How Do Financial Advisory Asset-Based Fees Work?
Financial advisors are specialists that offer advice and guidance on how to best manage your money. They help you formulate a financial plan to achieve your goals at a pace that is most suitable to you. Their services include investment management, tax planning, estate planning, life-care planning, debt management, and much more. Your financial advisor is your go-to source for decisions related to money, personal finance, and investments.
Some financial advisors charge clients through a fee-only structure, wherein they get exclusively paid for their services, while some financial advisors are fee-based, wherein they are compensated by clients for their services while also earning commissions by selling specific products or investments. Although both types of advisors facilitate financial planning and wealth management, they differ in their functioning and principles. Most importantly, irrespective of the type of fee-model, the cost is likely ascertained based on the services provided by the advisor and the assets they manage on your behalf.
Here is everything you need to know about different financial advisory service fee structures, and one of the most popular fee-structures used by financial advisors, the asset-based fee model:
What are the different types of financial advisory fee models?
Ideally, there are two broad ways financial advisors charge their clients:
1. Fee-only advisors: Fee-only advisors earn their remuneration in the form of a fee from clients. If you engage with a fee-only advisor, you will pay them a flat fee, an hourly charge, or on a project basis. The main advantage of a fee-only model is that you can expect uniformity in a financial advisor’s charges irrespective of the size of your investment or assets.
Fee-only advisors can further be categorized into:
- Flat fee advisors: As per this model,your financial advisor can charge you a fixed amount for the entire year, within which you may consult your advisor on your financial concerns and queries. This type of model costs a higher amount in the first year. Subsequently, the advisor may reduce the annual fee as the engagement progresses.
- Asset-based fee advisors: This is the most popular model that a majority of advisors use to charge their clients. In this model, your advisor will charge you in terms of a percentage (generally 1%) of the assets that they manage. These advisors usually dedicate more time and attention to their clients, and guide them through the entire process of creating their financial plan, executing it, and rebalancing their portfolio whenever necessary.
- Performance-based fee advisors: Performance-based fee advisors typically have a two-tier fee structure. Primarily, they charge a base fee linked to the assets, which is further clubbed with a share in the profits at a defined percentage upon fulfillment of some rules. Even though this option is more economically feasible, it is also highly risky. Advisors might take a higher risk on your portfolio than your portfolio warrants to get lucrative and higher returns that improve the advisor’s gains.
2. Fee-based advisors: Fee-based advisors might not charge you anything upfront and their fees are likely to be lesser than what other advisors charge. Fee-based advisors earn primarily through a commission on investments you make through their services. Such professionals hold licenses to sell investment and insurance products in return for a commission. This means that they may tend to push high-value products to you even if it may not be a perfect match for your portfolio. Hence, you will need to be wary of their salesmanship.
What is the difference between an asset and fee-based financial service?
| Criteria | Fee-only (including asset-based pricing) Financial Advisory Services | Fee-Based Financial Advisory Services |
| Remuneration method | Paid by the client upfront for specific services rendered | The client is billed but the advisor also receives a commission from financial firms for the sale of their products and services |
| Sources of income | Single source of earning and no other medium of compensation like payments from fund providers, etc. |
Multiple sources of earning including the client fee, as well as commissions from financial products purchased by the client |
| Standard of service delivery | Most are financial fiduciaries, implying they are obligated by law to put the interest of their clients first | These advisors (brokers, dealers, etc.) are not fiduciaries and only follow the suitability standard of care for their clients. |
| Risk | Less risky as there is a fiduciary guarantee and also, the interest of both parties are aligned | Riskier as there is no fiduciary guarantee and interest of both parties may or may not be aligned |
Overall, when it comes to choosing a financial advisor’s remuneration model, it is advisable to pick a professional that uses the annual asset-based fee model.
What is an asset-based fee model?
The asset-based fee model is a remuneration model that involves a specific percentage of money being allotted to the financial advisor based on the assets under management (AUM). Assets under management refer to the present market value of the assets/investments that your financial advisor or institution is in charge of managing on your behalf. As a general rule, AUM only includes the value of funds that are directly managed and invested on behalf of the client. The Securities and Exchange Commission (SEC) also defines AUM as those securities for which the financial advisor offers “continuous and regular supervisory or management services”.
Typically, advisors charge around 1% of the total assets they manage. So, if your financial advisor manages assets worth $200,000, then you could be paying anywhere between $2,000 and $4,000 as remuneration under the asset-based fee model. However, the exact charge is also influenced by the experience of the advisor and the popularity of the firm you choose to manage your assets.
Annual asset-based fees often reduce as the value of your assets increases over time. Some financial advisors have a specific benchmark scale that lists the change in fee percentage upon attainment of an asset-value goal.
However, ‘AUM’, i.e., the key factor for this kind of pricing model, is calculated differently by different firms.
What is the AUM fee?
Different companies use different methods to measure AUM. The AUM calculated by some firms is based on their inherent structure of the operation. For example, a mutual fund company will calculate AUM fees differently from a financial advisory firm. Similarly, other companies such as insurance firms or brokerage houses may use a different method. Sometimes, it is simply a matter of preference. All in all, the firm offering the service you subscribe to has full control over how they define AUM. Most companies also consistently update their AUM terms. But the SEC specifies certain rules on what can and cannot be a part of the AUM. That said, because AUMs are defined per the market value of assets, the value of AUM fluctuates daily.
Hence, it is critical to understand the AUM definition as per your financial advisor and determine the terms in advance. Additionally, if the advisor is also in charge of managing your bank account and separate mutual funds, shares, etc., he/she will also include this in the list when ascertaining the fees they will charge you. This type of remuneration is also sometimes known as ‘Assets under Advisement’.
