How to Find a Good Financial Advisor at a Fair Price

Today we are going to talk about how to find a good financial advisor at a fair price. There are four main methods of paying for financial advice, and some advisors use two, three, or even all four methods. They are:

1. Commissions
2. Asset Under Management (AUM) Fees
3. Annual Retainer Fees
4. Hourly Fees

Financial Advisor Commissions

The problem with number one is that the conflicts of interest are so large that even good people cannot withstand them for an entire career. The worst investment (and insurance) products carry the highest commissions. They have to in order to be sold. So your advisor is constantly faced with the dilemma of sending your kids to college or sending his kids to college. That's too much to ask from your advisor. Paying for advice in this manner is not only likely to cause you to end up in high cost, poorly performing investments, but you are also likely to switch between them way too often, generating additional costs and lowering returns.

AUM Fees

The problem with number two is not necessarily that the advice is bad. There are some conflicts of interest involved in this model including:

1. Incentivized against recommending you pay down your student loans instead of investing
2. Incentivized against recommending you pay off your mortgage instead of investing
3. Incentivized to recommend too high of a savings rate
4. Incentivized to recommend too low of a retirement withdrawal rate
5. Incentivized to recommend ill-advised IRA rollovers if they are paid on IRA balances but not 401(k) balances

These are relatively minor conflicts of interest compared to those introduced by paying commissions in our opinion. Plus, these fee-only advisors generally have a fiduciary duty to you and frankly, know a lot more about investing than the salesmen. So we have always been okay with you using an advisor who charges AUM fees.

The problem, however, is these advisors often charge too much for that good advice. How much is too much? Well, if you can get the same quality advice for much less elsewhere, you are paying too much. Since you can find good advice for a four-figure amount per year, we see little reason to pay a five figure amount. 

The other dilemma is that financial advisory firms charging flat fees tend to not be as profitable as the ones charging AUM fees.

Doing the Math on AUM Fees

We recommended that readers actually do the math each year if their advisor is charging AUM fees and ensure that they are getting more value out of the relationship than the cost. Today let's actually do some math using the fee schedules of a couple of real but unnamed advisory firms as examples. Here's one:

AUM Fee Schedule

• <$250K        1.75% AUM
• $250-500K   1.5% AUM
• $500K-$1M 1.25% AUM
• $1-2M          1% AUM
• $2-3M          0.9% AUM
• $3-4M          0.8% AUM
• $4-5M          0.7% AUM

The nice thing about this firm is that they will take you with zero assets and give you advice. If you have zero assets, and you are paying an AUM fee, that's a very nice price, at least for that year. But let's do the math on how much that advice will cost you each year as your assets under management grow. Remember that most advisory firm fee schedules like this one “fill the buckets,” so even if you have $3 Million, you are still paying 1.75% on your first $250K. This is what the fee schedule above really looks like.

As you can see, you don't have to get very far down that list before you are paying a five-figure amount in advisory fees each year. We never recommended the asset management services of this particular firm because we thought those fees were too high. Let's take a look at another firm whose asset management services we actually have recommended.

AUM Schedule

• <$250K          0.78%
• $250K-$2M   0.72%
• $2-4M             0.58%
• $4-5M             0.48%
• $5-10M           0.43%
• >$10M            0.33%

This is obviously much lower than average and dramatically lower than the firm above. They will also take you with zero assets, which is really important for pilots since the time they need the advice the most is in the beginning when they don't have much. An advisor with a $500K or $1M minimum isn't very useful to most pilots in those early years. So what do these fees actually add up to?

As you can see, those fees are dramatically less than those of the first firm. How much lower? The math is elementary.

It is pretty easy to see why we chose to recommend the second advisor but not the first, no? Especially if you compound the difference in those fees over decades. That said, a halfway decent aviator saver probably ought to fire both advisors by mid-career. In the first case, the fees hit a five-figure amount at an asset level of around $700,000. In the second case, the fees hit a five-figure amount at a little under $1.5 Million. For a pilot saving $50,000 a year and earning 8% a year on it, those figures should be hit approximately 10 years and 16 years out of flight school respectively. Another alternative to firing the advisor, of course, is to negotiate a cap on fees. At that point the advisor is faced with a tough decision–either do the same work they did last year for the same fee or lose $10K in revenue. We suspect many will choose to cut you at least a partial reduction in fees. 

Flat and Hourly Fee Advisors

However, our preferred methods of paying for financial advice are flat annual fees (typically for investment management) and hourly fees (typically for financial planning.) Pilots, lawyers, accountants, and many other kinds of professionals are paid this way, why not financial advisors? Can you imagine charging your passengers an AUM fee? Insane, right? But does it really take a lot more time to manage a $1M portfolio than a $100K portfolio? Not really. Perhaps there is more risk there if the advisor screws up and gets sued. Perhaps there are a few more accounts to manage. Perhaps a slightly higher fee can be justified. But a 10X fee? No way. In addition, an AUM arrangement really isn't fair to the advisor when you have a small portfolio. 1% of $10K is only $100. How much time do you really expect from a professional for a mere $100?

To be fair, at a low level of assets, it can be cheaper to use an advisor charging AUM fees than one who charges a flat annual retainer. Nearly all of the flat fees charged below are four-figure amounts, but there is still a lot of variation there. For ease of reference, consider one who charges a fee of $7,500 per year. It is the same fee when you have $50K as $5 Million. Let's compare that to what you are paying the two AUM advisors above.

As you can see, up until an asset level of nearly $500,000 with the expensive AUM advisor and a little over a million with the cheaper AUM advisor versus the flat fee advisor, you're actually paying less by using an AUM advisor. How long will it take to get there? Well, it depends mostly on how much you save and a little on how much you earn. But saving $50,000 a year and earning 8% per year, we're talking about 8 years and 13 years respectively. That could take even longer if the advisor is only charging AUM fees on your taxable and Roth IRA accounts and not your 401(k). You just have to do the math each year to know.

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