Why Flat-Rate Fee-Only Advisors Are the Future of Financial Planning

Key Points:

• Transparency in Flat-Rate Fee-Only Planning: Unlike other fee structures, flat-rate fee-only planners offer complete transparency by charging a predetermined annual fee, eliminating hidden costs and conflicts of interest.
• Fiduciary Responsibility of Flat-Rate Fee-Only Planners: Most flat-rate fee-only financial advisors are fiduciaries (I am!), meaning they are legally required to act in the best interests of their clients at all times.
• Cost-Effectiveness with Flat-Rate Fee-Only Planners: For investors with larger portfolios, flat-rate fee-only planners can provide comprehensive financial planning services at a more reasonable cost compared to AUM-based fees.
• Long-Term Relationship Building with Flat-Rate Fee-Only Planners: Engagements with flat-rate fee-only planners are designed for long-term collaboration, allowing for a more meaningful and accountable financial planning experience.
• The Hidden Costs of AUM Fees vs. Flat-Rate Fee-Only Planning: The article highlights how AUM fees can escalate over time, especially in a thriving market, making flat-rate fee-only planners a more cost-effective choice for long-term financial planning.

Introduction

When choosing a financial advisor, the most important consideration is a good fit for your personality and financial situation, including whether they offer a flat-fee fee-only structure. If you don’t enjoy working with the advisor or their areas of expertise differ from your situation, you might not realize the relationship’s full potential.

Once you have established those two items, the next thing to understand is how the adviser gets paid. You don’t work for free, and expecting advice from a professional without paying them is unrealistic. There are five main types of fee structures:

• Commission Only: No direct payments are made from clients to advisors. Instead, advisors are paid through selling insurance or investment products to clients. The advisor then gets paid a commission directly from the insurance or investment company.
• Fee-Only based on Asset Under Management (AUM) fees: AUM fees are a percentage of the total value of your investments you pay your advisor each year. The percentage stays constant, but the value of the investments changes each year.
• Fee-Based: A direct payment is made from the client to the advisor, either in the form of an AUM or flat fee, but the advisor then has the opportunity to sell products to the client and earn additional revenue.  
• Hourly fees: Hourly fees are charged by the hour for your advisor’s services.
• Flat-Rate Fee-Only: Flat-Rate Fee-Only advisors are paid a predetermined annual amount for their services, which can vary based on their experience and the services offered, but are agreed upon in advance.

Each type of fee structure has its advantages and disadvantages.

Commission Only Fee Structure

A commission-only fee structure is where the financial advisor is paid a commission on the financial products they sell to their clients. The advisor receives no other compensation, such as a flat or hourly fee.

Advantages of Commission-Only Fee Structure

There are a few potential advantages to working with a commission-only financial advisor:

• Affordability (at least perceived): Commission-only financial advisors can be a good option for investors on a budget. The advisor can seem reasonable because investors typically do not pay any upfront fees. However, the actual cost to the client may be huge if they are sold a product they do not need or an expensive investment. Still, the lack of upfront payment keeps this type of advisor around.

Disadvantages of Commission-Only Fee Structure

There are also a few potential disadvantages to working with a commission-only financial advisor:

• Conflicts of interest: Commission-only financial advisors may have a conflict of interest when recommending financial products to their clients. The advisor is incentivized to recommend high-commission products, even if they are not in the client’s best interests.
• Product cost: The commissions that commission-only advisors receive are paid for by the financial product providers. This may result in increased costs for investors and difficulty in exiting the products later, which could be expensive.
• Product selection: Commission-only financial advisors may only be able to sell the products of the company they are associated with, such as TransAmerica or LiberyLife products.
• Lack of fiduciary responsibility: Commission-only financial advisors are not typically held to the same fiduciary standard as fee-only financial advisors. This means that they are not legally required to act in the best interests of their clients at all times.

Fee-Only Asset Under Management (AUM) Fee Structure

An asset under management (AUM) fee structure is a fee structure where the financial advisor is paid a percentage of the total value of the client’s assets under management. The AUM fee is typically charged on a quarterly or annual basis.

