Ooh La La

Fee, Flat, or Free?

Dec 10, 2024

“I wish that I knew what I know now, when I was younger.” When it comes to the value of a financial advisor, there is not much that’s clear until you have hindsight. In many ways, the value can only be proven over time, requiring you to have faith in the process and relationship. Often, to obtain real value, you have to continue in the relationship when you feel the least confident in it.

Most clients wish they had more knowledge when selecting an advisor, even if they select themselves.

Note: Bonus points if you knew Faces contained Rod Stewart, and I acknowledge that I’m old enough that you may not know who Rod is. The dude could still sing in 2004, as noted here (Amy Belle, wow). Ronnie Lane is in this shot, too. And Ian McLagan. And Ronnie Wood. There were reasons why they were awesome. Fun time is over. Back to work.

There is much noise regarding the cost of working with an advisor, the value received, and the various fee models. Guess what? There is no right way or model. The right one is the one that works for you. And how are you to know that? Realistically, experience is the only way you will know, and that experience is shaped by your behaviors, your advisor’s behaviors, and economic and market conditions that neither of you control. Success is relative for every one of us. My goal here is education and not defense of one model. With education in mind, we will cover what “real” financial advisors do, what financial salespeople do, and then of course there are folks who do some of both.

Real Financial Advice

What is a real advisor? This is someone who is never intentionally selling. A real advisor is educating and doing so in a way that best positions you to make an informed decision that is in your best interest. Like being an attorney, the world of financial advice has a huge body of knowledge. A real advisor doesn’t know everything and they also know what they don’t know. They know where to find the knowledge they don’t have and they know when they need to team with an expert in a given domain. There are folks who contend that real advisors are unbiased, and there are folks who market themselves this way. My belief is that no person is unbiased. Our brains just don’t work this way. My bet is that defeating the brain’s “safe mode” is extraordinarily difficult. If we accept this premise of embedded, implicit bias in everyone, a real advisor has the behavior orientation such that they are always thinking about and doing their absolute best to stand in your shoes and deploys and guides the process in a way designed to benefit you at all times. They are devoted to serving their fiduciary duty to you.

When someone has a fiduciary duty to someone else, the person with the duty must act in a way that will benefit someone else financially.
The person who has a fiduciary duty is called the fiduciary, and the person to whom the duty is owed is called the principal or the beneficiary. If the fiduciary breaches the fiduciary duties, the fiduciary would need to account for the ill-gotten profit. The beneficiaries are typically entitled to damages.

The graphic here represents a decent summary of the domain of financial advice.

We also see all kinds of special situations. Each family and individual is unique, and of course not all of this may apply to you. Subsequently, the advisor never knows what they are going to see and forms no initial opinion. A real advisor’s mind is open, focused solely on collaborating with the client to design and implement the right path for that client. A real advisor has the courage and commitment to say: “You might fire me for telling you this. You should fire me if I don’t (h/t Carl Richards).”

Sales

You face a lot of sales people in this business, too, and it can be extremely hard to distinguish salespeople from real advisors. That’s part of the tarnish that affects this business. Nearly every client (and advisors, too - I talk to a lot of them) I speak with has been “sold” something, and they do not, in hindsight, appreciate it. We have to acknowledge that sales incentives can affect behavior and that some try to disguise what they are doing and/or mean to deceive people in order to make the sale. Sales people are most often compensated by commission or some compensation structure tied to closing each sale. It is common for additional incentives or compensation resulting from sales volume and/or the size of the sale. There are sales people who are salaried. However, it is rare for there to be no incentives.

My general test, whether it’s the financial services business or any other, is to think about the conversation. Are we talking about alternatives? Does the person have access to multiple products and manufacturers? Are they trying to apply one product or focusing on product features? Or are we talking about a process and the outcome, and then determining the path and product set? Are we discussing costs of various approaches along with any difference in benefits from going one direction or another?

The challenge in the sales person model in our business, assuming incentive-laden compensation, is that the incentives affect human behavior. This is well-documented and highly likely, regardless of how much the sales person is aware of the influences. It is extremely hard for me to believe that an incentive-influenced person is going to guide you to the best decision for you.

Free

By free I mean that you are self-guided. If you are working with someone who calls themself an advisor, and they charge no visible fee, they are in sales. They are getting paid somehow, by some product or service provider, and most likely that is a commission model. You just don’t see or they don’t disclose how they are being paid.

Now, you might choose a financial planning product that is not free. And perhaps the investment funds you use have expenses. And maybe your custodian charges an annual account maintenance fee. These are businesses. They have to generate cashflow and make net income somehow. So free is relative in most cases. Done well, it is likely to be less costly than hiring an advisor. Do you achieve the same value as a professional, experienced, real advisor? That is the $64,000 question.

The self-serve model can actually be free, though. There are tools out there. There are zero-fee funds (I’m not saying you should use them, just that they exist). Here are some sites (Again, I am not recommending anything here, just noting that you have choices):

All of the investment custodians (Fidelity, Schwab, Vanguard, and the like) have calculators and planning tools, many of which are accessible even if you do not have an account with that custodian.

The fire and water here? Many options and tools. Choices. Technical expertise. If you understand how to use the tools, and/or are willing to spend the time to learn the technical skills, you certainly can develop a reasonable plan at least for financial independence and security. We have seen a few that are well-done. It can be fairly challenging to run more complex scenarios, understand the quantitative and qualitative impacts of being unable to work, dying too soon, or living too long, create the right estate plan (that’s a whole other area, and there are online, but not free, tools, there, as well), or develop any sophisticated tax planning scenarios. The tools I have seen do not offer much help for property and casualty scenarios/insurance planning, either, which also need to be part of your financial plan.

