Financial Advisor Fees: What You're Really Paying For (EP.268)

0:00Stay tuned for a special offer at the end of this episode pertaining to my new book, The Perfect Port We all need to make smart decisions with our money. The Long-Term Investor Podcast shows you how by distilling complex financial matters into easily digestible lessons. And now, here's your host, Chief Investment Officer at PlanCorp and the author of Making Money Simple, Peter Lazaroff. If you've been a longtime listener of the show or followed all my written work over the years, you've undoubtedly heard me tell the story about hiring somebody to mow my lawn. So my apologies if you've heard this before, but I have to set the stage for what we're talking about today, which is financial advisor fees and specifically what you're really paying for.

0:48So let me take you back to 2010 when I bought my first home. I was dead set on having a big yard and look, I got what I wanted, but I also got the work that came with it. Now at first, mowing took two or three hours and eventually I got it down to about 90 minutes and I think the result was acceptable, but it depended on my calendar and willingness to keep up. Now the summer my first son was born, I hired someone to cut the grass for$35 a week. The lawn definitely looked better and not only that, I got my Saturday mornings back and stop carrying the mental weight of I need to mow all week long.

1:25Years later, we moved to a bigger home with a more complicated yard and we actually went through a few providers because we found that our needs were more complicated and eventually we landed on the provider we had today and they really pay attention to whether the yard is actually ready to be mowed instead of mowing simply because it's Tuesday and it's on their schedule that way. They noticed problems, they responded quickly and they did things based on our specific needs. But I will tell you the time where I really felt good about paying much more than$35 a week for our current provider is when a storm knocked a tree onto our fence.

2:02I was just dreading the process of collecting quotes and coordinating schedules, but my lawn care provider offered to handle the tree removal and the fence repair before I even had a chance to get started. And to me, that was the moment that the added costs stopped feeling like I'm paying more for mowing and started feeling like I'm paying for someone to own the outcome. Different providers may charge different amounts for different levels of responsibility. What mattered to me wasn't the mowing fee in isolation. It was the responsiveness, reliability, and how much got handled without my involvement.

2:41Financial advice raises the same question. Not simply, what does it cost, but what responsibility does the advisor actually assume? Now, today I'm only going to talk about fee-only advisors. Fee-only advisors means that the advisor and the firm are compensated only by clients rather than through commissions or product sales or some other revenue from someone or something other than the client's fee for advice services. Now, there are three common pricing structures among fee-only advisors. Hourly, a flat fee or retainer, and a percentage of assets under management, commonly called AUM. And, of course, there are some firms that combine them.

3:24Here's the thing. Fee-only tells you where the compensation comes from. Hourly, flat fee, and AUM tell you how the bill is calculated. Neither tells you what service will be delivered. and every model creates its own incentives and blind spots. Now, I have to disclose my perspective. I'm an employee and owner of a fee-only registered investment advisory firm or an RIA that primarily uses AUM pricing, so I think candor about its trade-offs is especially important. As we compare the models, focus on what gets monitored, what gets handled, and what happens only when you initiate it. Let's start with hourly advice.

4:07Hourly advice is the simplest to understand because it matches how so many other professional services work. You pay for time, you get guidance, the meter stops. Hourly can be an excellent fit when the job is contained and you're comfortable implementing the recommendations yourself. So think about maybe a portfolio second opinion, a one-time plan, or helping decide where the next dollar should go of your earnings among cash reserves, debt repayment, a 401k, a Roth IRA, HSA, etc. The ideal candidate for hourly advice is typically someone in their 20s who's early in the accumulation phase, but also maybe someone who has only one or two investment accounts and little taxable complexity.

4:51But complexity, not age, that is actually the real dividing line. I do think that hourly advice can be a tougher fit during the decumulation phase when portfolio withdrawals, taxes, Social Security, Medicare, required distributions, and investment decisions interact year after year. It can still work, but it usually requires recurring reviews and a clear understanding of who is monitoring those moving parts between meetings. There's also a behavioral limitation. If every interaction feels billable, you may hesitate to call before panic selling or before a planning opportunity passes. And heck, you may not even realize a planning opportunity has come and gone.

5:36So if you're going to hire an hourly advisor, be sure to ask, when do you reach out to me without asking? The answer tells you whether the advisor is monitoring for issues or whether recognizing the need for help remains your job. The second model is a flat fee or retainer. I think the appeal of flat fees is their predictability and the idea that it is generally fixed or at most linked to inflation rather than asset growth. So you'll pay a set amount each month or each year or maybe even each quarter, and the advisor agrees to provide a defined scope of services. This model often fits the households whose financial complexity is high relative to the assets an advisor can actually manage.