Advantages of AUM Fee Structure

There are a few potential advantages to working with a financial advisor who charges an AUM fee:

• Fiduciary responsibility: It should always be verified with the individual advisor, but most fee-only financial advisors are fiduciaries. This means that they are legally required to act in the best interests of their clients at all times.
• Scalability: AUM fee structures can be scalable to meet the needs of investors with all levels of assets. This can be helpful for investors who are just starting out or who have complex financial needs.
• Comprehensive services: AUM fee advisors typically offer a comprehensive range of financial planning and investment management services. This can be helpful for investors who need help with all aspects of their financial lives. However, these comprehensive services are typically reserved for clients with more considerable AUM amounts. Smaller clients may have their services scaled back depending on account value.
• Ongoing Relationship: Engagements with these advisors are designed for long-term collaboration, spanning multiple years. This allows ample time to build a meaningful relationship, filled with numerous opportunities to discuss and brainstorm ideas on various topics. Such a sustained relationship minimizes the chances of overlooking important details or making mistakes.
• Reduced conflicts of interest: Unlike commission-only or fee-based, a fee-only AUM advisor does not receive commission or payment from any other company.

Disadvantages of AUM Fee Structure

There are also a few potential disadvantages to working with a financial advisor who charges an AUM fee:

• Cost: AUM fees can be expensive, especially for investors with large portfolios.
• Lack of transparency: Because the fee is typically deducted directly from the account balances, the clients are never presented with a bill outlining the true cost of the engagement.
• Potential for conflicts of interest: AUM fee advisors may have a conflict of interest when recommending investments to their clients. This is because the advisor is incentivized to recommend investments that will generate higher fees for them, even if those investments are not in the client’s best interests. Real estate investing is a common example of this dilemma. Financial advisors may be reluctant to suggest a real estate investment to their clients if the funds come from assets they manage. This is due to the potential reduction in compensation.

Fee-Based Fee Structure

A fee-based fee structure is a fee structure where the financial advisor charges a fee for their services but may also receive commissions from financial product providers. This fee structure is a hybrid of the fee-only and commission-only fee structures.

Advantages of Fee-Based Fee Structure

There are a few potential advantages to working with a fee-based financial advisor:

• Affordability: Fee-based financial advisors may be more affordable than fee-only financial advisors, especially for investors with small portfolios. This is because fee-based advisors may receive commissions from financial product providers, which can help to offset their fees.

Disadvantages of Fee-Based Fee Structure

There are also a few potential disadvantages to working with a fee-based financial advisor:

• Conflicts of interest: Fee-based financial advisors may have a conflict of interest when recommending financial products to their clients. This is because the advisor may receive commissions from financial product providers, even if those products are not in the client’s best interests.
• Lack of transparency: Fee-based financial advisors are not required to disclose their fees in a standardized format. This can make it difficult for investors to compare fees from different advisors.
• Potential for higher costs: The commissions that fee-based advisors receive are typically paid by financial product providers. This can lead to higher costs for investors.

Hourly Fee Structure

An hourly fee structure is a fee structure where the financial advisor charges a fee for the time they spend working for the client. The hourly fee is typically charged on an hourly basis.

Advantages of Hourly Fee Structure

There are a few potential advantages to working with a financial advisor who charges an hourly fee:

• Transparency: Hourly fee advisors must disclose their hourly rates in a standardized format. This makes it easy for investors to compare fees from different advisors.
• Flexibility: Hourly fee structures can be flexible to meet the needs of investors with different needs.
• Cost: Hourly fee structures can be cost-effective for investors who only need help with specific tasks, such as developing a financial plan or creating a budget.

