It
is estimated that 95% of all "fee-only" financial advisers
use the asset management fee structure for compensation and
here's why.
Asset Management Fees: How They Work
Typically, your financial adviser will manage your
investment assets (i.e., IRAs, brokerage accounts, money
market funds, etc.) through a single custodian firm (i.e.,
Fidelity, Charles Schwab, etc.) that he or she works with on
an exclusive basis. Your financial adviser is listed as your
"agent" on the account.
As
your agent, your financial adviser may have discretionary
power to invest assets on your behalf or non-discretionary
power, in which case only you have access to your funds. In
either case, the custodian firm pays your financial adviser
the contractually agreed asset management fee on a quarterly
basis directly from your account. The withdrawal of these
fees from your account is shown on your account statement
sent by the custodian.
Asset Management Fees: The Intent
Asset management fees sound great in principle. Your
financial adviser is paid according to the dollar value of
your assets under his or her management. The theory is that the more money you have, the more complicated your
finances must be, and therefore the more money it costs to
"manage" those assets. Your adviser has an incentive to grow
your assets which in turn makes you wealthier. Of course the
more assets under management, the more money your adviser
makes. Everybody makes more money. It's a
win-win arrangement. Or is it?
Asset Management Fees: The Reality
The reality of asset management fees is not nearly as pretty
as the theory. Conflicts of interest abound for financial
advisers whose compensation is tied to assets under
management.
Conflict #1 - The mutual funds most financial
advisers recommend in managed asset accounts typically have higher expense ratios.
That can cost you an additional 1% per year on average and
it has a significant impact on your long-term wealth. For
example, if you contribute $3,000 per year to a Roth IRA and
receive an average annual rate of return (after expenses) of
10% for 30 years, that additional 1% expense ratio will
cost you $97,105 over
that time.
Conflict #2 -
401-k plans and 529 college savings plans are not an adviser's best friends
because they normally cannot
collect asset management fees on such accounts. Instead,
advisers
aggressively push for rollovers to IRAs so they can
collect their fees or, they may simply ignore your 401-k
assets altogether. Likewise, advisers may avoid 529 college
savings plans in lieu of other opportunities. There are many good reasons for
rollovers from 401-k plans to IRAs or to choose other
college savings plans than a 529 account, but one of them
shouldn't be your adviser's paycheck.
Conflict #3 - Using an exclusive custodian for client
accounts means that the financial adviser is limited to only
those investment options available through that custodian.
You may not be offered the best selection of investments to
meet your needs.
Conflict #4 -
Financial advisers have an incentive to keep as much of your
assets under their management as possible, even if paying
down debt, making a large purchase with cash, or gifting for
estate planning purposes is more
prudent. Such decisions are rarely straight by the numbers
and it's easy to argue them either way. You may not get an
unbiased perspective.
Conflict #5 -
Financial advisers gets paid whether or not your assets
grow. If you had $500,000 last year, then you paid your adviser
$5,000 at a 1% annual fee. If you lose 20% in the market
(now you have $400,000), you will still pay your adviser $4,000
this year.
Sure, it's a cut in his or her pay, but it hardly breaks the bank.
Advisers also collect their fees to "manage" your money,
even if you are engaging in a "buy and hold" strategy.
Conflict #6 -
You are not an attractive client if you haven't already
accumulated sizeable assets. Most financial advisers require
minimum asset levels, typically $100,000 or more. So, the
very people who need help the most (the middle-class, young
couples starting out in life, or those who have had financial difficulty) are left out in the cold.
How Can You Avoid These
Conflicts?
At
Liberty Financial Planning, we believe that compensation
based on an hourly rate for services rendered is
just more sensible and economical for clients because it
eliminates conflicts of interest. We work hard to
provide you with unbiased advice that's best for you.
Give Liberty a call today for a free initial consultation to see how we can
serve you.
We
appreciate your business!
Think we're nuts? Check out these related articles to see what others have to say:
1. Your Financial Security - How to Get It Back,
article condensed from Arthur Levitt's (former SEC Chairman)
book, Take On the Street, Reader's Digest, November
2002.
2.
Morgan Stanley Fund Sales Get Close Look, Tom
Lauricella and Randall Smith, Wall Street Journal, April 1,
2003.
3. Getting Going, column by Jonathan
Clements, Wall Street Journal:
