The WSJ has an excellent article on the fee structures of personal financial advisers. They cite four ways to pay your financial adviser:
1. Asset-Based Fee – Pay a percentage of the assets under management. This is the traditional compensation plan for a financial adviser and it remains the most common way that advisers are paid. The fees normally run between 0.50% and 2.00%, depending on the size of the portfolio. Advisers are going to want more assets under management so the bar for getting an adviser under this pay structure is high. These advisers typically provide great service and you never worry about calling them, but because they make more money on a larger asset base, they have an incentive to take undue risk in order to increase the size of your portfolio.
In the online financial planning model, Wealthfront and PersonalCapital.com both charge a percentage based fee. However, both firms provide free services to clients with less than $25,000. Wealthfront has a flat rate fee and PersonalCapital has a graduated scale, meaning that PersonalCapital may have more incentive to push riskier investments. What you won’t get from these two online financial advisers is the ability to discuss College Savings Plans, Life Insurance, or Estate Planning, where a person to person adviser may be able to provide those additional services.
2. Fee Plus Commissions – These advisers charge a set fee or percentage of assets to have an adviser set up a financial plan and then receive a commission when they purchase the investments for that plan. It is a hybrid system where the planner is the broker. The idea is to provide a more comprehensive service because the adviser isn’t a middle-man. Critics argue that the adviser who operates under this structure has an incentive to buy the product with the highest commission instead of the product that is best for the client.
Wealthfront’s commission structure has some similarities here because they charge a flat percentage and then as a brokerage house. There are a lot of reasons to have this set up in an online world. Again, the downside is that you lose some flexibility. MarketRiders creates your portfolio allocation and then leaves it to you to purchase the securities so you can find the lowest rates.
3. Flat Fee – A financial adviser provides a flat fee for a specific service. This is a great option for people with limited funds, however this one time fee does not get you the ability to return to your adviser with questions. It also might not be the right way to spend your money but you haven’t paid an adviser to tell you that so you could end up with something at the wrong time.
In the online financial adviser world, MarketRiders provides a flat fee for their service. In my MarketRiders Review, I discuss their fee structure and what you get, but in summary, they’ll use their proprietary software to build a risk-adjusted portfolio and help you rebalance it over time to preserve the right mix. As in the real world, this is not a comprehensive planning solution, but it is a great option for a service that you cannot easily or realistically replicate on your own.
4. Net Worth and Income – This is similar to the Asset-Based Fee except it is based on your Net Worth and/or Income. This is another good option for families with less discretionary cash to purchase expensive adviser services. On the other hand, you’ll need to be careful to make sure that you are getting the best value. Other options may be cheaper.
Online financial advisers cannot replicate this model, but that’s really not necessary. Their flexibility and low-cost is a function of their online presence so they are accessible to a much broader base of individuals. I don’t see this gaining traction in the online financial planning world.
5. Hourly Fee – You pay a set fee for the hours worked. Think attorneys and accountants. this is another one that works well for people on a budget, but you’ll have to be careful that the adviser doesn’t run the clock. I love this quote from the journal on this structure:
One of the reasons this isn’t adopted is that the current model is quite cushy.
That quote is the reason that online financial advisory services are changing the industry. The high fees based on assets managed or net worth will be obsolete if the work of the adviser is replicated by algorithms. Think about the model that currently exists. The adviser interviews you and sets up your portfolio then reviews your portfolio during the year a few times and then charges you not for the time it took to do the work, but for the value of the assets managed. It’s not quite aligned. The reality is that most people don’t need the level of service that this supposedly provides.
The future is probably a hybrid method where advisers rely on the best personal finance software to manage client assets and charge either a fee for services or an hourly rate, similar to CPAs or Attorneys. This formula leverages the new online personal finance solutions that make asset management easier and still provides people access to college savings plans, retirement planning, and other solutions that need more personalization. I anticipate additional online solutions in the future. Online financial management is quietly changing the structure of the financial advisory world.
