It’s always pretty important to know what and how you’re paying for, especially with investments and advice. We mentioned this in our mutual fund fee analysis post. Advisors come in all sorts of shapes and sizes but there are 3 main methods of charging. Fee only, Fee based and commission.
Fee only means the advisor charges a flat fee or an hourly fee, or even possible a set amount. Most advisors charge a version of this, mainly through AUM or assets under management. This fee ranges usually from .75% to 2% of the assets managed for the client. This is helpful in that advisors have a vested interest in you have a good bright and rich future. Taking a percentage of the assets managed, the more they manage, the more they earn. So besides bringing in new money, if they grow your money correctly, they will also enjoy the benefits. On the flip side, if they perform badly and lose your money, their income shrinks as well. An example, an advisor manages 50 million dollars and charges a 1% fee. He earns 500,000 a year. If he performs well in 5 years and assets increase to 75 million, his income will increase to 750,000. But if the investments do not perform well and after 5 years the assets are only 25 million, then his income is only 250,000.
Fee based means they charge a fee in addition to possible commissions on products. This is what we at Lodestone Capital Solutions are and how we charge. In addition to the % fee we charge for assets under management, we also earn commissions, primarily on insurance products. As we provide a full service insurance brokerage, we offer a wide array of products. In our minds, the more services we can provide for clients the better, regardless of the commissions. Generally speaking, commissions on insurance products are not large, except for annuities and variable life policies. So be careful when buying those products. They do have their places, but they are not a one size fits all and are not the end all product for everything.
The 3rd method is straight commission. This is where advisors are paid a flat fee, possible A share mutual fund fees for recommending products and services. (See our mutual fund fee comparison) This method of compensation has decreased in popularity in recent years, except brokerages still charge commissions for trades. The conflict for brokerage houses is, they earn a commission on trades, so the more often you trade, the more they make. So a greedy broker would recommend lots of switching back and forth to generate income. For advisors, if they receive a flat 5% up front, they have no interest or “skin in the game” whether the investments they recommended have gone up or down.
At Lodestone Capital Solutions, we are glad that we are able to operate as a fee based financial planning firm. This allows us to align our interests as far as fee in addition to our investment philosophy of ”eating our own cooking” and investing all of our own investable assets alongside our clients.