Financial advisors who work on an asset-based fee model may act as fiduciaries. A fiduciary status for a financial advisor indicates that the professional is liable to put your needs before their own and that they are legally bound to provide you the best of their services. They have a fiduciary duty towards their clients.
What are the benefits of engaging with an asset-based financial advisor?
Here are some of the most significant benefits of engaging with an advisor who provides asset-based fees financial planning service:
1. Assurance of your best interest:
Asset and fee-based financial services professionals are mostly committed to performing a fiduciary duty. Hence, by engaging with an asset-based financial advisor, you can be sure that your money is being handled by an advisor who has your best interest in mind, and that the investments undertaken are to your advantage.Owing to their fiduciary status, an asset-based financial advisor is compelled to place your needs before their own.
2. Transparency in financial services:
Asset-based fee advisors have a fiduciary responsibility towards their clients and are registered with theU.S. Securities and Exchange Commission (SEC). This provides you complete access to their qualifications, certifications, remuneration methods, and more. Also, if the advisor fails to honor the relationship and/or does not maintain 100% transparency in their actions and objectives, they can be legally sued. In case of an extreme condition that results in a serious crash in the value of your portfolio, the SEC can also revoke the license of the advisor or ban the individual permanently from providing any financial services.
Asset-based financial advisors also specify their terms and fees, disclose how AUM will be calculated under different situations, as well as how the fee will change over the years. They make you aware of all possible areas of conflictupfront to prevent any chance of disagreement in the future. Moreover, because these advisors cannot use your assets and investments to benefit another client, the level of trust in the advisor’s loyalty is higher.
With an asset-based financial advisor, who is also a fiduciary, you are more at peace because of their trusted financial support. Life stages like marriage, childbirth, divorce, retirement, etc., often require you to adopt an updated financial plan, which can be formulated and executed with the help of your trusted financial advisor. Hence, with their assistance, you can be better prepared for life’s uncertainties by creating a financial plan in advance.
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How does an asset-based pricing model compare against the normal fee for a financial advisor?
There is no standard or ‘normal’ fee that financial advisors charge. Each financial advisor levies a different fee based on their expertise, fee structure, certifications, services offered, and location. Hence, it is difficult to precisely know how much you should pay a financial advisor for their services. For example, a CFP (Certified Financial Planner) might offer a narrower range of services than a money coach, but might be more expensive than the latter.
Therefore, the price range when hiring a financial advisor essentially depends on your needs and your budget. For example, if you only require basic investment advice for a small investment account, it might be wise to pay a flat fee or an asset fee worth $1,000 or more. However, if you have a larger investment portfolio, paying for an expert with sound financial knowledge and fiduciary standards might be the ideal way to go.
Besides, because there are plenty of advisor fee models, it is advisable to shop around and compare your options before sealing the deal with a financial advisor. There are multiple companies, brokerages, banks, and advisory firms to choose from. Also, human financial advisors are not your only option. You can also consider using the services of a Robo-advisor or an online investing platform, provided they fit your needs.
Tips to ensure transparency in advisor fee costs
Once you decide on the final fee-model that suits your financial needs, here are three steps to take to ensure you are well informed of the advisor fees involved:
1. Be aware and ask questions on charges openly:
Before you engage with any financial advisor, be sure to know their fee structure. Understand how they charge and how much they charge, and whether they follow a flat-fee or an asset-based fee model. If they have an asset-based model, find out about the scope of their AUM and their calculation methods. Ask your questions openly and get answers explained to you clearly.
2. Be careful with your investment choices:
The investment world is complicated. Hence, when you invest in specific securities like mutual funds, you might have to pay add-on charges. In such cases, ensure that you clarify who will bear these charges with your financial advisor. Additionally, work with your financial advisor to identify more economical investments that suit your risk appetite and monetary goals.
3. Negotiate well with the financial advisor:
Before picking your financial advisor, clarify all the contractual terms and the conditions of the relationship. Do your research, check all options, on fee-terms with your shortlisted financial advisors.
Which fee model will work best for your financial needs?
Financial advisors are paid in a variety of ways. But understanding how your advisor is paid is of utmost importance. The fee-model speaks volumes of their interest alignment, transparency, and loyalty. Typically, fee-based advisors rank low on these three parameters and are more likely to offer you ‘suitable’ advice, which might not necessarily be the finest option.
Hence, when it comes to finding the best financial advisor, it is wiser to consider engaging with a fee-only, more specifically with an annual asset-based fee advisor. These professionals are considerably more economical than their counterparts and may also follow a fiduciary standard, guaranteeing you transparency, optimum financial advice, and loyalty in service.
To sum it up
Choosing the perfect financial advisor is not an easy task. It requires that you comprehensively understand their way of functioning, areas of expertise, and experience. Even though prospective investors keenly research and seek out information on the amount financial advisors charge, the method of payment is often forgotten. However, as highlighted in this article, an advisor’s preferred mode of payment is important for the type of financial service the advisor delivers. It is wiser to evaluate several options and select the advisor that best meets your financial needs and budgetary limitations, and to pick an advisor who charges you in a way that is comfortable for you. Remember that your financial advisor is the custodian of your hard-earned money. Hence, be careful in your selection.
If you think you need help in selecting a financial advisor, you can always use Paladin Registry’s Matching Tool to find a vetted and qualified financial advisor. Answer a few simple questions to get matched to 1-3 financial advisors based on your financial requirements. You may check their certifications, fee structures, etc., set up a free initial consultation, and choose a financial advisor that is most suitable to your needs.
For additional questions on asset-based fees and how they work, visit Dash Investments or email me directly at dash@dashinvestments.com.
About Dash Investments
Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.
Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.
CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.
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