Should You Pay 1% For Financial Planning and Investment Management?
Most people who are working with financial advisors are compensating their advisor in one of two ways: buying products from them, or permitting them to extract fees from their investments.
I’ve written in the past about my concerns related to working with product salespeople, but haven’t explored (to the same extent) the problems associated with allowing your financial advisor to charge you based on investments under their management.
Typically fees begin at 1.5% for smaller accounts and adjust as your portfolio grows. It’s not uncommon for firms to charge you 1% when your combined account value with them reaches the $1,000,000 threshold.
For simplicity, I’m going to reference 1% even though many firms have a scale that ranges in fees.
Why do people pay 1%?
I’m a little surprised that so many people are willing to pay 1% for investment management and (possibly) financial planning. Perhaps they do so because most advisors are paid that way. We can chalk it up to the fact that it’s the environment that we live in. These types of fees are so ubiquitous that they remain unquestioned. If you look back on history, there are things that people did that we would be shocked to see anyone do today. And I’m sure that in the future we’ll look back and be shocked at some of the things we currently do today. It would not surprise me if the 1% fee is one of those things.
Perhaps people are willing to pay this fee because they have a misunderstanding of what financial advisors actually do. From conversations with investors, I sometimes get the sense that they imagine their financial advisor hunched over a monitor watching symbols flash across the screen and making lightning fast decisions to earn their clients money for the day and avoid pitfalls along the way. Clearly, that’s not what most financial advisors do. And a word to the wise, if your financial advisor does do that, you should consider getting a new one.
Probably the greatest reason why people pay 1% of their assets is because they don’t actually feel the pain of the fee. When your accountant sends you a bill for the services they provide, or your estate planning attorney lets you know that it’s going to be $4,000 to do your will and trust, you feel the pain associated with that service that they provide. It’s still an important service, and something you need to do, but you feel it when you write that check or take out your wallet.
In contrast if you have a $1,000,000 portfolio invested with a firm that charges 1% fees . . . you’re paying $10,000 per year for that service. Now you may not feel the pain because the fee is coming directly out of your investment account, but make no mistake, that fee is still being paid. And it’s money you don’t get to enjoy.
What do you get for the 1% fee?
But it’s all about the value that you get in return, right? Some of you are paying 1% fees and only getting investment management. Are you aware that there are plenty of firms that are providing investment management AND financial planning for the same 1% fee? While I’m no fan of 1% fees, don’t you feel like if you’re going to pay them, you might as well get some quality financial planning advice too? Just make sure that your investment advisor is actually qualified to provide financial planning advice. It helps if they work with a lot of people like you and they have some leading industry credentials like the CFP®️ or the ChFC®. That shows that they have the minimum level of training and experience to talk to you about your planning.
Investment management v. financial planning.
I used to work at a 1% fee type firm. While I was there a financial advisor I worked with would tell prospective clients that they would get the financial planning for “free” and the investment management was just how we got paid. That line of thinking struck me as odd then and it still doesn’t make sense to me now. Because clients had different sized portfolios and were being charged 1%, they were all paying different amounts for the same service.
But what does investment management actually entail? What are you paying for? Some of the things you are paying for include:
Asset allocation and portfolio construction
Ongoing monitoring and rebalancing
Asset location (for tax purposes)
Behavior and accountability coaching in fluctuating markets
Due to the rise of index mutual funds and “passive” investment strategies, many advisors find themselves needing to provide financial planning services in order to justify their 1% fees. Financial planning includes:
Student loan planning
Cash flow management
Debt reduction planning
When might paying 1% make sense?
You’ve probably already determined that paying 1% for investment management and financial planning can make a lot of sense when you have a small account. A $100,000 account at 1% is only $1,000—quite a steal of a deal in my opinion for comprehensive planning, if it’s being offered. Unfortunately, many advisors set a floor on how low they will go to accept new accounts. It’s not unheard of for an advisor to tell a prospective client that they aren’t a good fit for them simply because the would-be client doesn’t have $250,000 to invest. So don’t be surprised if you would be willing to pay for advice, but the 1% fee firms won’t take your business because you don’t have an account that is large enough.
A hypothetical scenario.
Let’s consider a $1,000,000 portfolio held at two different firms. The first charges 1% of assets under management and the second charges a flat annual fee of $2,500.
After one year at the 1% fee firm, you have paid $10,000. With the flat fee firm you’ve paid $2,500. In year two the cumulative fees are $20,000 for the 1% firm and $5,000 for the flat fee firm. After five years you’ve now paid $50,000 to the 1% firm and $12,500 to the flat fee firm. Now in the real world it’s unlikely that your portfolio will stay static over the course of five years. Hopefully it increases in value, right? If so, the total fees you pay to the 1% firm also increase. In contrast, the flat fee firm doesn’t increase its fees because your assets have increased.
The rise of flat fee only.
Financial advisors provide a service—and one that I think is very valuable.
Though 1% firms are common today, I believe that in time they will be a thing of the past. Pay your financial advisor for the service that they provide, not 1% of your wealth.
Some final thoughts.
Although many people don’t seem to question the 1% fee, that doesn’t mean that YOU shouldn’t question it, or that you should pay it either. The legendary Jack Bogle said, “you get what you don’t pay for.” This is especially true for the 1% fees that you are paying to your advisor. As your portfolio increases in value, but not in complexity, you should be asking yourself if that increase merits additional fees. Though you aren’t writing a check or taking out your wallet, remember that those fees are being paid.
Be wise, work hard, and enjoy the journey.
These are my opinions, unless I’ve specifically cited other material. The information and ideas I’ve presented are for informational purposes only. Before you implement anything, make sure you have a thorough discussion with a qualified professional who understands your situation.