While it’s only one of several factors when evaluating how to choose a financial advisor, understanding how we’re compensated is crucial for aligning incentives with yours.
Here are five reasons to work with a flat fee, advice-centric financial advisor:
There’s very little conflict to try and “gather your assets”.
Why is this important? If you’re working with an advisor who charges based on the amount of assets under management, there will always be an inherent incentive to try and “gather” your assets since the more money that’s managed, the higher the fee the advisor can receive. This can cause conflicts of interest in certain situations. For example, leaving money in an employer-sponsored retirement plan can be advantageous to keep pre-tax money out of a Traditional IRA and minimize taxes for backdoor Roth contributions. The assets under management (aum) fee model is not close to being the worse compensation model (for fee-only financial advisors) and many great advisors use this model.
However, you cannot deny the conflicts it creates.
There’s no more work involved managing a $100,000 portfolio versus a $10,000,000 portfolio.
Technology has leveled the playing field when it comes to managing investments. There’s still tremendous value in getting people invested appropriately for their needs, goals, time horizon, etc.. However, when it comes to the logistics of managing investments, it’s literally the click of a button. Even less if the advisor uses a third-party manager. There is an argument to be made that higher dollar decisions justify higher fees, but paying (potentially) 100x for a similar service doesn’t make sense to me.
Financial Planning is the main focus.
Regardless of the compensation model, advisors that are advice-centric, planning focused are the most beneficial. Why? As mentioned, since technology has provided us with so many great, low-cost investment options, the most value an advisor can provide you is by taking advantage of the resources available to you. This means putting you in a position to succeed based on your short and long term goals. Planning for tax diversification, understanding how much of your income you need to save to achieve your goals, and how to transfer (or mitigate) risk are a few essential parts of financial planning that have very little to do with investment selection. An advisor that charges solely for advice will always be accountable to provide continuous value.
Percentage fees can have a massive impact on long term growth.
If we’re being conservative and making realistic long term assumptions about investment returns — even a percentage (1%) can have a large impact on the end value of an investment portfolio.
For example, if we assume long term returns of a “diversified investment” portfolio to be 7% and inflation to be 2.5%, that leaves you with a “real” 4.5% growth. Even at a 1% asset management fee, that’s (potentially) eating away at 20-25% of your real return.
Food for thought.
You always know exactly how much you’re paying and what you receive in return.
It’s just like paying for any other professional who provides a service. You make a conscious decision about how much you’re willing to pay and what you receive in return.
Pretty straightforward. 🙂
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— T.J. van Gerven (@TJvanGerven) February 5, 2020