How planners get paid–and how that can, should and will change

iStock_000014977164MediumThe best way to pay a financial planner is directly through fees you pay, rather than indirectly through commissions. That way, you don’t have to worry that the advice you’re getting is influenced by how much your advisor stands to gain by selling you certain investments.

But most fee-only planners have adopted the “assets under management” approach, where the fees you pay depend upon how much you invest with them. And people who think deep thoughts about the industry wonder if that’s the best way to go.

One of those deep-thought-thinkers, Bob Veres of the trade information resource Inside Information, moderated a panel exploring “alternative fee structures” yesterday at the annual conference of the National Association of Personal Financial Advisors, the biggest group of fee-only planners.

There are several problems with the AUM model. One is that the planner’s compensation is tied to the whims of the market—income goes up when the market’s up and down when the market’s down, something that’s beyond a planner’s control. While the complexity of planning tends to increase the more money someone has, planners can still wind up doing a lot for a client who isn’t charged much and “charging a lot and doing not a lot” for another, as one panelist put it.

Another issue is that the planner may be tempted to hoard assets, encouraging you to keep your money invested even if paying down your mortgage, buying rental real estate or investing in a start-up may actually be a better deal.

“AUM has too many conflicts of interest to be the long-term solution for the profession,” Veres declared. He qualified the statement saying it was only his opinion, but he’s got a pretty good track record of predicting financial planning trends.

For planners, the biggest hazard with AUM is that they are charging for what is essentially a commodity—investment management—and throwing in the real value, comprehensive financial planning, for free.

“We are the ones training clients to focus on investment management instead of financial planning” through the AUM model, said panelist and CFP Carolyn McClanahan, who charges a flat fee based on the complexity of a client’s situation. Other panelists based their fee on a client’s net worth or charged by the hour.

Investment management fees are about to get squashed, thanks to so-called “robo-advisors” that use computer algorithms to invest and rebalance portfolios. Start-ups such as Betterment and Wealthfront, as well as established players including Vanguard and Schwab, offer digital advice services for about 30 basis points, or .3 percent. That compares to the 1 percent or so charged by many investment managers (and fee-only planners). Yes, some people will still want a human to manage their portfolio, but in the future fewer and fewer will be willing to pay that premium for it, said McClanahan.

I still hear a lot of scoffing from planners who don’t think robo-advisors will affect their business. A conversation I had with a couple of women who aren’t planners, but who use them, will illustrate that many planners are more vulnerable than they think.

Both women acknowledged that their planners did a lot of work up front, setting up their portfolios and advising them on other aspects of financial life: insurance, taxes, estate planning and so on. But neither felt they were getting enough on-going service to justify their AUM fees, and both were thinking of jumping ship to a cheaper solution. After all, if all they were going to get was investment management, why pay three times more for it? That 30 basis point fee starts to look pretty good. Increasingly, those who charge more will face the burden of proving they’re worth it.

 

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Dear Liz: You’ve been answering questions about ex-spouses and Social Security benefits. My first marriage was longer than 10 years, and I was the primary earner. My ex remarried but later divorced again.

Does his getting remarried nullify his claims forevermore — or is his ability to claim spousal benefits based on my income back on the table as long as he remains unmarried?

Answer: It’s the latter. Your ex can claim spousal benefits based on your work record as long as your marriage to him lasted at least 10 years and he is not currently married.

Q&A: Investing vs Saving for college tuition

Dear Liz: We recently inherited some money. We’ve never had much. We want to invest our inheritance for our kids’ college education.

We asked around to find investment firms that people have had a good experience with. But how do we know they are honest and make sound investment decisions? How do we know if the rates they are charging are fair and reasonable? (For example, one charges a percentage of the value of the account. How do I know if their rate is a fair amount?)

Answer: If you want to invest the money for college education, you don’t need to consult an advisor at all. You simply can use a 529 college savings plan. These plans allow you to invest money that grows tax-deferred and can be used tax free for qualified college expenses nationwide.

These plans are sponsored by the states and run by investment firms. You might want to stick with your own state’s plan if you get a tax break for doing so (check http://www.savingforcollege.com for the details of each plan).

If not, consider choosing one of the plans singled out by research firm Morningstar as the best in 2014: the Maryland College Investment Plan, Alaska’s T. Rowe Price College Savings Plan, the Vanguard 529 College Savings Plan in Nevada and the Utah Educational Savings Plan.

College savings plans typically offer several investment choices, but you can make it easy by choosing the “age weighted” option, which invests your contributions according to your child’s age, getting more conservative as college draws nearer.

If you still want to talk to an advisor — which isn’t a bad idea when dealing with a windfall — you’ll want to choose carefully.

Relying on friends and family isn’t necessarily the best approach. Many of the people who invested with Bernie Madoff were introduced to him by people they knew.

Most advisors aren’t crooks, but they also don’t have to put your interests ahead of their own. That means they can steer you into expensive investment products that pay them larger commissions.

If you want an advisor who puts you first, you’ll want to find one who agrees to be a fiduciary for you, and who is willing to put that in writing.

Here are three sources for fiduciary advice:

•The Financial Planning Assn. at http://www.plannersearch.org

•The Garrett Planning Network at http://www.garrettplanningnetwork.com

•The National Assn. of Personal Financial Advisors at http://www.napfa.org.

Garrett planners charge by the hour with no minimums. Expect to pay around $150 an hour.

NAPFA planners often charge a percentage of assets — typically about 1%.

FPA members charge for advice in a variety of ways, including fees, commissions and a combination of the two.

Any planner should provide you with clear information about how he or she gets paid.

You’ll want to check the advisor’s credentials as well. The gold standard for financial planners is the CFP, which stands for Certified Financial Planner.

An equivalent designation for CPAs is the PFS, which stands for Personal Financial Specialist. People with these designations have received a broad education in comprehensive financial planning, have met minimum experience requirements and agree to uphold certain ethical standards.

Each of the organizations listed above has more tips for choosing a plan on its website.

Q&A: 401(k) employer limits

Dear Liz: My company doesn’t allow us to contribute more than 50% of our paycheck to our 401(k). This limits my contribution to far less than the IRS’ $18,000 annual limit because I’m low paid.

How can I tackle this situation, as I would want to contribute more but am being constrained by the 50% contribution cap?

Answer: Your zeal to save for retirement is admirable. Your company may not have anticipated that anyone in your situation would be able to save so much, so consider simply asking if the limit can be raised.

You can explore other avenues as well, such as contributing to an IRA or a Roth IRA. Many people incorrectly believe they can’t contribute to these individual retirement accounts if they have a workplace plan, but that’s not true.

You can contribute up to $5,500 to a Roth (plus a $1,000 catch-up contribution if you’re 50 or older) if your income is below certain limits. The ability to contribute is reduced between modified adjusted gross incomes of $116,000 and $131,000 for single filers and $183,000 and $193,000 for marrieds filing jointly. Alternatively, you can contribute $5,500 (plus the $1,000 catch-up contribution) to an IRA regardless of your income, although your ability to deduct your contribution if you have a workplace plan is phased out for incomes between $61,000 and $71,000 if single and $98,000 to $118,000 for marrieds.

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