[FPMD: The following guest post is authored by Dave Denniston of Capital Advisory Group Advisory Services LLC. We have no financial relationship.]
I get this question a lot - "How do financial advisors get paid?"
If you want to work with a financial professional, it may be beneficial to know how they get paid. It can be an awkward question to bring up when you're trying to decide whether or not to jump into a relationship that may last a lifetime, which is why I'm telling you this now...
The Way Advisors Used to Get Paid (& Many Still Do)
The number one way that traditional advisors are paid is a commission. For example, if you ever buy a life insurance policy... or you buy a disability policy or you buy an annuity or a loaded mutual fund… the advisor gets paid a commission.
- Life Insurance pays around 60% to 80% of the first year's premium. No trail in term, but cash value life insurance can have a little bit. As you can imagine, the higher the premium, the higher the commission - no surprise, many agents have a preference towards cash value insurance.
- Disability Income Insurance pays around 30% to 40% of the first year premium and it usually pay a 10% trail. The agent selling the policy has a decent incentive to not turn-over the policy every few years like life insurance agents can be.
- Annuities typically pay based on the surrender schedule. Fixed annuities usually pay less than variable annuities. For example, a 4-yr product pays around 4%, a 7-yr product around 7%. This is why many folks build their financial practice around seminars sponsored by…. wait for it…. annuity companies. A single client with $300,000 in a seven year annuity could pay $21k.
As you can probably tell, I don't like the commission model for many reasons. For one, it isn’t right for most people. Also, the fees are usually 2-4x what could be done in a brokerage account.
Secondly, as an advisor you are constantly starting from ground zero every month. You can’t count what is coming in every month. You HAVE to sell every month to feed your family.
Being On The Same Side of A Very Expensive Table
The second way that a lot of financial advisors get paid has been the assets under management model. This means that the advisor could charge you anywhere from 0.5% to 2% assets under management. The more money you invest with them, the more than they get paid. The less money, the less pay.
The advisor is rewarded and punished to a degree based on how your portfolio does. (By the way, robo-advisors all work this way too just on a lesser scale!)
As a resident or a young attending- not so bad! 1% on $50,000 is only $500. 1% on $100,000 is only $1,000.
On the other hand, the bad news is that you end up having a large, large, large bill later in life... particularly for many physicians where they have one or two or three million dollars under management. You paying 1% on those tidy sums translates into $10,000, $20,000 or even $30,000 a year!
And here's the thing - is there a DIFFERENCE in the work between that one million dollar client and the three million dollar client?
Here's the truth.... NO
Maybe A Better Way?
This leads me to where I am headed towards which is an hourly flat fee, known as the Fee-Only model. Rather than paying your advisor via commission or a percentage of assets under management, you pay a flat fee per unit time for their financial advice. Just like how you would pay a lawyer for legal advice.
There are no commissions, no hidden fees, no assets under management. It's crystal clear on how they are compensated for the work they do for you. Even robo-advisors can’t offer that kind of value.
I would love to hear from you! E-mail me at email@example.com with your experiences and stories.
[FPMD: There are an increasing number of financial advisors who offer their services under the Fee-only model. The range of fees I've heard of for attending physicians in practice varies from $1,500-$4,000/year, with differing amounts of discounts for residents and fellows in training. The transparency of the flat-fee model is its biggest draw. But there are shortcomings:
Let's say you are a seasoned attending physician and you subscribe to Dave's flat-fee service at the rate of $200/month. Dave will make $2,400 from you in one year. That's it! No more, no less. Compare that to the $10,000-30,000/yr in asset management fees. It's easy to see why the flat-fee system can be less lucrative for advisors. For an advisor to transition entirely to a fee-only model, 1 of 2 things need to happen:
- The advice offered has to be so good that the advisor can demand a high fee/client or
- The advisor must develop a large client base.
In addition, by limiting the incentives to an advisor to the fee you pay them, you limit their financial incentives. And where there are limited incentives, there is a theoretical risk of complacency. Of course, great financial advisors are motivated not only by how much money they can make of you, but (hopefully) also by how proud they feel when they see you accomplish your financial goals.]
Dave Denniston, Chartered Financial Analyst (CFA), is an author and authority for physicians providing a voice and an advocate for all of the financial issues that doctors deal with.
- You can find his latest blog post by clicking here.
- You can learn more about his flat-fee advising services by clicking here.
Advisory services through Capital Advisory Group Advisory Services LLC and securities through United Planners Financial Services of America, a Limited Partnership. Member FINRA and SIPC. The Capital Advisory Group Advisory Services, LLC (CAG) and United Planners Financial Services are not affiliated.
The views expressed are those of the author and may not reflect the views of United Planners Financial Services. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. In addition, the above list of articles and publications is not, and should not be constructed as, a recommendation, endorsement or sponsorship by United Planners Financial Services