5 Hidden Costs of Fee-Only Advisors

So, you've decided to hire a financial planner. You want someone that can help you manage your investments. And you've done some research. You've decided you want to stick with a fee-only advisor, and it's a good choice. Fee-only advisors, by law, have to be fiduciaries, which is just a fancy way of saying they have to keep your best interests at heart when they're making decisions uh with you. They can't take a kickback or a commission from an investment product that they recommend. They can only accept the fees that you pay them. But, what you've noticed is most of them want to charge you a percentage of the amount of money uh that you give them to manage for you. It's called assets under management or AUM. 1% is a very common fee amount in the industry. Some are more than that. Some are less. But, 1% is very common. And you want to know, is that a good deal? Is that the way I should go? Are there alternatives? Well, we're going to talk about that in today's video. We're going to look at the five, I think, very significant hidden costs uh that you you can find with fee-only fiduciary advisors that charge you a percentage of the investments you you give them to manage for you. Then we're going to talk about an alternative that I think is much, much better. We're even going to talk about why so many people don't choose that alternative. Why do they still choose a percentage of assets under management, which I think is by far uh the most prevalent way these financial advisors charge their clients. So, that's what we're going to cover today. We're going to start with the five hidden costs, and we'll jump right in. The first one is the fee itself, and you may say, "Well, that doesn't seem hidden, Rob. If the advisor says they're going to charge me 1% of the money they manage for me, that that doesn't seem hidden." And and it's not. And we'll just assume, for the sake of discussion, you've got a million dollars. Doesn't matter. You may have more. You may have less. But, we'll assume a million dollars for the sake of easy math. 1% is $10,000. Now, we can stop there and say, "Boy, that's a lot of money." Uh in fact, it may be one of your largest expenses uh each year. And it's not a one-time fee. It's each and every year you decide to continue using their services. But what that doesn't tell us is how much did we lose because that $10,000 that gets pulled out of our account every year takes away from compounding. We'd love to have that money stay in our investments to continue to compound and it's now gone. And when you factor in the compounding, that 1% fee even on a million-dollar portfolio can easily cost us six figures and in some cases depending on how long you stay with this advisor could be seven figures. In fact, one tool that you can use I've used in the past is called Empower. It's a free financial dashboard. You connect your accounts and they have a retirement fee analyzer. I'm telling you if you try it, the number will shock you. But there's another way we can look at these fees to see just how hidden they are and let me show you that. By the way, I'll leave links to all of this below the video. This is FI Calc. We've looked at this on the show before. It's a free tool. And it just shows you it's you know, your chance of success for retirement if we're going to assume a 30-year retirement, million-dollar portfolio. We're going to take out 40,000 the first year. So kind of following what's called the 4% rule. We're going to adjust it for inflation. And with this stock, bond, and cash allocation you can change it but we'll leave it where it is. We have a we'll call it a 97% chance of success. This is based on historical data going back to 1871. Well, what if our advisor we we go to an advisor and they're going to charge us 1%. You can see the annual fee here. .04 that's kind of like I guess the kind of fee you might have if you have an index fund. But let's add an advisor fee of 1%. And we'll just do this down here for cash as well cuz if they've if they're holding cash, it's still same assets under management. Now when we do that, you'll notice it drops from about 90 with 97% to about 92%. Now, you may be saying, "Okay, I I don't like that drop, but that's not terrible." Uh and you might even be able to live with that chance of success. But let's look at it a different way. Let's assume we could. Let's say 91.9 we're comfortable with that. Well, what if we went back and took this 1% fee out? Do that here. And here. So, we're back to our 96.8% and now let's start raising our initial withdrawal. I mean, if we're comfortable with 91.9% success rate, maybe we can take out an extra an extra grand. 41,000. Boy, that didn't even change it. How about 42? That went down a little. Let's jump to 44. Oh, we're getting closer. If we go to 44,500, we get to that same 91.9%. So, that 1% fee, of course, is costing us 10,000 in year one if our portfolio if we retire in a good time and our portfolio goes goes up and up, that fee's only going to get bigger. This is actually modeling a worst-case scenario where, you know, where maybe the portfolio doesn't go up in value. Uh but we're still losing $4,500 the first year in money we could be spending on ourselves. Uh that's over 10% of our initial withdrawal and of course, that's going to get adjusted for inflation. And so, when we think about the fees this way, very practical, down-to-earth, how's it going to affect us living day-to-day, that seemingly small 1% fee gets really really big. Now, there's a second fee issue that really is hidden uh that we need to talk about. We got five, this is number two. Uh a lot of uh fee-only financial advisors, not all of them, but they will put uh their clients into expensive mutual funds. You know, not