There has been a lot of news coverage this past year on the topic of fiduciary advice. The DOL (Department of Labor) rule, which requires advisers to act as a fiduciary when advising on retirement accounts has brought some clarity to this issue. The public now has a better understanding of the difference between commission-based advice, which is based on suitability, and fee-only financial advice that’s held to a fiduciary standard.
Fee-only advisers are all held to the fiduciary standard, but they don’t all price their services the same. This week, I want to look at the two most common pricing models.
Hourly Rate Pricing Model
Hourly rates can vary widely from adviser to adviser, just like attorney or accountant rates. The rates are not tied to the value of investments. Flat fees are sometimes quoted based on the project, such as creating a financial plan. Otherwise a rate-per-hour is charged for advice as needed. For example, you may pay an adviser an hourly rate to tell you how to allocate the investments in your 401(k) or to calculate the optimum amount to contribute pre-tax vs. a Roth.
Sheryl Garrett is one of the advisory world’s leading proponents of an hourly rate payment model. She believes most people need occasional advice rather than a full-time adviser. The hourly fee is easy to describe, and there are no minimum asset requirements. A quick online search revealed that fees can range from $100 to $400 per hour. You can expect to pay a higher hourly rate for experienced advisers, or those who have an area of specialty.
I feel one of the biggest drawbacks to hourly advice is that the client must implement the advice on his or her own. The adviser will prepare the 401(k) allocation, but the client would typically be responsible for actually making the changes that the financial planner suggested. Hourly planners generally provide a written plan or list of recommendations. Their service includes discussion of the recommendations, but they usually do not get involved in the implementation.
The hourly billing model also encounters resistance because many people don’t like to receive (and then pay) an invoice for services. Clients are not as likely to seek advice they may need knowing the call will generate an invoice. This can create the tendency to do nothing or go it alone which may lead to mistakes. The adviser is then called in to fix the mistakes rather than providing the guidance to avoid them in the first place.
Percent of Account Value
Advisers who are compensated by a percent of account value usually provide investment management and financial planning together although in some circumstances, only investment management. A typical asset management fee can range from 2.0% per year on the high side to .50% per year on the low side. Expect to pay a higher fee if the adviser is providing full-service financial planning along with investment management. Typically, the more assets you have, the lower the fee percentage.
The percentage of account value model provides an incentive for the adviser to grow account values and to minimize expenses. As the account value grows, the adviser makes more money. If the account value goes down, he or she will make less money.
Fees are generally deducted from the account, and account returns can be calculated net after fees. Many clients like this structure as no check needs to be written, and the fees do not have to come out of the monthly budget. Fees can be debited from IRAs so they are paid with pre-tax dollars.
What many clients like most about percent of account value pricing is that it includes Once the plan is developed and accepted, it becomes the adviser’s responsibility to implement it. Investment management, tax planning, following up on beneficiary changes, etc. are all included in the account value fee. Many people may need ongoing advice from a long-term trusted adviser, rather than a one-time engagement. The percent of account value fee was designed to work best in an ongoing relationship.
Fee-only advisers are required to act as fiduciaries regardless of which way they choose to price their services. The fiduciary standard requires advisers to put their clients’ interests above their own. Acting as a fiduciary requires avoiding conflicts of interest and disclosing any potential conflicts to placing the clients’ interests first.
While conflicts of interest between adviser and client are reduced from other compensation models, both pricing models can still carry some conflicts. For instance, with the hourly model, the adviser may have an incentive to bill as much as he or she can. The client has an inherent disincentive to spend time sharing information with the adviser or to call the adviser for planning advice. The percent of account value adviser may have a disincentive to recommend deploying assets to be used elsewhere in the plan, such as paying off a mortgage. Again, under the fiduciary standard any real or potential conflicts must be disclosed to the client.
Both pricing models have strong and weak points. For a person with a smaller, less complex portfolio who is good at following through on implementation and only needs occasional advice, the hourly adviser could be an attractive option. Alternatively, those with more complex issues who may benefit from tax reduction strategies and estate planning may fare better with an ongoing relationship. A client engaging an adviser who will handle the implementation and coordination of all aspects of their financial lives may be better served with a percent of account value fee model.
- Advisers charging hourly rates can vary widely just like attorney or accountant rates.
- One of the biggest drawbacks to hourly advice is that the client must implement the advice on their own.
- The percentage of account value model provides an incentive for the adviser to grow account values and to minimize expenses.