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How does a financial planner charge for
their work?
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Is one method of compensation better than
another?
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How does a financial planner charge for
their work?
One of the key issues when hiring a financial planner is how that planner is
to be paid and whether that form of compensation is the right one for you.
There are many forms of compensation, and the planner may even offer a
choice, depending on services. But there’s been much debate in the media,
and within the profession itself, about which is the best form. Are fees
better than commissions? A combination? What about annual retainers?
There’s no one right answer to these questions, except the answer that’s
right for you. What is important is that the planner fully discloses how he
or she charges, that you understand the pros and cons of each form of
compensation, and that the arrangement best fits your needs. Ultimately, the
key is finding a competent, ethical planner who will look out for your
interests first and foremost, regardless of the type of compensation. Below are three typical ways to be charged for a financial plan:
- Fee only: Usually this type
of planner sets a one-time charge dependent upon the size of your
portfolio. It could be a flat rate or a typical hourly rate of $100 to
$250. This planner may or may not execute his recommendations. You
might have to go elsewhere to purchase the recommended financial
products. This removes product-sale bias and the approach is flexible
for those who want limited advice. But this arrangement may not
promote an ongoing relationship with the advisor. Furthermore, hourly
consultation fees could easily pile up for continuous comprehensive
planning, or encourage the planner to perform unnecessary work.
- Commission only: Like a
full-service broker, the commission-only planner makes money if and
when a financial product is sold. The commission is paid by financial
institutions for each financial product sold to the client, such as
insurance, mutual funds, limited partnerships, or stocks and bonds.
For example, the planner might be paid up front a percentage (say 5.75
percent) based on the value of the shares bought in a mutual fund, or
the planner might receive an annual commission (typically one percent)
based on the amount of money the client has in the fund account.
This approach creates a conflict of interest because planner may push
products that might not be in the best interest of the client, or may
encourage a rapid turnover of products, known as “churning.” On the
other hand, commissions can be a more affordable avenue than fees for
more modest-income clients.
- Fee plus commission: This
planner may use the same fee scale as the fee-only planner or he may
elect to take 1 to 2 percent of the portfolio's value on a yearly
basis for developing a financial plan or particular strategy. He will also sell you the products recommended in his plan and
take the sales commission. A variation is fee-offset. Say the
planner charges $2,000 in initial fees and receives $1,000 in
commissions. The planner would then credit the client $1,000 toward
future fees.
Below are other ways of compensating a
financial planner:
- Fees for assets under management:
The planner charges an annual fee based on the total value of the
client’s invested assets the planner is managing. A typical fee for
this service is 1 to 1.5 percent. Proponents argue that this removes
the commission-sale bias. But others say this arrangement can
encourage the planner to keep as much money invested as possible, even
when some of that money is needed elsewhere, such as for insurance, to
pay down debts or to donate to charity.
- Fees for total client assets:
Some planners are beginning to charge a percentage based on the total
value of the client’s investment and non-investment assets on the
assumption that they frequently provide advice on assets they don’t
directly manage, such as a 401(k) plan or a vacation home. This, they
contend, removes any incentive to keep liquid investments under
management. This method, of course, may not work for consumers with
modest estates.
- Retainer fee: A new trend is
to charge a flat fee for the year based on the size and complexity of
a client’s finances. Conflicts of interest may be minimal, but with
annual retainers ranging from $2,000 to over $10,000, the cost can be
prohibitive for many families, and there can be an incentive for a
planner to do as little as possible to maximize profit.
- Salary: A small
percentage of planners use this method. Most of them work for
financial institutions such as a bank. While the planner receives no
direct commission from the sale of a product, critics note that the
planner’s salary is paid by fees or commissions generated by the sale
of products and services sold by the financial institution to the
consumer.
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Is one method of compensation better than
another?
The method that produces the best financial plan is the best. It doesn't
matter which kind of planner you choose, if the investment recommendations
aren't good, then it's not worth cost. The personal chemistry between you
and the adviser, as well as your confidence in his or her ability, is more
important than the cost. Before you do business with any financial planner,
do your homework by understanding the fees and/or commission schedules. If
the financial planner is a commission-only person, familiarize yourself with
the costs of other products that have the same objectives as those
recommended by the planner. You need to know before you buy if your are
being sold an investment for its merits or its commission structure.
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