all financial advisors, fee-only fiduciaries, they don't all use index funds like we talk about on this channel. Many of them put put their clients into very expensive funds. Now, we could talk about why they do that. Some may genuinely believe that they'll perform better even though the data tells us that it's highly highly unlikely that they won't. I have a different theory I'll share with you in just a minute, but let's take a look at how that affects our numbers because we can go back to this financial calculator at FI Calc. Here we could put in the the 1% fee that the advisor charges, but then we could increase it instead of 1.04 which might reflect an advisor putting you in an an index fund. Let's do 1.75. I think 75 basis points for an actively managed fund is is is not at all. That's actually would be considered on the low side. We'll just leave the cash at 1%. And you can see now look at this, we've dropped we've really sunk down 72.6% taking a big hit. Now, we're still at 44,500. But we've dropped 20% in the success rate. If we go back to the 4% rule, we're at 79%. So, when you add in not only the advisor's fee, but an expensive mutual fund if that's what they put you in, the fees can really take a bite out of your retirement. And of course, if we were looking at this in terms of just lost compounding, the number grows, it gets even bigger. So, those are the first two of the five. Now, there's a third sort of inherent conflict of interest and you may say, "What? Wait a minute, they're fiduciaries. They have to have our best interests at heart. How can there be a conflict of interest? Well, we remember how they're getting paid. They're getting paid on a percentage of the assets you have invested with them. So, they would prefer for that that number to be as large as possible. So, what happens when you go to them, you want some financial advice, and you ask them, "Hey, should I pull money out that you're managing for me to pay off the mortgage? Should I pull money out that you're managing for me to go buy an annuity? Should I delay Social Security to get a higher benefit, but that's going to require me to pull money more money out of the account you're managing for me every year, lowering your your fee. There's an inherent conflict of interest in my view between a fee-only advisor that charges a percent of assets under management and these very common financial questions that particularly folks in retirement are going to have. Now, I want I want to be clear. I'm not suggesting that all fee-only financial advisors that charge a percentage of assets under management are bad people or that will steer you wrong when you go to to ask them these questions. By the way, the same could be true of commission sales people that will sell you an investment and take a commission from the investment themselves. Some of those individuals are really good at what they do. The point though is there is an inherent conflict of interest between a fee-only advisor that's getting paid a percentage of the assets they manage for you and financial decisions that you need to make that could impact their fee by taking money out of those investments for some other purpose like to pay the mortgage or perhaps to buy an annuity and so on. And we have to recognize that. This is not a conflict-free zone. There is absolutely a conflict there. At a minimum, we should be aware of it if we're going to use an advisor that charges us a percentage of assets under management. Now, the fourth one and you know, I mentioned earlier that sometimes they'll put you in expensive mutual funds and I have this theory as to why. Well, there's something else that I've seen fee-only and I I have to be specific. Fee-only advisors that charge a percentage of assets under management, they tend to overcomplicate the portfolio. Not only do I see instances where they're putting clients in very expensive funds, but they're putting clients in a lot of funds. We're talking 20, 30, 40 or more ETFs, mutual funds and in some cases individual stocks. And that's true even with clients that don't have you know, you'd think some kind of portfolio with 40 different investments, they must have 10 or 20 million dollars. I've seen that with clients that have $500,000. Frankly, I should I think it should be a crime. Uh but I see it time and time again because you all email me your portfolios. And here's the email I get. Rob, I used this financial advisor. I'm sorry I ever did. Uh they were managing my taxable account. I've got 30 different investments. Uh some of them are very expensive. How in the world do I unwind this? And I'll be honest, I don't have easy answers for people. It's a tax nightmare. And so, you've got to be very careful. Again, I'm not suggesting that every financial advisor that charges a percentage of assets under management is going to do this to your portfolio. What I am telling you is it's I've seen it very it's very very common. I can't tell you I've lost count of the number of emails I've received from people. And I'm they'll they'll they'll literally attach a spreadsheet to the email. Here all my investments. What in the world do I do? And there's just not an easy uh answer. And so, you've got to be very very careful with that. It's a big issue. Now, uh the fifth and final one, maybe a little controversial, but it's it's also been my experience is this. A lot of investment advisors that charge a percentage of assets under management will offer financial planning. A lot of times it's almost like a loss leader. It's like a an extra thrown in to justify the fee. The issue is for them, it's spending time that doesn't add any money to the bottom line because they're getting paid based on the assets under management and whatever percentage they're charging