If you have the interest, the time, a modicum of math skills, a focus on process, and the commitment to regularly review and modify your plan, you can be your own advisor.

There is one substantial assumption I am making: you understand your own biases and can deal with a forecast and/or fact set that contravenes what you believe or wish to believe. Can you look yourself in the eye and say: “Naw, we ain’t doing that”; when it’s something you really want to do?” My belief is this is the, by a long shot, largest obstacle to successfully being your own advisor.

I am not against being your own advisor. Will it save you fees? Probably. Will it deliver more value? No way to tell. In my opinion, and of course I am a professional (well, I think so - but ask my clients!!!) advisor with my own biases and experiences, it is really hard to do.

Flat

This approach is psychologically compelling to many, and most of the authors I run across who are writing about fee models advocate a flat fee. By flat fee, I mean that the advisor charges an annual fee that is not a percentage of your net worth or investments under the management of that advisor.

How the flat fee is determined depends on the advisor. Most advisors who work this way have some sort of process for determining the complexity of your situation and then set their fee accordingly. They might bill this monthly, annually, or quarterly. So you might pay $250 monthly, $750 quarterly, or $3,000 annually, for example. I’ve personally seen flat fees ranging from $1,000 to $100,000 on an annual basis, and there are folks paying $250,000 or (much) more annually.

The advantage for you is that you know the exact dollar amount you are paying each year. You can reasonably easily have a discussion with your advisor as to value received, recognizing that there is value delivered, for most folks, that is counseling/behavioral in nature and therefore hard to quantify. Positive markets don’t drive up your fee and negative markets don’t reduce your fee. It’s up to you and your advisor to set the fee each year.

The downside of a flat fee is that the incentive for your advisor is to minimize the amount of time they spend managing your affairs. When revenue is capped, the way to increasing profitability is to reduce costs. Of course, your advisor can always increase fees. Inflation will demand this over time, and if additional services are added then it is reasonable for fees to increase. Fee increases do require client/advisor conversation, which can be emotionally and behaviorally difficult.

Percentage Fee

The most prevalent model at this juncture is a percentage fee based on either the market value of the investments managed by the advisor (Assets Under Management or AUM). Increasing AUM often indicates increased complexity. There are exceptions on both sides, such as higher net worth and/or AUM people with simple lives, investments, and planning needs or lower net worth and/or AUM people with complex situations.

We might clients with $20 million in investments and net worth of $22 million who live in the same home they’ve owned for the last 20 years, have no children, are highly charitable and intend to leave their wealth to a few charities. Let’s postulate that they don’t care for private equity, don’t own businesses, and prefer simple investments. This is a simple and probably low risk client from the advisor’s perspective.

Or we might have a client with $1 million in investments and net worth of $4 million, married twice with a combined family, partner in three entities, children ranging in age from 4-18, high income but relatively poor saver, and multiple homes in different locales. Here is a scenario where a real advisor is going to do a lot of work.

Generally, though, complexity increases with wealth. And invested assets/dollars often increase with wealth. The percentage fee is a decent proxy in most instances. The arguments against this approach is that it is not truly associated with the amount of work and that it seems expensive. Other foibles of this model are the advisor gets a “raise” when markets are positive and a “pay cut” when markets are negative. For the most part, the work load is not significantly increasing in positive markets. Oftentimes it increases in negative markets, instead. None of this seems right, so why is it so prevalent?

It is seamless, easy to execute, and unless you look for it on your statement, invisible. The fee is (generally) deducted quarterly from your account(s), making it easy to administer. Most people don’t really look at their statements (Note: I think you should, although in negative markets it can be quite valuable to ignore your balances). If they do look and see their account balance has grown, they don’t feel the fee or just plain ignore it (I’m not saying you should ignore it, just that most people do. I think you ought to know what you are paying for and what you are receiving for your payment). Oftentimes, the fee comes into question during down markets, when balances are dropping. And this is completely unrelated, in most instances, to the work performed by a real advisor, and there are benefits to be had in down markets, like tax-loss harvesting. From the advisor’s perspective, the “uncompensated” work in down markets is addressed covered by the increased compensation during positive markets - it all balances out, essentially.

If you do an exhaustive analysis of cost over time, it certainly appears that flat fee and percentage AUM fees, given reasonable assumptions, are not greatly different in terms of lifetime cost.

What is Right for You?

The real $64,000 question: what is right for you? I can only wish the decision was black and white. You decide value, not who you speak with or what you read. You are the only person who can be honest with yourself as to your interest and discipline level.

I do believe that you are more likely to achieve any goal you might set, financial or otherwise, by clearly articulating, in writing, your goals and by supporting those goals with a plan and a timeline for achievement. Having a plan is better than not. Aside from that, there are many roads to success.

Sundry:

Every ten years or so I re-read ( I think I was early teens at first reading) The Hobbit (published in 1937) and The Lord of the Rings trilogy (published in1954-1955). I find much of it applicable today. I understand the movies are equally terrific, and yes this is me saying I’ve never watched them.
Just in case you want to critique my listening habits, here is part of my Replay. By August I had listened to more than 500 artists, and in January I listened to 166 hours of music. Music heals the soul.

The Uncertainty of It All

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