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.


Are you paying too much for advice?

Dear Liz: You always mention fee-only financial planners and I’m not sure about the true meaning. My husband and I have a financial planner who charges us $2,200 per year, but we got a summary of transaction fees in the amount of $6,200 for last year. Is this reasonable? We have $625,000 in IRAs and are adding $1,000 a month. In addition we have over $700,000 with current employers, adding the max allowed yearly. The planner gives advice on allocations for these employer funds as well. Are we paying too much for the financial planner? The IRAs seem to be doing well, but the market is doing well (today!).

Answer: It appears you’re paying both fees and commissions, so you’re not dealing with a fee-only planner. Fee-only planners are compensated only by the fees their clients pay, not by commissions or other “transaction fees” for the investments they buy. One big benefit of fee-only planners is that you don’t have to worry that commissions they get are affecting the investment advice they give you.

You’re paying about 1.3% on the portfolio you have invested with this advisor. That’s not shockingly high, but once you add in all the other costs associated with these investments, such as annual expense ratios and any account fees, your relationship with this advisor may be costing you 2% a year or more. That’s getting expensive, unless you’re getting comprehensive financial planning — help with insurance, taxes and estate planning, as well as investment advice — from someone qualified to provide such planning, such as a certified financial planner.

What you pay makes a big difference in what you accumulate. Let’s say your investments return an average of 8% a year over the next 20 years. If your costs average 1% a year, that would leave your IRAs worth about $3 million. If your costs average 2%, you could wind up with $2.5 million, or half a million dollars less.

Keeping your expenses low would mean you stop trying to beat the market with actively traded investments. Instead, you would opt for index funds and exchange-traded funds that seek to match market returns. These funds typically come with low expenses, often a small fraction of 1%. Using a fee-only planner can be another way to reduce what you pay for advice.

At the very least, consider bringing a copy of your portfolio to a fee-only planner for a second opinion. He or she can give you a better idea of whether what you’re paying is worth the results you’re getting.

Get second opinion before buying cash-value insurance

Dear Liz: I think you missed one of the possibilities when a reader wrote to you about a pitch he received from an insurance salesman. The salesman wanted the reader to stop funding his 401(k) and instead invest in a contract that would guarantee his principal but cap his returns in any given year. You thought the salesman was pitching an equity indexed annuity, but it’s possible he was promoting an indexed universal life policy, which would offer the same guarantees of principal and offer tax-free loans.

Answer: You may be correct — in which case the product being pitched is just as unlikely to be a good fit for the 61-year-old reader as an equity indexed annuity.

Cash-value life insurance policies typically have high expenses and make sense only when there’s a permanent need for life insurance. If the reader doesn’t have people who are financially dependent on him, he may not need life insurance at all.

Furthermore, the “lapse rate” for cash-value life insurance policies tends to be high, which means many people stop paying the costly premiums long before they accumulate any cash value that can be tapped.

Before you invest in any annuity or life insurance product, get an independent second opinion. One way is to run the product past a fee-only financial planner, who should be able to analyze the product and advise you of options that may be a better fit for your situation. If you just want a detailed analysis of the policy itself, you can pay $100 to, which is run by former state insurance commissioner James Hunt.

Windfall in your 50s? Don’t blow it

Dear Liz: I am 56 and will be receiving $175,000 from the sale of a home I inherited. I do not know what to do with this money. I have been underemployed or unemployed for six years, have no retirement savings and am terrified this money will get chipped away for day-to-day expenses so that I’ll have nothing to show for it. Should I invest? If so, what is relatively safe? Should I try to buy another house as an investment?

Answer: You’re right to worry about wasting this windfall, because that’s what often happens. A few thousand dollars here, a few thousand dollars there, and suddenly what once seemed like a vast amount of money is gone.

First, you need to talk to a tax pro to make sure there won’t be a tax bill from your home sale. Then you need to use a small portion of your inheritance to hire a fee-only financial planner who can review your situation and suggest some options. You can get referrals for fee-only planners who charge by the hour from the Garrett Planning Network at

You’re closing in quickly on retirement age, and you should know that typically Social Security doesn’t pay much. The average check is around $1,000 a month. This windfall can’t make up for all the years you didn’t save, but it could help you live a little better in retirement if properly invested.

You should read a good book on investing, such as Kathy Kristof’s “Investing 101,” so you can better understand the relationship between risk and reward. It’s understandable that you want to keep your money safe, but investments that promise no loss of principal don’t yield very much. In other words, keeping your money safe means it won’t be able to grow, which in turn means your buying power will be eroded over time.

Don’t buy life insurance if you don’t need life insurance

Dear Liz: I recently inherited around $200,000. I’m on track for retirement, so my broker is encouraging me to consider buying a policy for long-term care. He recommends a flexible-premium universal life insurance policy that requires a one-time upfront payment and provides a death benefit as well as a long-term care benefit. It does appear to me to be a better option than buying a long-term care policy in which I pay a certain amount every month, which can of course increase greatly as time goes on, with no guarantee of ever needing or using the benefits and no hope of money paid in becoming part of my estate.

Answer: Long-term care policies can indeed be problematic, since the premiums can soar just when you’re most likely to need the coverage. So if you need life insurance for another purpose — to take care of financial dependents should you die or to pay taxes on your estate — then a life insurance policy with a long-term care rider may not be a bad idea, said Laura Tarbox, a fee-only Certified Financial Planner in Newport Beach who specializes in insurance.

But buying life insurance when you don’t need it just to get another benefit, such as long-term care coverage or tax-free income, is often a costly mistake.

“The golden rule is that you do not buy life insurance if you don’t need life insurance,” Tarbox said. “It would probably be better to invest the money and have it earmarked for long-term care.”

If you decide you want to buy this insurance, don’t grab the first policy you’re offered. Shop around, because premiums and benefits vary enormously. The financial strength of the insurer matters as well. You want the company to still be there, perhaps decades in the future, if you should need the coverage.

What you don’t want to do is take guidance solely from someone who is going to make a fat commission should you buy what he or she recommends.

“Get two or three proposals from different agents,” Tarbox said. “A fee-only financial planner can help you sort through them.”