have a mutual understanding of their expectations, regardless of the billing method used.

    Jan Sackley
    Fiduciary Foresight, LLC
    Risk and Regulatory Compliance Consultants
    jan@fiduciaryforesight.com
    Twitter@jansackley

  2. Hi – recently found your blog and really like the info you provide. Over the past 28 yrs. I’ve built a decent sized portfolio by consistently living well below my income. For the past 10 yrs I had been working with an advisor that charged a % of my portfolio AND had sold me some products (annuities) that also landed him a good commission. While I focused all my efforts on earning money I trusted the advisor to be ethical in handling my investments. Obviously I was completely ignorant of the business model my advisor was operating under and the fact that it is NOT in my best interests. I interviewed two “fee only” guys and started working with one to develop a comprehensive plan and possibly manage my assets after the plan is finished. I paid him for the plan but he’s dragging his feet. I believe he wants me to decide to go assets under management and not flat fee. As I’ve educated myself more by reading/studying several quality books, I’m coming to the conclusions that perhaps I should just manage my own portfolio. I’m in a position now to allocate the time to do it, and my high income earning yrs are behind me as I have switched jobs; less money, more fulfillment. So it seems to make sense to save the several $K per year in a % fee to just do it myself. And anyway, after the initial setup the work load should get much easier with just the rebalancing issue. I feel I have a beginning understanding of the principles of asset allocation/balancing, minimizing fees and churn, and a bit about tax efficiency – but NO practical experience in the mechanics of how to do this. It’s scary because I already have substantial holdings that need to be unwound from where they are and then redeployed into low cost investments according to my planned asset allocation. So, for me and perhaps others in my situation who are beginning to see the cost-to-value proposition from many of their adivsors, can you recommend a course of action or resources that speak to the practical, actual do-it issues associated with managing your own portfolio. I apologize if this was already covered in your blog – if you provide the link I promise to read it. Thanks!

  3. Thinking about finding a financial adviser is something I’ve been contemplating for a while, especially after I buy a house in a few months.

    I like the hourly approach because the fees never grow with the assets that I have. I also don’t want the adviser to sell me on any funds.

    I want them to guide my actions, not manage my funds and the hourly approach seems to best fit that scenario.

  4. Hi Mary.

    You say: “I’m coming to the conclusions that perhaps I should just manage my own portfolio…After the initial setup the work load should get much easier with just the rebalancing issue.”

    In general, I’m a big fan of educating oneself enough to do it on your own–or perhaps with as-needed help from an hourly or pay-per-project advisor.

    And in general, I’d agree that the workload goes down after the initial set up of a portfolio.

    On the other hand, there are a couple points I’d make in favor of using an advisor:

    1. As you near retirement, the opportunities for tax planning go up dramatically. For example, intelligently planning the order in which you spend-down your portfolio (Roth first? taxable first? traditional IRA first?) can significantly reduce your overall tax burden. (You can find a little more about that topic here.)

    2. There’s a lot less room for error once you reach the point where you’re spending down your portfolio (because things such as the order of returns matters a great deal). To the extent that an advisor can help you navigate this potentially tricky situation, he/she can really earn the fee.

    If you elect to go the DIY route, I’d point you in the direction of the Bogleheads forum. It’s an excellent resource for asking specific questions.

    And as to the annuities, I might give Vanguard a call for information about swapping them for lower-cost options. You can find more info here.

    Hope that helps. If you have other questions, feel free to ask.

  5. MoneyNing: It’s probably not a surprise, but if I were to hire an advisor myself, I’d go the hourly route as well.

  6. This is a good list that highlights the conflicts of interest most advisers are exposed to. This is why it is very important that you pick a payment scheme and a financial planner that make you comfortable. Your gut is probably a good guide. I don’t think that there is one right answer to which way to go since financial planning is really about the individual for whom the financial planning is drawn up. What works for one person does not work for another. What would you suggest should be part of an individual’s decision making process?

  7. I hunted around and met with asset based and hourly feed advisers. Personally I became disillusioned with it all and decided to keep all the fees myself and go it alone. The book title ‘Where are the customers yachts’ also made me think twice.

    This forced me to educate myself, make some mistakes along the way and I now feel I’m a better person for it. I’m fully in control of my own actions and if it fails I only have myself to blame.

  8. If you’re able to find another advisor whose advice is every bit as good–and whose fee would only total 0.5% of your portfolio–wouldn’t that be preferable to using the advisor with the 1% fee?

    If you have a $500K portfolio, even .5% is $2500. (And what, annually?) If the advisor has 100 clients, that won’t buy a yacht, but it could buy a nice boat or small house at my expense. Phooey, say I. If I’m paying Vanguard .2% ($1000 annually) for a portfolio I’ve already set up on my own, why should I want to boost my expenses to .7% or $3500? What am I getting that I wouldn’t get from the Bogleheads books or the forum?

