To know whether you’re getting your money’s worth, you first have to know how much money you’re actually paying your advisor. (Rest assured you are paying). I took a beach walk last Sunday with some friends here on the Cape where I live. We were talking about how Covid-19 has increased peoples’ financial stress. One of my friends commented, “What I like about my financial advisor is that he is a fiduciary,” and then added, “I don’t have to pay him anything for his ongoing advice.” She said his advice is “free.” I asked how then does he get paid? She told me the mutual funds he recommends are paying him. He gets a commission once she invests. She said she’s “fine with that arrangement because he has lots of investments to choose from.” I asked her who is paying the fund’s fees that compensates the advisor? She hadn’t connected those dots. She simply never realized that those management fees and embedded expenses were actually coming out of her pocket.
A lot of people are just like my friend. As long as they don’t know or see the fees, they’re good to go. With today’s stock market volatility and underlying economic uncertainty, now it might be more important to consider your financial advisor’s business model and question whether it is truly aligned with your interests. Then consider if your advisor is a sales rep, what makes him or her qualified to provide broader financial advice?
It Matters How An Advisor Makes Money
Some advisors, like my friend’s, get paid commissions or have a revenue sharing arrangement for selling certain funds or annuities. That means given two investments where one fund may have better performance, lower fees, and be more appropriate for your situation, the broker may get paid more by recommending the more expensive, less appropriate option.
Ultimately you’re paying for all these fee arrangements. But when you ask, you’re likely to get a less-than-transparent answer. That’s because these advisors are not legally held to the fiduciary standard. Even with the newest attempt by the Securities and Exchange Commission to make sure brokers act in your best interest and follow their “Best Interest Rule,” they still don’t have to break down and reveal every fee you pay. Sometimes, the brokers or insurance agents themselves don’t know the internal fee structures.
Other advisors are labeled “fee-based,” which means they get paid in two ways: You may pay them a fee for their advice, but they may also receive commissions from investments, insurance or annuities they sell you.
There’s only one fee model that’s truly fiduciary. “Fee-only” advisors have to be 100% transparent because they are held to the fiduciary standard by regulators. Fee-only means they are paid only by you and not from commissions from an investment firm or insurance company. They may work for you on retainer, by the hour, or they may base their fee on a percentage of the assets they manage for you. The total all-in advisor fees normally shouldn’t exceed the equivalent of 1% of the total assets you ask them to oversee. The fee talk is a conversation you’ll have with a fee-only advisor at the outset of your relationship, and you should ask to be walked through every fee and expense you’ll pay when you decide to engage.
What Is Your Advisor Actually Doing For You?
It’s the very first question I ask any advisor because it helps you understand the value proposition. Getting a complete picture of what you’ll get and how much that advice will cost means you have the facts needed to evaluate the cost-benefit relationship. A recent report by the financial research firm Cerulli found that 77% of investors believe their advisors are worth the cost. Trustworthiness, dedicated relationships and personalized advice are the main drivers of investors’ satisfaction with their advisors.
Even though you could pay practically nothing to work with a “robo advisor” that provides computer-generated investment advice, about 66% of the investors surveyed prefer to interact with a human rather than using the latest technology tools.
An excellent financial advisor provides more than just investment picks. Vanguard has been studying the extra value that a financial advisor can provide for more than 15 years, and concluded that advisors who follow certain standards can add an average of about 3% per year to investment returns. This “advisor alpha” isn’t just because they choose better investments, but also because other help they can provide -- such as investment allocation strategy, tax efficiency, withdrawal advice, and also behavioral coaching to make sure you don’t get nervous and make short-term financial decisions that could jeopardize your long-term goals.
A good advisor stops you from making expensive mistakes that can add up over time. A study by Dalbar, an investment-research firm, found that people who invest on their own tend to perform more than 3% worse than the market. It’s not because of the investments they choose, but because they tend to jump in and out of the market at just the wrong time. In 2018, for example, the S&P 500 index lost 4.38% but the average investor actually lost 9.42%, according to the Dalbar study, because investors reacted out of fear.
At the end of the day, to assess an advisor’s worth, you need to consider performance: Are you getting the returns that the market is giving? Are you investing in a tax-efficient way? What are your total returns after fees and taxes? Do you sleep better at night because you’re not investing all on your own?
In addition to choosing investments, a competent advisor or planner can also help you step back and set your financial priorities. You can collaborate with your advisor on money decisions as they come up -- big or small. You may need help figuring out how to juggle saving for retirement and your kids’ college, or wonder if you can afford to buy a new home or help your aging parents. Your advisor can also help you minimize the risk of running out of money in retirement and make a plan for leaving a legacy. These are complex decisions that come from an ongoing, trusted relationship versus one based on transactions you make.
The decision to hire a financial advisor is important and comes with consequences. Like money, good advice compounds over the years.