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.
There are no guarantees. There is always uncertainty.
Even when you have an unbelievable vision.
I love this clip of Jeff Bezos (scroll down). It shows his foresight about the future of retail and customer service. What stood out to me was his humility to recognize the uncertainty of who the expected winners of the ‘internet revolution’ would be.
“Long term I believe that it is very easy to predict that there are going to be lots of successful companies born of the internet. I also believe that today, where we sit, it’s very hard to predict who those companies are going to be.”
In hindsight, it’s easy to look back at Jeff Bezos and his vision to ‘know’ that Amazon would be a massive success. Even Jeff Bezos recognized the uncertainty he faced along the way.
For long term investors, it’s not about predicting the exact winners, it’s about making sure you have exposure to those winners.
As long as you’re saving enough on an ongoing basis, a long term investor can afford to own companies that will not be winners to the magnitude of Amazon.
What the long term investor cannot afford, is completely missing ‘the next Amazon’ altogether. The best way to do that is through diversification.
Jeff Bezos in 1999 explaining (ironically) the importance of diversification.
There are no guarantees. There’s always uncertainty. Even when you have a great idea and vision.
For the majority of us, the wealth building process does not happen overnight! Here are five starting points for the modern wealth builder:
1. Understand where your money goes
What are your fixed monthly expenses? How much wiggle room do you have for discretionary spending? In order to grow your net worth, you must first understand how much money you can afford to put towards your savings and investments on a consistent basis. Even if you’re not sticking to your budget on a monthly basis, being able to review what you actually spent is important for projecting out savings goals.
2. Have a dedicated cash cushion
Responsible wealth builders have a dedicated cash reserve at all times. This is so they are not dependent on their investments to pay for life’s unexpected expenses. Having a cash cushion also allows the modern wealth builder to invest with confidence and stay disciplined to their investment strategy.
3. Take advantage of employer benefits
Modern wealth builders take advantage of employer benefits and don’t leave free money on the table. This includes taking advantage of an employer match through a workplace retirement plan and making the most of other pre-tax benefits.
4. Have a hierarchy for investing accounts
Modern wealth builders have a hierarchy for investing in the different types of tax-deferred retirement accounts. Making sure to utilize tax advantageous accounts first will help improve a wealth builder’s bottom line net worth.
5. Invest based on goals and controllable factors
Modern wealth builders are concerned with investing based on the goals they are trying to accomplish. They focus on the factors that are within their control and tune out the noise of financial media.
It’s not uncommon for a young professional’s first interaction with a financial advisor to be through their parent’s advisor. However, just because that advisor was a good fit for your parents, does not necessarily mean they are a good fit for you.
So, when should you break up with your parent’s financial advisor?
You’re not receiving personalized advice
The relationship is investment centric
You feel like an afterthought
They don’t understand the challenges you face
They’re not easily accessible
Since most advisors are compensated based on the size of a person’s investment assets, a young professional who is early in a career most likely won’t have the assets to incentivize that advisor to spend the time needed to help them make smart decisions with their money. The reality, however, is that an advisor can add a tremendous amount of value to the future financial health of a young professional before they’ve accumulated an investment portfolio large enough to be “profitable” for a traditional financial advisor.
Luckily, hundreds of advisors specialize in working with young professionals. A great place to start your search is the XY Planning Network. The XY Planning Network is a network of independent advisors who are required to put your interests before their own and strictly operate on a fee-only basis, meaning they never sell products with commissions.
Also, many advisors in the network (including myself) utilize a subscription fee for their services — meaning regardless of your age or asset size, you can work with someone who is going to provide you the attention you deserve.
You’re doing everything right — living below your means, have a sufficient cash reserve, and are taking advantage of your tax-deferred retirement accounts to the full extent. So what’s next when you still have discretionary cash flow left over?
First of all, this is a good problem to have and you should congratulate yourself for not falling victim to lifestyle creep!
When deciding on how to allocate additional cash flow towards a worthwhile goal, consider the following:
Is there a shorter-term goal you have outside of investing for financial freedom (retirement)?
Do you have a business idea you’d like to pursue? Investing in yourself is often the best return on investment.
Real Estate – consider adding a rental property to your portfolio for income generation.
Enjoy life in the present more — travel more, go out to dinner more and invest in experiences!
From an investment standpoint, continuing to do more of the same is often a great option! Sometimes, as our net worth and incomes rise, we believe adding complexity to our investments is a natural form of progression.
This is not the case!
If you’re looking to use your money to enjoy life more in the present, consider what your money dials are.
Think about the things in your life that you can outsource, because you:
Don’t enjoy doing them.
Want to free up your time for things you do enjoy.
Want increased convenience.
Time is our most valuable commodity, freeing it up is a form of wealth on its own!
Choosing an appropriate fee structure as a fee-only financial advisor is one of the hardest parts of the business. Especially when clients can have such unique needs, it can be difficult to charge appropriately without knowing ahead of time the level of service someone is going to require.
This is (partly) why I have chosen to take the route of charging a flat fee based on what my time and expertise is (currently) worth. Let me be clear — I do not care how much other financial advisors charge their clients, as long as they are transparent about what their time and services are worth. If a client is willing to pay $3,000 a quarter for your services — great that’s called free market capitalism.
However, I don’t believe the standard 1% assets under management (aum) fee is an equitable way of charging fees. It also still leaves potential conflicts of interest open, even for the fee-only financial advisor.
I think any advisor that’s honest with themselves would admit, there’s incremental (if any) additional work required to manage a $500,000 portfolio vs. a $5,000,000 portfolio. So why should we be entitled to a 10x fee ($5,000 vs. $50,000 annually), when we’re not doing 10x the work?
With the increased efficiencies that technology has provided the financial advisory community, there is no reason someone cannot create a profitable practice (IMO) charging an appropriate $5,000 annual fee regardless of assets under management (for example). Again, if your time and expertise is worth more — charge more.
Since I tend to work with high earning young professionals, I can also tell you that the next-gen of consumers are not going to sit back and pay 1% on a million dollar portfolio to meet with someone once a year. In my (brief) experience, the next-gen of investors I’ve worked with are considerably more informed compared to previous generations that are used to “doing business” a certain way.
This has led them to demand a higher level of transparency and service that aligns with an appropriate value proposition.