you. And so, what I found is they don't give the time and attention that I think is required on the financial planning side of things. Again, this isn't true for for all of them, but I can tell you I've experienced it myself first hand. And and they just weren't interested in giving me the time and attention we needed for a a comprehensive thorough financial plan. They just wanted to get the assets into that they wanted to manage and to charge a percentage of that fee and I ended up not going with this firm because of that. So, you've got to be very careful. They may talk a lot about the financial planning services that they offer, but are they really going to give the time and attention that your situation requires for that kind of financial planning? And by the way, even if they will, you still have to ask does it justify the 1% or whatever the fee is because you can go get financial for a few hundred dollars an hour, maybe a flat fee of several thousand dollars and you're done. All right. So, given all of those, I'll call them hidden costs of fee-only percentage of asset assets under management financial advisers, why are they the dominant force? Why do why do so many people go to that kind of financial adviser rather than the alternative, which I think is much much better and that is a flat fee adviser, somebody who's going to charge you by the hour or just a flat fee, perhaps yearly, could be a one-time fee if you're just getting a financial plan, or it could be a flat annual fee if you're going to getting ongoing services. Why don't people go that route? And I think there are two reasons. The first is from just a business perspective as a financial adviser, it's you're going to you have the potential to make a truckload of money charging a percentage of assets under management. I was looking at one very large financial planning firm that has 250 billion dollars in assets under manage under management. This is they're in all 50 states and countless countries. This is a big big firm and you know what their starting fee is? 1.2%. Now, it goes down for people with a lot of money, but boy, if you've got 10 million, you're paying this firm almost $100,000 a year. Are you kidding me? Well, why do they have 250 billion dollars under management? They must be doing something right. Why are people going to this firm? And I think part of the answer is for a lot of people, all of this is scary. Particularly particularly when you start to have some some some money to invest, maybe you're getting close to retirement, you just you just want someone to handle it. But I think there's a bigger issue at play and it's this. Imagine you go to a percentage an advisor that charges a percentage of assets under management, you talk to them and then you talk to a flat fee advisor that's going to charge you say, let's just say they're going to charge you $5,000 a year, the percentage of assets under management is going to charge you 1% and you've got a $1 million portfolio. When you go to that that percent of assets under management advisor and you want to if you're going to get started, you say, "Okay, how much do I owe you?" You get your credit card out or your checkbook. What do I owe you? They say, "Oh, you don't owe me anything. You don't have to pay a nickel. I will conveniently take your fee out of your investment account every quarter. You don't have to worry about it. Your checking account will never see this fee. It'll never hit a credit card. You're good to go." On the other hand, if you go to that flat fee advisor, at least in my experience, yeah, you're going to cut them a check. You're going to give them the credit card. I just did this with a flat fee advisor 1 week ago. Someone that I'll talk to you about in a few weeks, but yeah, I had to pay them right up front. Didn't conveniently come out of my account. And here's the deal. I think when people don't see the money leaving their checking account or hitting their credit card, it's like they can forget about it. It's as if it's not real. It's just all part of their assets under management and their investments account investment account. It comes out and they they don't even notice. And they're willing to pay 10 grand to someone charging a percent of assets under management rather than having to write a check for 5 grand to pay a flat fee advisor every year. Now, in the end, the percentage of assets under management is costing them a truckload. We have to feel that pain. We have to realize what's going on. We have to realize our own sort of behavior and dynamics going on there in terms of what feel it feels worse to write a $5,000 check than to have 10,000 come out quarterly from your investment accounts, but we have to realize which one is costing us more. There are plenty of really good flat fee hourly or you know sort of annual fee advisors and I'll leave links below this video for some of you might want to consider. If you are going to use an advisor that charges a percent of assets under management, you should at least be aware of all of these issues and try to find the advisor that's going to charge you the least the smallest percentage possible is going to put you in sensible portfolios with in my view low cost index funds and it's going to give you the time and attention you need for good sound financial planning. So, there you go. Those are my five hidden costs of fee only financial planners. I hope you take this to heart. If you have any questions, leave them in the comments below. Maybe you have some stories to share. Put those in the comments as well. I'd love to hear about them. If you have any questions, leave them in the comments. I'll be happy to help you out any way I can and until next time, remember the best thing money can buy is financial freedom.