Financial advisors are instrumental in helping you navigate your financial future. But just as important as their advice is understanding how much the services of a financial advisor will cost you. At Sovereign Wealth Management, we believe in clear, transparent, and, most importantly, ethical fee structures.
Understanding Different Fee Structures
The fee structure used directly impacts the financial advisor cost you bear. The most common fee structures are:
- Percentage of Assets Under Management (AUM): In this model, the advisor charges a percentage of the total assets they manage for you. The fee usually falls between 0.5% to 1.5% annually, with the average being 1.02% in 2021.
- Flat Fees: Some advisors charge a flat fee for specific services, like creating a financial plan.
- Hourly Rates: Advisors may also charge on an hourly basis for their time.
- Commissions: In this case, advisors earn a commission from the investments they recommend to you.
- Performance-Based Fees: Certain advisors may charge an additional fee if they outperform a defined benchmark.
Now, let’s delve deeper into why Sovereign Wealth Management advocates for a particular fee structure, that is, AUM-based compensation.
The Sovereign Wealth Management Approach: AUM
At Sovereign Wealth Management, we operate on a return-based AUM compensation model. This ethical approach aligns our interests directly with yours. The better your portfolio performs, the better we are compensated, which encourages us to aim for the best possible returns for you. As a fiduciary firm, this is the best way for us to operate.
By charging based on a percentage of AUM (assets under management), our return-based compensation ensures that we’re motivated by your success and growing the size of your portfolio. Compared to a commission-based structure, it eliminates potential conflicts of interest, as we don’t earn commissions on the investments we recommend. It also avoids the lack of motivation that comes with flat-fee structures that guarantee a fixed payout to your investor regardless of performance.
Different Types of Financial Advisor Compensation Scaling with Investment Scale
- Commission-Based Compensation: This is one of the most traditional methods of compensation for financial advisors. Advisors are paid a commission on the financial products that they sell to their clients. The more products (like mutual funds, annuities, and insurance) they sell, the more commission they earn.
Thus, the scale of the investments does impact the compensation. However, this model can create a conflict of interest as the advisor might prioritize products that offer higher commissions rather than those that would be most beneficial to the client. - Fee-Only Compensation: In a fee-only model, the financial advisor charges a flat fee for their services or a percentage of the assets they manage. The latter is also known as assets under management (AUM) fee and generally ranges between 0.25% to 1.5%. As the value of the client’s portfolio increases, so does the fee. This model aligns the interests of the client and the advisor as the advisor’s compensation grows as the client’s wealth increases.
- Fee-Based Compensation: Fee-based advisors earn both fees and commissions. The fee is usually a flat or AUM fee like the fee-only model, and the commission is earned from selling financial products. Thus, their compensation scales with both the scale of the investments and the financial products sold. However, this model might also have potential conflicts of interest, like the commission-based model.
- Hourly or Fixed Fees: Some financial advisors charge an hourly rate or a fixed fee for a particular service, like creating a financial plan. These fees are not directly related to the scale of investments but are determined by the complexity of the financial planning work required.
- Performance-Based Fees: In this model, advisors earn a fee only if the investments they manage perform above a specified benchmark. Thus, their compensation directly scales with the performance of the investments. This model is less common and is typically used by hedge funds and certain types of high-net-worth investment accounts.
- Salary: Some financial advisors are salaried employees of a bank or brokerage. In this case, the scale of the investments doesn’t directly influence their compensation, though it may indirectly influence bonuses or job security.
Each compensation model has its own benefits and drawbacks, and the best model can vary based on the client’s needs and investment goals. Regardless of the compensation model, it’s important that the financial advisor clearly communicates how they’re paid and any potential conflicts of interest that might exist.
Why Does a Financial Advisor’s Fee Structure Matter?
The fee structure may directly impact the advice you receive and the cost of that advice. Understanding how your financial advisor cost gets paid helps you make an informed decision about who to trust with your financial future.
For instance, advisors working on commission may be influenced by the product that pays the highest commission rather than what is best for you. In contrast, an AUM compensation model aligns the advisor’s success with your own. If your investments do well, so does the advisor, creating a win-win situation. This model encourages advisors to work diligently to ensure your portfolio performs at its peak.
Wrapping It Up: What Should You Expect?
The cost of a financial advisor varies widely based on their fee structure, the services they offer, and geographical differences. In essence, there’s no one-size-fits-all answer. At Sovereign Wealth Management, we believe that a return-based compensation model is the most ethical and fair approach, aligning our interests directly with those of our clients.
Before you hire a financial advisor, ensure you understand their fee structure, what services you’re paying for, and how their charges compare with industry standards. With this knowledge, you can make an informed decision about which financial advisor is the right fit for you. And remember, a fee structure that aligns the success of your advisor with your financial success is a model that serves your best interests.
Disclaimer:
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, JEFFREY TRUCHON, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security, or any security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary.
Foundations deems reliable any statistical data or information obtained from or prepared by third party sources that is included in any commentary, but in no way guarantees its accuracy or completeness. Mr. Truchon is also a licensed insurance agent and can effect transactions in insurance products and earn compensation for these activities that are separate and distinct from the advisory fees earned from the advisory services he provides to clients. Advisory clients are under no obligation to purchase insurance products from Mr. Truchon and may use an insurance firm or agent of their choice.