When it comes down to it, most of us focus on the cost when hiring a professional—any professional. That's entirely natural. But a problem arises when costs aren't transparent.
Unfortunately, hidden costs are common in the financial planning and wealth management industry. The issue lies in how the industry is run and how expenses are presented to clients.
Think about it. Many people will tell you that a financial advisor should almost always be free. And many advisors promote themselves by providing free financial advice and options to clients.
But the fact is, it's not free guidance. A "free" financial advisor takes commissions.
Other, more savvy investors already know this. But the upfront expense of hiring a fiduciary - usually a 1%advisory fee, still feels too generous. So they go with the salesman anyway, because the difference can't be too big, right?
It's tempting to hope that what they are selling you, these commissioned recommendations have high rewards. And that higher rewards will make the back-end commission "worth it."
But investments and retirement planning rely on more than gains. Gains are variable and unpredictable. Any financial advisor or wealth manager worth their fee - upfront or otherwise-understands how crucial limiting expenses are.
To give you a better picture of what this looks like in practice, let's take a look at the cost of a commission-based product over a fee-only investment.
Let me give you a real-life example of a client who was nearly sold a specific index fund.
Let’s call this fund Growth Fund A. This mutual fund reports:
The expense ratio or the expenses deducted from the fund annually is 0.75%, promoted as half the industry average. It sounds like a good deal.
Of course, some costs were minimized in the disclaimer. On top of the annual 0.75% expense fee, we have:
Let’s translate this into a real example.
And 3% essentially only keeps up with pre-pandemic inflation.
You paid $575 out of your principal. That commission fee reduces the capital you have to grow. Instead of earning interest on $10,000, you’re earning it on $9,425.
How much would you have earned if you removed the front-load commission fee?
Imagine that you’ve looked for mutual funds on your own and found Growth Fund B.
Growth-Fund B has the same return, expense ratio, 12b-1 fee, and taxes. But there’s no 5.57% commission.
As a result, you gain $934.15 in profit, with a total of $10,934.15. This is a whopping 9.34% increase from your original investment.
In other words, the 5.57% commission from Growth Fund A cost 66.67% of your potential profits!
Commission-based financial products carry hidden costs across the board—from annuities to bonds and insurance. It’s important to sit down and do the math before investing. Your chosen assets should help you meet financial goals, not barely get by.
A fee-only planner, meanwhile, would take 1% of all assets under management. Assuming this fund is your only asset, you would still have earned $924.81, for a total of $10,924.81 or a 9.24% increase.
Unlike a free advisor’s option, a fiduciary planner costs only 1.07% of your profit.
Okay, we’ve covered the upfront costs of a commission-based advisor. But not everything is easily translated into dollars and cents. What about:
Commission-based advisors may not be able to help at crucial life moments. And many are too busy selling their products to provide in-depth insights about other aspects of your financial planning, such as handling legacy decisions or career changes.
It’s not their fault. Their job description is to sell policies and investments—they are not fiduciaries.
A fiduciary is legally bound to think in your best interests. These are the registered investment advisors (RIAs) and fee-only advisors. They take an upfront fee on all assets because they offer a wider range of services and assistance.
RIA’s are often:
All of these characteristics can give you peace of mind and shave hours off of chasing down your financial planner.
Unlike brokers, registered investment advisors have access to institutional funds. Most brokerage accounts, like Vanguard, Schwab, and neo-investing platforms like Acorns or Ally, use retail investments. These investments generally come with a high commission rate, adding to your expenses.
That isn’t to say there aren’t any good retail funds. There are. But you need to find them.
Institutional funds work differently. These are higher-grade mutual funds with expense ratios as low as .01%. For individuals, they can be difficult or impossible to access. Most institutional funds require a minimum investment of $1 million dollars. Fiduciary advisors who invest millions at a time, however, can extend their access to you.
Most fiduciaries, however, have a minimum investment limit. For a 1% fee, assets under management should generally be at least $200,000 to ensure your profits aren’t eaten up by fees.
For that reason, not everyone can immediately afford to go to an RIA. That doesn’t mean you can’t grow your wealth. When evaluating potential investments:
And when you’re ready to choose an advisor, take care to find someone who you feel comfortable with. Check out our article on choosing a financial advisor for more tips.
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