  9. Nice piece. From a practitioner standpoint, I have concluded that there is no perfect fee schedule. Personally, I charge a flat fee, which I think is preferable to an hourly fee because of my client base. I am a generalist, not a specialist. I make every attempt to apply as much work, time, and research in a way that applies to as many clients as possible. In an hourly context, it’s then difficult to bill for such time.

    For example, I recently wrote a ten page brief (not so brief!) on Roth IRA conversions. I am having discussions about this with all of my clients. Because of the flat fee, the energy and time was spread across my client base in what I believe is a fair way. For practitioners that are considered “specialists,” in which every client is dramatically different, an hourly fee is arguably fair since each client pays their share of the load. Other issues arise, though, such as “what is billable time?” I also don’t like clients to feel like I’m starting an egg timer every time they call me.

    Also, I operate in a “non-discretionary” environment, in partnership with Folio Investing which allows me to “look over a client’s shoulder” without them having to sign over power of attorney to me. I hope that the financial advisory world moves more in that direction.

    The one problem with the “do-it-yourself” approach is that you may not know what you don’t know. The Roth IRA conversion issue is a good example. Most journalists and financial institutions just don’t get the factors that drive the decision. I’m a smart guy and could probably fix my own toilet if I spent the time and energy to learn how. Then again, I might mess up or skip a step and be worse off than when I started. Just because something isn’t rocket science doesn’t mean I’m best served doing it on my own.

    Keep up the good posts!

  10. Personally, I charge a flat fee

    And what is your flat fee?

  11. While I have never consulted with a financial planner, the fee only route seems better to me. I don’t like sales pitches just solid strategies and recommendations.

  12. Daddy Paul says:

    After dealing with a commission based advisor I decided I was going to become educated enough to manage my own money. It was the smartest move I ever made. Now I want to tell everyone what I know so they do not get taken to the cleaners.

  13. Mike,

    I have to agree an hourly fee appeals to me the most. MaryS’s comment on this article made me think that the biggest problem is finding an advisor that will give solid investment advice. I wrote a post on how I would choose a financial advisor:
    http://ponderingmoney.com/2010/01/28/how-i-would-choose-a-financial-advisor/

    I came up with some tough questions to ask the advisor that should weed out the salesmen and find someone that might be worth paying. If you can find a few candidates then compare the rates. You could go to an insurance salesman for free financial advice- however it is likely to cost you a fortune in the long run.

    -Rick Francis

  14. John Gay writes, “The one problem with the ‘do-it-yourself’ approach is that you may not know what you don’t know.”

    Point taken. But the question is how much I would be paying to learn something I “may” or “may not” know already through other reading. There’s a tremendous amount of information available either free or low-cost through the Internet and the bookstores. I can spend $6 for Otar’s retirement book and only $99 for his full-featured calculator. I can spend $15 apiece for the Boglehead books. I can get free advice via the Internet, and it cannot necessarily be assumed unreliable.

    Right now I am 5-6 years from retirement and would not mind spending $500-1000 for a one-time consultation with an advisor in the hopes that it would give me insights I don’t have. But I would not want to spend much more. Just as with investments, fees matter, and they add up. And yet (without naming names) there’s one advisor active on Boglehead who preaches the wisdom of low investment costs, has published books on the matter, but then turns around and charges a minimum of $500 per quarter in his own practice and .025% for accounts over $800K. This is still $2000 per year: 1/3 of the allowable IRA contribution for people over 50, and 2% of a $100K portfolio.

    Which leads me to the other objection I have to this fee structure: charging people with smaller portfolios proportionately more. It’s as if those with more limited resources, who have less room for error and might be the most in need of good advice, are to be hit for a higher percentage of their assets than a millionaire who can more easily absorb the charges. I don’t like that at all.

  15. As a client, the bottom line on determining ‘value’ when buying advice, shouldn’t by judged by the amount of effort provided (i.e. hours) or products bought (i.e. investments). It should be determined by you achieving greater certainty and better outcomes in your financial life. If neither of these are occuring, it’s simple – the fee isn’t worth it.
    What is a good and fair fee for advice?
    It’s a fee that give you believe is fair for the certainty and financial outcomes you seek. As markets continually change, as your financial circumstances continually change, as laws governing distribution of financial products and advice continually change and as new financial products and services continually appear, clients need on-going certainty that their financial dreams, hopes and ambitions have the greatest change of being achieved.
    We’re advocates of retainers, not hourly rates, not percentages of assets that aren’t fixed (sometimes you hit rock and the initial assumptions on which the retainer were developed were incorreect) but agreed at least annually between adviser and client.
    We might be wrong, but we know that rewarding hourly rates, or slicing a lazy percentage off the product has no direct link with providing people with greater certainty.

    Jim Stackpool
    Strategic Consulting & Training Pty Limited
    twitter@jstackpool
    Author of “What Price Advice”
    http://www.scat.com.au

If you want to discuss this article, I recommend starting a conversation over at the Bogleheads investing forum.
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