Fee: a payment made in exchange for advice or services.
Cost: the effort, loss, or sacrifice necessary to achieve or obtain something.
The amount a financial advisor charges in fees is often a determining factor when deciding whether to engage their services. However, the fee quoted can oftentimes be misleading.
Every financial planner will charge a fee for services provided, typically a percentage of assets under management. That should be fully transparent and disclosed up front. As a client, the impulse to gravitate toward the lowest stated fee is to be expected. When advisors offer similar services, why wouldn’t one opt for the least expensive option? However, the total cost that you bear for all services provided by an advisor can add up to be significantly more than the fee proposed. You see, there can be many obscured costs hidden under layers of product fees, transaction charges, commissions, platform expenses, mark ups, mark downs, revenue share, soft dollar compensation, etc. These can lead to diluted returns on your investments and often add up to much more than the initial attractive fee that was presented to you.
A fee is “what you pay,” a cost is what you really “bear” (costs include fees, however, fees do not include total costs). For example, Advisor “X” quotes a fee of .60% of assets under management, while Advisor “Y” is a fiduciary and charges a fee of .90%. Advisor “X” has a trading desk, may work for a bank, sell insurance, receive revenue share and/or placement fees, among a multitude of other revenue streams. Advisor “X” also receives “soft dollars” in the form marketing budgets, technology spend, recognition trips, and potentially, a research budget. Advisor “Y,” has a restriction of receiving only remuneration via transparently disclosed fees paid by clients. There is zero added remuneration, economic or otherwise.
Consider this: Advisor “X” works with a custodian that pays 2.33% on their clients’ cash balances in sweep accounts, this sounds appealing in light of rate fluctuations and what traditional banks pay on cash. Simultaneously, Advisor “Y” works with a custodian that pays clients 3.98% on their cash balances in money market sweep accounts. Both money markets are regulated and invested in identical types of instruments. One pays the client 2.33%, the other pays the client 3.98%. Where is the 1.65% difference going? It is earned by the bank/custodian/broker dealer and relayed to the advisor in many different ways, often as a form of direct and indirect compensation. This 1.65% is not a fee you pay; it is a cost that you bear.
A report from the White House Council of Economic Advisers found that cumulatively, Americans lose well in excess of $17 billion a year as a result of conflicted financial advice. Your portion of that might be a minuscule percentage, however, these costs often amount to more than 1% of assets under management, in addition to the advisory fee one pays, thus with compounding, it’s massive to you. That optically lower fee is likely costing you more than you realize.
Like the compounding effect of fees and its impact on one’s wealth, the compounding effect of costs can be far more severe. Only financial advisors who serve as fiduciaries are legally obligated to serve in your best interests. Working with a fiduciary is critical in avoiding these hidden costs.
Banks, wire houses, broker dealers, and even some fiduciaries often earn commissions on products they sell to you. Advisors at those firms are often monetarily incentivized to sell you solutions and supplemental services. Incentives drive outcomes, and a misalignment of incentives can lead to a suboptimal outcome, another cost that you bear.
For example, money markets, which are strictly regulated by the U.S. Securities and Exchange Commission (SEC), have yields that vary greatly. The yield discrepancy from one organization to another often represents the yield that they are keeping for themselves – this is the profit they earn from your investments, which is an indirect cost to you. This is one of many hidden costs that you should be keenly aware of when evaluating the cost structures of working with an advisor, along with the other costs previously referenced.
Borrowing money from your financial institution can be another way to accrue hidden costs. Do a bit of research across lenders, and if the financial institution you are considering working with is quoting loan rates higher than its competitors, they may likely be keeping the difference. Your wealth manager should be able to provide you access to exclusive rates within the industry.
So, what questions should you be asking to ensure you avoid bearing unnecessary costs?
- Are you legally a fiduciary? In other words, are you bound by the fiduciary standard in all aspects of the advisor/client relationship?
- Will you outline any and all sources of revenue and compensation that you or your wealth management firm receive from any investments, solutions, strategies, or products you may recommend for my portfolio?
- Is your investment platform a source of revenue for you or the greater firm?
- Do you accept or receive “soft dollars,” defined as alternate forms of consideration or remuneration, for allocating my assets to a particular custodian or manager, or in a particular solution, strategy, or product?
- Are there any circumstances where you can or will receive commissions?
- Will you be willing to provide the full details of the embedded costs in addition to advisory fees of any portfolio you recommend?
- What services do you and your firm provide besides investment advice?
If the answer to any of the above is something other than zero or no, or your potential advisor won’t state the answers in writing, your quoted fee likely understates your total costs.
Each time a seemingly small cost is borne, whether in the form of a direct commission, a custodial fee, mark-up or spread, or some sort of soft dollar arrangement, that is money that can’t grow for you. A true fiduciary advisor will provide total fee transparency that clearly conveys that the only fee they are receiving is the advisory fee and should be able to illustrate this for you regularly through third-party reporting of your assets.
Do not let the sticker shock of fees impress or throw you. Dig in, understand, work with a True Fiduciary® who is incentivized to lower your costs. An advisor who is accountable for investment performance, which leads to client satisfaction, can meaningfully increase returns simply by minimizing costs. You have the power to ensure that whomever you entrust with the security of your assets is working first and foremost in your best interests. Find a True Fiduciary ®. Ask the questions listed above, get the answers in writing, and you’ll be one step closer to financial alignment.
If you would like to work with a True Fiduciary ® who serves in your best interest, please reach out to schedule a call with our Founders.