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:
- Its benefit to you, or
- Its replacement cost–how much you would have to pay another provider for a similar service.
In other words, be sure to shop around!