Managing your finances well takes some time, energy and knowledge—and not everyone wants to take it on. Financial advisors promise to do this for you. But, with a dizzying array of fees, it can be difficult to figure out when they are really worth the cost. While a lot depends on you and your own personal needs, there are some key guidelines that can help you make an informed decision.
The right financial advisor can help you find the right answers to your life’s biggest, most difficult financial decisions. They can tell you where and how much to invest, strategize around your taxes and avoid big mistakes like retiring too early or panic-selling investments at a loss.
A report by mutual-fund company Vanguard found that advisors can potentially add 3% or more to a client’s net investment returns by picking cost-effective investments, behavioral coaching and more.
But individual financial advice from a trained expert isn’t something to purchase lightly. Fees, which are frequently tied to how much money you have to invest, can easily run into the thousands, if not tens of thousands, of dollars each year.
If you do hire an advisor, you want to make sure you are getting your money’s worth—and that they are always working in your best interest. “The compensation to the advisor has to be aligned with what the service is,” says Rick Ferri, founder of Ferri Investment Solutions, a portfolio review firm in Georgetown, Texas.
Read on to understand how financial advisors get paid, when they might be worth it for you—and when it’s probably safe to go with a less expensive option.
How do financial advisors get paid?
If you’re trying to figure out whether an advisor is worth the money, the first step is to figure out what you will pay. Unfortunately, that’s not always easy because there are a slew of different compensation models.
A one-time fee
If all you need is a comprehensive financial plan—a look at how your current savings, including your 401(k) and investments stack up—you don’t need to retain a financial advisor. You can hire one for a one-time financial plan. Expect to pay anywhere from $1,000 to $4,000 for the plan.
An annual fee based on your assets
If you plan to have a continuing relationship with a financial advisor, you will need to pay them an annual fee. The most common form is an annual percentage tied to the total value of the assets the advisor oversees for you. While fees range widely, 1% is typical.
Frequently fees shrink in percentage terms as your assets grow, so that an advisor who charges 1% a year for investors with $100,000 might only charge 0.8% a year for investors with several million dollars in assets. Investment minimums can be significant: Many of these types of advisors won’t work with investors who have less than $500,000 or $1 million assets in assets.
You generally do not pay the fee on assets that are not directly overseen by the financial advisor, such as your home and your 401(k). The fee often, but not always, covers the cost of a financial plan.
Fee only vs. fee-based advisors
If your financial advisor does charge an annual fee, it’s important to know if they are “fee-only” or “fee-based.” Fee-only advisors are paid only by their clients and do not receive commissions from any financial institution. Fee-based advisors are also paid by their clients but they can sell commission products such as stocks, certain mutual funds, and life insurance, which can create a conflict of interest.
Most important, ask if the advisor is a fiduciary, which means they must operate in your best interest not theirs, based on the Investment Advisers Act of 1940. Fee-only advisors are fiduciaries. Fee-based advisors may or may not be depending on the situation.
Commission-based advisors are compensated only by the commissions on the products they sell such as stocks, certain mutual funds and annuities and insurance. They are essentially brokers, not advisors that provide financial planning services, and their numbers are shrinking. The commissions they collect vary widely, depending on the products they sell. Those commissions usually exceed 1% and can range as high as 8% (for a fixed index annuity).
Consumer advocates have long argued this business model creates a conflict of interest because it is in the advisor’s interest to sell the product that will pay them the highest commission.
Hourly, subscription or retainer
Some advisors charge an hourly rate ranging from $250 to $550 an hour or, a monthly subscription or retainer fee or flat rate, which can be paid out annually, quarterly or monthly. These last three are essentially multiples of the hourly rate an advisor expects to spend working on your finances.
Lower cost robo-advisors
These digital automated services are a cheaper option, with annual fees near 0.25% of assets or lower, but investors will only have access to human advisors if they pay for a premium service which costs more.
How to evaluate financial advisor fees
Before hiring a financial advisor, ask for an estimate of your total costs, including investment costs since advisors’ fees usually exclude the annual investment fees charged by mutual funds and exchange-traded funds as well as the brokerage commissions you pay when you buy stocks, insurance or annuities.
While advisors often quote fees in percentage terms, it’s important to translate that into dollars and cents in order to truly understand whether or not you’re getting your money’s worth, according to Micah Hauptman, director of investor protection at the Consumer Federation of America.
