What Am I Paying My Financial Advisor?

When working with a financial advisor, understanding how they’re compensated is crucial to ensuring you’re getting value for your money. Advisors typically charge in one of three ways: assets under management (AUM), commissions, or flat fees. In this blog, we’ll break down how to figure out what you’re paying in an advisory account based on AUM and a commission-based account with mutual funds. We’ll also explore why a flat-fee advisor might be a better option for many investors.

Advisory Account Based on Assets Under Management (AUM)

An advisory account charges fees based on the total value of your portfolio, known as assets under management (AUM). Here’s how to determine your costs:

1. Find Your Portfolio Size
   • The first step is identifying the total value of the assets your advisor is managing. This amount will serve as the base for calculating the fee.  You can find this information on your account statement.
2. Locate the AUM Fee Percentage
   • Most advisors charge an annual fee ranging from 0.25% to 2% of your portfolio’s value.  This information is also found on the account statement, but could also be found in an advisory agreement that is signed at the beginning of an advisory relationship.
     • For example:  If your portfolio is worth $500,000 and your advisor charges a 1% fee, you’ll pay $5,000 annually.
3. Consider Breakpoints
   • Some advisors offer discounts for larger portfolios. For instance:
     • Portfolios under $1 million may be charged 1.25%, while portfolios over $5 million might be charged 0.75%.
4. Calculate Your Fees
   • Multiply your portfolio size by the fee percentage to estimate your annual cost. If fees are billed quarterly, divide the annual fee by four.  Remember these numbers will change each quarter with the value of your portfolio.  As the portfolio increases in value, your advisory fees will increase, the fees decrease if the portfolio decreases in value.  Example:
     • If your portfolio is worth $300,000 and your advisor charges 1.25%, you’ll pay:
       • $300,000 × 1.25% = $3,750 annually, or about $938 per quarter.

Commission-Based Account with Mutual Funds

Commission-based accounts operate differently, as advisors earn money through commissions on mutual funds or other investment products they sell.

1. Review Mutual Fund Prospectus
   • Start by reviewing the prospectus of any mutual fund you’ve purchased through your advisor. Look for:
     • Annual fund operating expenses: These include management fees and marketing/distribution fees (12b-1 fees).
     • Shareholder fees: These may include front-end loads (sales charges) or back-end loads (fees upon selling).
2. Understand Sales Commissions:  Mutual funds often charge sales loads:
   • Front-end loads: Also known as “A-Shares”. Paid when you buy shares, typically up to 5% but sometimes as high as 8.5%.
   • Back-end loads: Also known as “B-Shares”. Paid when you sell shares, often decreasing over time.
   • Level-load: Also known as “C-Shares”. Paid as a recurring annual fee (typically around 1%) instead of upfront or back-end sales loads.
3. Account for Ongoing Costs
   • In addition to sales commissions, mutual funds have annual operating expenses ranging from 0.25% to 1%, or more, depending on whether they’re actively or passively managed.
4. Broker Fees
   • Some advisors earn commissions directly from transactions or products they sell, which can range from 0.25% to 1.50% per trade.  Example:
     • If you invest $10,000 in a mutual fund with a front-end load of 5%, you’ll pay:
       • $10,000 × 5% = $500 upfront.
       • If the fund has annual operating expenses (12b-1 fees) of 0.75%, that’s an additional $75 per year.

Why a Flat-Fee Advisor May Be Better

Flat-fee advisors charge a fixed dollar amount for their services, regardless of portfolio size or product sales commissions. This model has several advantages:

1. Transparency:  Flat fees are straightforward and predictable—you know exactly what you’re paying upfront without worrying about hidden costs like loads or expense ratios.
2. No Conflicts of Interest:  Unlike commission-based advisors who may have incentives to sell higher-cost products or AUM-based advisors who benefit from growing your portfolio size (even if it’s due to market performance), flat-fee advisors focus solely on providing advice tailored to your needs.  Flat fee advisors aren't compensated any differently based upon what they recommend to clients.
3. Cost Savings for Larger Portfolios:  For investors with substantial portfolios (e.g., $1 million+), flat fees can be more economical than AUM-based fees that grow proportionally with your assets.  Example:
   • If an advisor charges a flat fee of $6,000 annually and you have a $2 million portfolio:
   • AUM-based fee at 1%: $20,000/year in fees.
   • Flat fee: $6,000/year in fees.
     • You save $14,000 each and every year by choosing a flat-fee advisor.  Compound those savings over the life of your entire portfolio and that is some serious savings.

Conclusion

Understanding how financial advisors are compensated is essential for making informed decisions about who manages your money—and how much it costs you to do so. Whether you’re working with an AUM-based advisor or commission-based account, knowing the details can help you evaluate whether their services align with your financial goals.

If you value transparency and cost efficiency—or if you have a large portfolio—a flat-fee advisor may be the best choice for ensuring unbiased advice tailored to your needs without any unnecessary expenses tied to asset size or product sales.

By taking the time to understand these compensation models and comparing them against your financial situation, you can make smarter choices about managing your wealth.