It was Oscar Wilde that said, “A cynic is a man who knows the cost of everything, and the value of nothing.” I might put it a bit differently: a well-informed investor is one who understands both the true cost of a financial advisor and the value of a financial advisor.
By the end of this post, you will be a well-informed investor.
Different fee structures
The first thing that you need to know when it comes to the true cost of a financial advisor is that there is no one true cost: different financial advisors charge in different ways. I’ve covered this in both my posts on types of financial advisors and financial advisor rates. To recap, there are three major types of financial advisors:
- Commission-based advisors: to you, a commission-based advisor might seem free. After all, they’re not explicitly charging you anything. This is misleading, though, because they are (of course) making money: they get a cut of everything that they convince you to buy (such as life insurance, annuities, specific stocks, and so on.) In this sense, commission-based advisors are salesman. I don’t generally advise people to go to commission-based financial advisors. With them, the true cost of a financial advisor, at least when they’re commission based, is that they’re more interested in selling you something than improving your finances.
- Fee-only and fee-based advisors: Fee-only and fee-based advisors will charge an hourly rate for their advice, much like a lawyer might charge. You can expect to pay between 150 and 300 dollars an hour for a decent fee-only advisor — note that fee-based (as opposed to fee-only) advisors also make money via commissions. As I’ve mentioned in the past, fee-only advisors are a good choice if you need either specific advisor, or would like to actively implement a plan that they help you put together.
- Percentage-based advisors: Percentage-based advisors typically act as active money managers. They will take care of your assets, for the price of 1% each year. As I said last time, I like this because it aligns your advisor’s success with your success.
Thus, for a fee-only advisor, you can expect to pay between 150 and 300 dollars an hour. Depending on how much time they spend on your case, you could be looking at paying between 1,000 and 5,000 dollars for a financial plan.
Alternatively, you could go the percentage-based route, in which case you’re going to be paying 1% of your assets per year. So, the amount you’ll be paying depends on how much money you want the financial advisor to manage.
True cost of a financial advisor: Taking into account compounding returns
But that’s the upfront cost. This doesn’t take into account the true cost of a financial advisor.
Imagine, for instance, that you’re 30 years-old, and have 100,000 dollars saved up for retirement. You want help managing this money, so you consider paying a financial advisor to do it for you.
Naively, at 1%, you might think that this would cost you 1,000 dollars per year.
Except… you need to take into account the returns on that investment you won’t be getting — 1% less each year. If, optimistically, your portfolio returns a 9% return each year, and we ignore taxes, after 25 years, your portfolio will be worth $862,308.
What if we take into account that 1% less each year? $684,848, or almost $200,000 dollars less.
Thus, learning to manage your own investments has a handsome return.
True cost of financial advisor: But what if you didn’t have a financial advisor?
This still doesn’t get at the true cost of a financial advisor, though, because you have to ask: would my returns be the same with and without a financial advisor? If, right now, your savings are in cash, such that your return is probably negative (given inflation), then you’ll get a lot of value out of a financial advisor. (Maybe a million dollars worth or more.)
On the other hand, if you spend, say, a year learning about your own finances, to the point where you can manage them as well as a professional, you could be saving yourself $200,000 dollars (or more).
This means that the true cost of a financial advisor depends on your willingness to manage your own finances.
And, hey, if you manage them yourself, you won’t even have any receipts to deal with.