6:22So think someone with strong income but still building up savings, or maybe somebody who has significant equity compensation, or a private business, or wealth concentrated in a single stock or illiquid holding. Now one nuance is that a flat fee tells you how the bill is stated, not necessarily how the firm arrived at it. I think this is really important because many firms use the starting or projected AUM as a major input when assessing scope and complexity, so they might just convert an initial AUM calculation into a fixed dollar fee. And there's nothing inherently wrong with that, but you should ask how the fee was determined and what could cause it to change and how often is it reviewed?

7:07I guess what's included is an obvious question, but I really think the better questions after you understand how the fee is determined are questions about what happens after you sign the agreement. How often is the plan updated? What gets monitored between meetings? What triggers proactive research? What access will you have when markets or your life change quickly? A well-run retainer firm can be every bit as proactive as an AUM relationship. It's all about the agreement, the staffing, and the systems that determine whether or not that can be true. It's really not about the billing label. So keep that in mind because a vague or understaffed relationship can easily drift into a plan-delivered, then quiet sort of situation.

7:53The third model is AUM, or Assets Under Management. AUM is probably the most common pricing structure in wealth management. Here, you pay a percentage of the assets the advisor manages, and that percentage often steps down as assets increase. People will criticize AUM because the dollar fee rises with the portfolio, even when the scope and complexity of the work may not rise proportionately. And that criticism is fair, but it is also true that larger portfolios can raise the stakes of tax, implementation, and behavioral mistakes. That said, higher stakes alone do not establish that a proportionally higher fee always provides good value.

8:34I think the better criticism of AUM fees is that they can create conflict when the best advice would reduce the assets being billed. So that could be paying down a mortgage, funding a business, or keeping money outside of the advisor's platform. So you might ask an advisor to explain how these decisions are approached if they use AUM fees. But to me, the biggest reason to criticize AUM fees is when the relationship is a commoditized investment offering without comprehensive planning. Because at that point, an AUM fee can be very difficult to justify. So if you hire someone that uses AUM billing, then you'll want to understand what service and accountability to expect.

9:15So who are the types of people that best fit AUM? I think that AUM tends to fit someone who wants investment management, financial planning, and implementation integrated into an ongoing relationship. Some of the work is steady and easy to overlook. Portfolio maintenance, rebalancing, tax-aware implementation, and keeping the plan current. Other value arrives in bursts. During market stress, a job change, a health event, a one-time liquidity event, an inheritance. But a well-run firm should be built for both of those kind of things. But the fee itself does not create that service. The firm's scope, staffing, and systems do.

9:57If AUM is being presented as comprehensive wealth management, ask what the advisor does beyond portfolio construction, including tax planning, retirement distributions, professional coordination, and communication during down markets. You'll also want to ask about breakpoints and your all-in costs as well. So how should we compare financial advisor fees and services? When people compare these three models, I think they tend to make two mistakes. The first is treating the fee as the product. The fee is the wrapper. The product is what gets monitored, what gets handled, and what happens when the plan gets tested.

10:38Two advisors charging the same amount can deliver very different levels of planning, coordination, and responsiveness. So compare cost and scope together. The second mistake is assuming you'll always know when to ask for help. Proactiveness matters most in the moments you can't schedule. And plus, if you don't know what you don't know, the cheapest option can get really expensive. Before hiring anyone, there are four questions you should ask, particularly as it pertains to what we've been discussing here today. First, what services are included and what is not? Second, what will you monitor and handle without me asking and what triggers proactive outreach?

11:22Third, how is my fee calculated and what would cause it to change and what is my all-in cost? Fourth, does your firm receive compensation from anyone other than clients and will you act as a fiduciary at all times when advising me? In the end, the right fee model depends on what you need, what you want to remain responsible for, and what you want the advisor to own. If you're hiring someone for comprehensive advice, the value should extend beyond managing investments. It should include helping you make better decisions, implement them well, and stay on plan when life gets complicated. Now, those four questions I gave you, they are only a starting point.

12:05Chapter 11 of my new book, The Perfect Portfolio, includes a much more comprehensive checklist for interviewing an advisor, including questions about fees, services, conflicts, credentials, and investment philosophy. Now, I have a special group of people who have signed up for email updates via theperfectportfoliobook.com. And that link is at the top of the episode description as well. If you pre-order the book, you will get chapters delivered to you early. So if you're hoping to get a sneak peek of this, please do go sign up for theperfectportfoliobook.com. We also have subscriber-only webinars, behind-the-scenes stories, and other special offers that this list and only this list will be hearing about going forward.

12:49As always, thanks for listening. And until next time, to long-term investing. Thanks for listening to the Long-Term Investor Podcast. To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com. Peter Lazaroff is an employee of PlanCorp and BrightPlan. All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.