Financial advisers don’t work for free. Clients understand this and don’t mind paying reasonable fees for services rendered. The structure of those fees and the manner in which they are paid, however, can have a significant impact on the advice clients receive and on their pocketbooks. (See Are There Conflicts In Your Portfolio? for a related article on conflicts of interest.)
There are two basic fee structures used by most “fee-only” financial advisers:
- Percentage of Assets Fee – charging a percentage of the assets under management
- Hourly Rate or Flat Fee – charging per hour of work or a flat fee for services rendered
It is estimated that 90% of all “fee-only” financial advisers use the percentage of assets fee structure for compensation and here’s why.
Percentage of Assets Fee — The Cost
Annual asset management fees range from 0.5% to 3.0% of assets under management, but typically average between 1.0% to 2.0%. The following table outlines the costs (in red):
|Annual Percentage of Assets Fees Paid|
Percentage of Assets Fees — The Devastating Impact
These fees are paid every year. Think about the devastating impact on your overall wealth.
Example #1 – Let’s say you have $500,000 in assets and are paying $5,000 per year in asset management fees at a 1% rate. You are also contributing the maximum amount to a traditional or Roth IRA for you and your spouse (that’s $5,500 each for a total of $11,000 in 2015). That means you are essentially suffering a 45% loss on your traditional or Roth IRA contributions ($5,000/$11,000). How long can you afford to do that?
Example #2 – Let’s say you have $1,000,000 in assets and you are paying $10,000 per year in asset management fees at a 1% rate. You are also contributing $18,000 each year to your 401k plan (the maximum for 2015). That means you are essentially suffering a staggering 55% loss on your annual 401k contributions ($10,000/$18,000). Is that what you’re working hard to save for?
Example #3 – Let’s say you are a recent retiree looking forward to the good life. You’re not super-rich but you’re not hurting either. You’re wondering whether or not you’ll have enough money to survive a long life without scrimping on your lifestyle. How much can you safely spend each year? Here’s the conventional wisdom:
The normal threshold for retirement spending is typically 4% of your accumulated assets. That is, under most scenarios you can safely spend 4% of your accumulated assets and not go broke before you die (depending on your longevity, rate of inflation, investment returns, etc.). If you spend anything over 4%, you increase the odds of going broke before you die. Anything less than 4% is considered pretty safe.
So, if you are paying 1% in annual asset management fees to your financial adviser, you are effectively giving up 25% of your wiggle room to stay under the 4% threshold. That is, your spending threshold is lowered to 3%. Does it make sense to do that? Did you work hard all of your professional life to turn over a quarter of your retirement income to a stranger?
Example #4 – Finally, consider how asset management fees may devastate your portfolio over the long-term. The table below details the impact of annual asset management fees over a 30 year period (in red), based on average annual rates of return of 6%, 8%, and 10% in a tax-deferred account.
|Long-Term Asset Management Fee Impact|
If you are paying just $2,500 in asset management fees every year for 30 years, it will cost you $452,360 at an average annual return of 10% over 30 years. That’s a lot of retirement money to give up. Is the service you receive from your financial adviser going to be able to replace that money?
How Can You Avoid These Extraordinary Costs?
At Liberty Financial Planning, we believe that compensation based on an hourly rate or flat fee for services rendered is just more sensible for clients because it saves them money versus the traditional commission-based or percentage of assets fee structures. You keep more of your hard earned money working for you.
Give Liberty Financial Planning a call today for a free initial consultation to see how we can serve you.
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