Disadvantages of Hourly Fee Structure

There are also a few potential disadvantages to working with a financial advisor who charges an hourly fee:

• Cost: Hourly fee structures can be expensive, especially for investors who need ongoing assistance from their advisors. Actual hours for a project might exceed the estimated hours due to scope creep or other issues resulting in unexpected bills.
• Limited services: Some hourly fee advisors may only offer a limited range of financial planning and investment management services. This can be a disadvantage for investors who need help with all aspects of their financial lives.
• Disincentive to engage: One of the most beneficial and highest returns on investment you can gain from a financial advisor is behavioral coaching and advice, even when you think it might be trivial. When you know you’ll receive a bill every time you call your advisor; you may not engage enough and potentially make costly mistakes.

Flat-Rate Fee-Only Structure

A flat rate fee-only fee structure is where the financial advisor charges an annual fee for their services. The advisor receives no commissions or other payments from financial product providers. This type of fee structure is the most transparent and conflict-free, as the advisor is not incentivized to sell you any particular product or service.

Advantages of Flat-Rate Fee-Only Structure

There are several advantages to working with a flat-rate fee-only financial advisor:

• Fiduciary responsibility: It should always be verified with the individual advisor, but most fee-only financial advisors are fiduciaries. This means that they are legally required to act in the best interests of their clients at all times.
• Transparency: Flat-Rate Fee-Only financial advisors are paid directly by their clients, so there is no conflict of interest. The advisor is not incentivized to sell you any particular product or service.
• Simplicity: Flat rate fee-only fee structures are simple and easy to understand. You know exactly how much you will pay your advisor upfront, and there are no hidden fees.
• Accountability: Flat-rate fee-only financial advisors are accountable to their clients. They are not dependent on commissions or other payments from financial product providers.
• Ongoing Relationship: Much like AUM engagement, these are designed for long-term collaboration, spanning multiple years. This allows ample time to build a meaningful relationship, filled with numerous opportunities to discuss and brainstorm ideas on various topics. Such a sustained relationship minimizes the chances of overlooking important details or making mistakes.
• Value: Flat-rate fee-only financial advisors can provide a lot of value to their clients at a more reasonable cost than AUM advisors for larger portfolios. They can help you develop a financial plan, choose investments, and manage risk.

Disadvantages of Flat Rate Fee Only Fee Structure

There are a few potential disadvantages to working with a flat-rate fee-only financial advisor:

• Cost: For advisors with small portfolios, flat-rate fee-only financial advisors may be more expensive than advisors who charge AUM or hourly fees.

Narrowing the Options

After exploring the various fee structures available in the financial advising landscape, it’s clear that each has its own pros and cons. From commission-only models that may present conflicts of interest to fee-based structures that lack transparency, the options are numerous but not without their drawbacks.

However, for this article, we will narrow our focus to just two fee structures that stand out for their fiduciary responsibility and fee-only approach: Fee-Only based on Asset Under Management (AUM) and Flat-Rate Fee-Only. These two models offer a level of transparency and accountability that is often missing in other structures.

As we delve deeper, you’ll find that while the AUM model has its merits, it also comes with higher costs that can accumulate over time, especially as markets naturally drift higher—regardless of the advisor’s efforts. This leads us to our final recommendation: the Flat-Rate Fee-Only model, which offers a transparent, accountable, and often more cost-effective solution for long-term financial planning.

Now, let’s take a closer look at why the AUM model might end up costing you more in the long run, and why Flat-Rate Fee-Only could be the best choice for your financial future.

The Hidden Costs of AUM Fees in a Bull Market

The Snowball Effect of 1% AUM Fees

Let’s start by breaking down what a seemingly modest 1% AUM fee can amount to over time, especially as your portfolio grows:

• Portfolio Value: $1 million
• Annual AUM Fee: $10,000
• Portfolio Value: $5 million
• Annual AUM Fee: $50,000
• Portfolio Value: $10 million
• Annual AUM Fee: $100,000

As you can see, a 1% AUM fee can quickly escalate into a significant annual expense, particularly for those with larger portfolios. It is crucial to consider alternative fee structures like flat-rate fee-only advising.

