Hiring a Financial Advisor: Don't Settle for 1% Fee

March 31, 2008 by TFB

As you all may know by now, I listen to the Marketplace Money program on public radio every week via their podcast. It's a great program. It always has interesting topics and their economics editor Chris Farrell always uses plain English when he answers questions. Chris Farrell recently started a blog Getting Personal where he answers one question a day from listeners. Unlike me who tends to write too long, Chris' answers are short and to the point.

Occasionally, I disagree with his answer. Back in February a caller Sue asked about finding a financial advisor after she inherited $1 million. She said she'd like to get some professional help because she and her husband were not familiar with investing. She contacted a financial advisor through referral from NAPFA but she was scared by the 1% fee the advisor charges. If you have RealPlayer, you can listen to the Q&A online .

When the host asked whether Sue would be comfortable implementing a plan herself if she gets a plan from a fee-only advisor, she said yes and she would like to do annual checkups with the advisor. Chris told Sue she will have to pay some fees and that 1% fee is normal. It's not. Paying 1% fee every year ($1 million * 1% = $10,000) for investing $1 million is outrageous. If Sue invests her $1 million with Vanguard, she gets Flagship Services immediately. She can get a financial plan, annual checkups, and telephone consultation from a Certified Financial Planner at Vanguard for FREE.

I'm always puzzled by why financial advisors charge their fees by the amount of money their clients have. It's based on the client's ability to pay, not on the time and effort to serve that client. No other professions I know of charge fees this way. Does it really take twice the time and effort to serve a client with $2 million versus a client with $1 million? I don't think so. And why should advisors  get an automatic raise at the rate of portfolio growth, which is usually much higher than inflation?

I understand the need for a financial advisor. Not everybody is interested in or good at managing their money. It's just like my hiring a gardener to maintain my yard while many others mow their lawn themselves. As the saying goes, in managing our money, the worst enemy is often ourselves. I've inflicted plenty of damage to my own finance in the past. I wish I had an advisor telling me no to my crazy ideas. Good financial advisors do add value and they do need to get paid for their work. But paying 1% on a $1 million portfolio is way too high. If I were Sue, I'd use the free service from Vanguard or pay a fee-only advisor no more than $3,000 for an initial plan and $1,000 a year thereafter for checkups and answering questions.

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Comments

15 Comments on Hiring a Financial Advisor: Don't Settle for 1% Fee

  1. Anonymous on March 31, 2008 | permalink
     

    I've often thought the same thing about tipping in restaurants.

  2. Kristin on March 31, 2008 | permalink
     

    It seems to be an industry wide standard to charge based on the amount invested. Aren't Mutual funds set up this way also? The management fee is a percentage of your assets in the fund. The more money you have invested the more you pay.

  3. Ted on April 1, 2008 | permalink
     

    Doesn't there need to be a definition of what "professional help" a "financial adviser" will provide for 1% before we determine if 1% is too much?

    I assume at a minimum this includes account set-up, risk tolerance evaluation, income need evaluation, asset allocation, asset distribution and annual evaluations.

    The questionable part in my mind, and probably the caller's because she needs it, is does this include other valuable services like estate advice and planning, tax advice and preparation, and limited legal advice regarding the inheritance?

  4. Michael Edmonson on April 1, 2008 | permalink
     

    "No other professions I know of charge fees this way."

    How about Realtors(R)?

  5. TFB on April 2, 2008 | permalink
     

    Kristin – While you are in no position to negotiate with the mutual funds, you can choose how you pay your advisor, especially when free or flat-fee service is available from Vanguard. I think one of the biggest challenge in hiring an advisor is knowing whom to trust. When you go with Vanguard, you greatly reduce the risk of falling prey to someone who sells you equity index annuities, variable universal life, illiquid limited partnerships, and all sorts of junk. Free or flat fee makes it even better.

    Ted – From the conversation between Sue and Tess and Chris, I'm pretty confident she will be well served if she takes the financial planning service from Vanguard's Flagship service. She will get all the services you identified as the minimum. If she needs her tax prepared and estate planned, her advisor can identify the need and she can go to specialists for those. CFPs typically don't do tax returns and wills/trusts themselves anyway unless they are also a CPA or attorney.

    Michael – You are right. Realtors also use a pricing model that doesn't make much sense. If you sell a 3 bedroom house and your brother sells a 5 bedroom house worth much more money, how do the required skills and time and effort differ?

  6. Anonymous on April 2, 2008 | permalink
     

    I have heard several mention that Vanguard Flagship services are not that high quality. You are steered toward Vanguard products, which while are very good in general, aren't always the best option for particular asset classes. They also only advocate market cap based portfolios (i.e., hold everything in proportion to how it is weighted in the market), and many academic studies suggest that this might not render the best risk-adjusted returns over the long run.