A 1% annual fee on $500,000 in assets may not sound like much but it’s $5,000 a year; more if the portfolio grows, less if it doesn’t. The question then becomes, “are you getting $5,000 worth of value every year?” says Hauptman.
When a financial advisor may be worth the cost
A financial advisor is worth paying for if they provide help you need, whether because you don’t have the time or financial acumen or you simply don’t want to deal with your finances. An advisor may be especially valuable if you have complicated finances that would benefit from professional help.
“There’s nothing wrong with doing things yourself provided that you know what you’re doing and have the time,” says Peter Palion, founder of Master Plan Advisory in East Norwich, N.Y. “The biggest problem is you promise yourself you’re going to really sit down one day and do it but then it never happens because life takes over.”
The most difficult task many Americans face is figuring much money they’ll need for retirement—and how to make the money last. The question becomes especially difficult in your last few years in the workforce, when you face the prospect of shifting your investments from growth-oriented holdings like stocks to more stable income-oriented ones like bonds.
A financial advisor can help calculate how much you’ll need to save for retirement, then make the difficult transition when the time comes. One key area where advisors often add value: figuring out the tricky tax implications of pulling money from a retirement account like a 401(k) or an IRA.
The IRS requires you to start drawing down from these accounts after you turn 73 (that rises to age 75 beginning in 2033), and those withdrawals can have major tax implications, such as boosting your income to a level that triggers the Medicare surtax. Advisors are well versed in strategies to avoid these kinds of pitfalls.
Major life changes
Other major life changes can have serious financial implications that may need—or want—help navigating. These include marriage, having a baby, divorce, loss of a parent and preparing inheritances.
For example, during a divorce—when you likely have a lot besides finances on your mind—an advisor can help you estimate the value of your assets in order to negotiate a fair settlement. Afterward the advisor can help create a plan for future cash flows based on your new circumstances, which may require downsizing a home or shrinking spending.
You want reassurance
Plenty of investors work with a financial advisor for less tangible reasons too. They can provide a second pair of eyes on your finances, offer dispassionate opinions and help you avoid bad decisions.
That’s especially true when it comes to mistakes that are hard to undo, such as panicking and selling your stock portfolio during a bear market, moving to a house you can’t afford, or retiring too early.
“They’re not your typical stock market, mutual fund and bonds discussions,” Sheryl Garrett, founder of the Garrett Planning Network, a network of financial advisors. ”It’s important that you get quality fiduciary advice on all those subjects because they’re irrevocable.”
When a financial advisor probably isn’t worth the cost
There are several financial areas where paying for a financial advisor may not be worth the cost, especially if you are willing to do a little basic research and have the discipline to stick to your goals.
You need to budget
Financial advisors are there to help answer difficult money questions. In general, they aren’t personal trainers for your wallet. Their time is expensive and you shouldn’t plan on checking in with them every week or every other week, just for a pep talk.
You mostly need to start saving
When you are just starting out in your career, your main goal should simply be to start saving and investing. That means signing up for a 401(k) (if you aren’t automatically enrolled) and setting aside a little extra money for an emergency fund or another savings goal like a down payment on a house.
If you aren’t comfortable picking your own investments, a target-date fund—-a common default option in 401(k) plans—or a robo-advisor can offer all the hand-holding you should need. Paying hefty sums to a human advisor will simply leave you with less money to invest.
That is especially true if the advisor leads with investment management rather than financial planning. “It would be like going to the doctor and be given drugs or undergoing surgery without the doctor diagnosing the problem,” says Eric Amzalag, chief executive of Peak Financial Planning in Los Angeles.
You want help picking stocks
A generation ago financial advisors were known as “stockbrokers.” They earned commissions on stock trades and offered clients advice and research about which names to buy.
Today most advisors build portfolios of funds rather than stocks, and more often than not their focus is on holistic financial planning. Those advisors that build stock portfolios will likely require hundreds of thousands of dollars if not millions to build one, and it won’t necessarily beat the market.
When what you really need is a tax planner
Financial advisors regularly take into account taxes when working with clients but if you are a small-business owner looking for complicated tax strategies or just someone to do your annual taxes, a financial advisor is not the tax specialist you need. Choose an accountant instead, one who can serve your particular needs.
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