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Is your financial advisor scuttling your investment gains

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A 2012 study by Cerulli Associates found that 60 percent of investors either did not know how their advisors got paid or thought that the service they offered was free. In fact, there are at least six ways a financial advisor will charge you fees. They are:

As a percentage of your account’s value. One of the most common ways that investment professionals charge clients is as a percentage of their account’s value. As your account grows, he or she makes more money and conversely as it shrinks, he or she makes less money. Fee percentages typically shrink as the account grows but overall they can range from a low of .25 percent to as much as 2.0 percent.

As a commission. This is one of the most common ways of charging for services. It muddies the water because it can be difficult to tell whether your financial professional is a good advisor or just a good sales person. Often professionals working under commission models operate under the suitability standard (meaning that advice must be appropriate for you, a weaker duty than fiduciary duty) and their main interest is in selling a product.

A combination of fees and commission. There’s a difference between the term fee-based and fee-only advisor. A fee-based advisor can collect fees and commissions.

An hourly rate. If you are willing to implement the advice on your own, an advisor that charges an hourly rate can recommend how you should allocate your resources for instance and then leave it to you to follow through on the advice. Since a financial professional working under an hourly rate model is not receiving a benefit from any decision you make, there’s a level of confidence that the advice is objective that doesn’t exist with commission-based advisors.

A flat fee. Flat fees aren’t tied to investments or generated by the purchase of a specific investment. Fees should be quoted upfront and you should get a clear description of what will be provided.

A retainer fee. While this might not be for everyone, individuals with a more complex situation such as those who own a small business, rental properties, or a need for regular income from investments for example may benefit from ongoing advice. Retainer fees are not tied to the value of the investment nor to products, you can be confident that your financial advisor’s advice will be objective. For more about advisors that only charge a fee for their services, please read this article on fee-only advisors.

Recently, there have been several stories in the news about potential conflicts of interest from firms such as Edward Jones, Schwab and Fidelity receiving revenue sharing payments. Understanding your advisor’s fee structure won’t just potentially save you money, it will provide you with an understanding of his or her responsibilities towards you. You should always ask how your investment advisor will be paid. A USNews article put it quite succinctly when it asked, “Who comes first when the advisor makes recommendations: you or the advisor?” The answer determines which standard applies to advice given by financial advisors. Fiduciaries have the highest level of accountability by requiring advisors to make recommendations that are best for the client even at the cost to the advisor. Financial advisors with fiduciary requirements may include certified financial planners, members of the National Association of Personal Financial Advisors (NAPFA) and CPAs with a personal financial specialist designation.

The suitability standard on the other hand just means that the advisor must make recommendations that are appropriate for the client at that time. Under the suitability standard a financial advisor is not under obligation to remind you to make appropriate adjustments to your portfolio. It may be perfectly acceptable to hire someone under a suitability standard but you should understand what it means and what your agent’s duties are to you under that standard.

This article suggests one strong reason to pay attention to fees is that it simply takes far less time for advisors to provide the service to clients than it did in the ‘90s. The result is that advisors can provide more service to more clients in a shorter period of time and the one benefitting is only the advisor.

For more on this topic, please read:

Protecting your 401(k) from excessive costs

How to know if you’ve hired a good financial advisor

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