    In my research, I have found that reputable fee-only advisors (e.g., those with access to DFA funds) charge 0.25-1.00% of assets. There is some difference on the basis – some do it on all investable assets not just those under their management (e.g., 401k).

    I chose to forgo the % of assets route and found someone who would do a one time plan and basically educate me. Cost was just over $1k and the knowledge and associated discipline that comes with that knowledge will last me forever.

  7. TFB on April 2, 2008 | permalink
     

    Anonymous – I'm glad you were able to pay a low fee for a good plan and a good education. You just proved my point — a flat fee service beats paying 1% of your asset year after year. As to Vanguard's planning service, if you know enough to be able tell a good advisor from a bad advisor, you can do better. For the no-so-experienced investor, like Sue who called the radio program, Vanguard's service can be good enough. Good enough gets the job done. If she were to pick a random advisor, even from fee-only NAPFA referrals, she wouldn't necessarily do better than going with Vanguard Flagship. I'm not saying all advisors are crooks, but there are certainly many crooks calling themselves advisors out there. Just read this Q&A for example.

  8. Kirk Mickelson on December 3, 2008 | permalink
     

    Your making a lot of assumptions. If you are talking about just drawing up a financial plan I agree. I have charged clients 1% in the past and basically felt like I was giving the financial plan away for free. For 1% I have to monitor the clients portfolio 24/7 365 days a year, and in this market money well spent. A client would spend much more in commissions or even fully invested in mutual funds at 4 or 5%. Also I wish you journalist types would quit bringing up Vanguard would you rather pay 1% for an actively managed portfolio or be down 40%?

  9. SV on February 14, 2009 | permalink
     

    I successfully avoided an Ameriprise guy who tried to get me into the VUL path. I tried my own thing after a year or so after that, but frankly, I just lack the clarify and discipline to steer the boat in the right direction. I am trying out an adviser from Ed Jones, who has just recommended some funds with 5.75% front-load.I have a portfolio of ~150K. Will I be able to get better financial advise and monitoring elsewhere? I don't mind learning the ropes for a year or two and then trying it out myself.

  10. TFB on February 14, 2009 | permalink
     

    SV – If you invest at least $100k with Vanguard, you qualify for their Voyager Service. You can get a financial plan from them for $250. I think it's a very good deal if you want some help.

  11. SV on February 15, 2009 | permalink
     

    Hmm.. I should've mentioned that out of the 150K, about 100K is in my 401K account with Fidelity. So I cannot move it out of Fidelity, atleast for now.

  12. TFB on February 15, 2009 | permalink
     

    SV – Although I haven't used them myself, I've seen other people recommending the Garrett Financial Planning Network. Members of that network are fee-only advisors who are not supposed to sell you anything except their time.

  13. philip b on May 31, 2009 | permalink
     

    TFB,

    I accidently came across your website and feel compelled to reply.
    As a quick note, I just returned from the Morningstar conference in Chicago and I got a chance to meet and speak with Jack Boggle. He sat next to me in a breakout session discussing Modern Porfolio Theory.

    Anyway your article is good but obviously you do not have much real world experience in dealing with HNW clients. They often require a lot more attention than just allocating 1 million dollars to amoungst 6 or 8 low cost index funds. When you get to investible assets of 1mil+ generally the complexity of the HNW needs go well beyound this simple task. The cost, as far as the fee I charge is really immaterial versus what they are getting for that fee. I have had several clients over the years tell me they really do not care what they are paying(within reason of course) as long as their expectations are met. The expectations, at least in my practice, are laid out in the IPS statement and the contractual agreement the client signs. Real world Financial Planning and investment management done at a high level with HNW families(1million of investible assets+), demand much more than a plan created over the phone and assets managed by someone they have never met, been around, been referred to, can call at home, would consider a trustee or steward of their financial affairs if something tragic were to happen to them, etc. If financial planning were really as simple as you think that it is, everyone would be at Vanguard. Just like every millionare would be driving a Toyota or whatever car you feel has the best value for the buck in your one size fits all utopia.

  14. TFB on May 31, 2009 | permalink
     

    philip b – I do not doubt that you provide good service and value to your clients who need it. My post is specifically about this Sue who called the public radio. Listen to the call and tell me what you think. I don't think the kind of HNW clients you describe would call public radio with their complexity.

  15. Otherwise preoccupied on June 9, 2009 | permalink
     

    I'm working with an Independent Financial Planner and much prefer that to the big firm I was using previously. He stated it very well when he told me "people may lack the desire, skill or time to manage their portfolio to the optimal level". That is very true as I have the skill as a CFO but I certainly do not have the desire or time. I would much rather be developing my company plans or spending time with my family. For me 1% is money well spent!

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