The Market’s Natural Upward Trend

Historically, the stock market has shown a tendency to rise over the long term. For instance, the S&P 500 index has averaged a 10% annual return since 1926 and increased 68% of the years. While this is excellent news for your investment portfolio, it has a less-than-ideal impact on your AUM fees.

The Unseen Impact of Market Performance on AUM Fees

Here’s where the catch lies: If you opt for an advisor who charges based on AUM, your fees will inflate in tandem with any market-driven growth in your portfolio. This is because the advisor’s fee is a percentage of your total assets under management.

To illustrate, imagine you have a $1 million portfolio managed by an advisor who charges a 1% AUM fee. Initially, your annual fee would be $10,000. Now, let’s say the market has a good year, and your portfolio balloons to $1.5 million. Despite your advisor not lifting an extra finger, your annual fee would jump to $15,000.

Secret Sauce Pitch

The counter, and the pitch, that many advisors will tell you is that they will outperform the market in excess of their fees if you let them manage your money. In truth, that is a pretty high hurdle to clear due to many factors, including:

Market Efficiency

The Efficient Market Hypothesis (EMH) posits that all available information is already reflected in stock prices. Therefore, gaining an edge over the market through analysis or timing is difficult.

Transaction Costs

Active trading involves frequent buying and selling, which incurs transaction costs. These costs can eat into profits and make it harder to outperform the market.

Emotional Factors

Human psychology often works against traders. Emotional responses like fear and greed can lead to poor decision-making, such as panic selling or overconfidence. Yes, this even happens to traders.

Skill vs. Luck

Even skilled traders can be, and usually are, outperformed by market indices. It’s challenging, if not impossible, to separate skill from luck in trading outcomes, and even successful strategies can become ineffective over time.

Taxes

Active trading can also result in higher capital gains taxes, reducing the net return on investment. Even if the trading is inside a proprietary fund, the capital gains are still distributed to the investors at the end of the year, and taxes will need to be paid.

Competition from Institutional Investors

Individual traders are competing against institutional investors who have more resources, including advanced algorithms and a team of analysts.

For these reasons, many financial advisors and experts recommend a long-term, diversified investment strategy instead of active trading and attempting to beat the market. If you would like to really dig into these topics, I highly recommend Burton G. Malkiel’s “A Random Walk Down Wall Street.”

The Bottom Line

While AUM fees might seem straightforward and even reasonable at first glance, their cost can spiral out of control, especially in a thriving market. This is why it’s worth considering a flat-rate fee-only advisor who can offer transparent, predictable fees and a fiduciary commitment to act in your best interest—regardless of how the market performs.

Additional Considerations

When choosing a financial advisor, it is important to consider the following factors in addition to their fee structure:

• Experience: How long has the advisor been in business? What is their experience level?
• Credentials: Does the advisor have any professional certifications, such as the CFP® (Certified Financial Planner®) designation?
• Investment philosophy: What is the advisor’s investment philosophy? Do their investment strategies align with your own financial goals and risk tolerance?
• Communication style: Do you feel comfortable communicating with the advisor? Are they responsive to your questions and concerns?

It is also important to interview multiple financial advisors before making a decision. This will help you find the best advisor for your needs and financial situation.

Conclusion

Navigating the labyrinth of financial advisor fee structures can be overwhelming. From Commission-Only models that may harbor conflicts of interest to AUM-based fees that can snowball as your portfolio grows, the choices are many but not without their pitfalls. However, if you’re looking for a transparent, accountable, and often more cost-effective solution, the Flat-Rate Fee-Only model stands out as the intelligent choice for your long-term financial planning.

Ready to take control of your financial future? Opt for a Flat-Rate Fee-Only advisor for a transparent and accountable financial planning experience. Don’t let hidden fees and conflicts of interest derail your financial goals. Make the smart choice today and set yourself on the path to a secure and prosperous future.

If you found this article helpful, please share it with others who might benefit from this information. And if you have any questions or want to explore how a Flat-Rate Fee-Only structure can help you achieve your goals, set up a time to talk. Your financial well-being is too important to leave to chance. Choose wisely.

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