(7 minutes to read)
One of the biggest areas of confusion I hear from people looking to hire a financial planner is understanding how we charge. Not everyone charges the same way, and the differences are worth noting—they can be significant. Here’s a quick review of various pricing models for financial planning services throughout the industry.
Fee-only vs. fee-based and commission-based
The first thing to be aware of is what fee-only means. Fee-only refers to a method of compensation in which clients pay financial advisors directly for the services they receive. You may also hear this described as fee-for-service.
This is in contrast to the two other compensation methods: commission-based and fee-based. With commission-based financial planning, clients buy products recommended by the financial advisor, who earns a commission on the product sales. In this model, the product company, an investment company or insurance provider, pays the financial advisor, not the client. This creates a conflict of interest for the financial advisor, who is incented to recommend products that may not be in the client’s best interest.
Fee-based means the financial advisor is compensated both by commissions from product sales and by payments from the client. While the term sounds similar to fee-only, the structures are very different. That’s because fee-based compensation has the same conflict of interest as commission-based compensation, since the commission portion of an advisor’s compensation is still paid by investment and insurance companies for product sales.
The fee-only compensation model was created in 1983 by a group of financial planners who wanted to remove the conflict of interest created by commissioned product sales. That group created the National Association of Personal Financial Advisors (NAPFA), the leading professional organization for fee-only financial planners that’s now in its 40th year, with over 4,400 members. I am actively involved with NAPFA and have served on its board of directors—it’s an affiliation I’m proud of.
With fee-only compensation, the cost of services is clearly and simply disclosed in writing by your financial planner before you begin working together. With commission-based and fee-based financial advisors, it can be more difficult to understand what up-front and ongoing commissions you will be paying. If you are working with someone other than a fee-only advisor, be sure to understand how much and how you are paying for the services you receive.
Fee-only pricing models
In all fee-only pricing models, the client pays the financial advisor directly, and the financial advisor does not earn income (commissions) from any product provider, which eliminates a major conflict of interest.
Yet there are some differences between the various fee-only models used, which include assets under management (AUM), as well as hourly billing, project-based, retainer, subscription, and hybrid.
Assets under management
The predominant pricing model in the investment management industry at large, as well as within fee-only financial planning and advisory firms serving individuals and families, is AUM. In the AUM pricing model, clients are charged a fee based on the value of their investment portfolio. AUM fees are typically paid quarterly, automatically by fee deductions from client investment accounts, and are typically tiered, so that with increasing amounts of AUM, the fee on additional assets decreases. This is an example of one possible AUM fee schedule:
Amount Managed Fee
$0 – $1,000,000 1.00%
$1,000,000 – $2,000,000 0.90%
$2,000,000 – $3,000,000 0.80%
$3,000,000 – $5,000,000 0.70%
$5,000,000 – $10,000,000 0.50%
$10,000,000+ 0.30%
For example, a client with $2,500,000 to be managed would pay ($1,000,000 x 0.01) + ($1,000,000 x 0.009) + ($500,000 x 0.008) = $23,000. Expressed as a blended percentage of AUM, the fee would be 0.92%. This is a hypothetical example similar to many firms’ fee schedules, but not any particular firm.
There can be significant differences between the services firms provide under the AUM pricing model. Some firms offer only investment management services—they open accounts, accept new cash, place trades to create and manage a portfolio of investments, and provide regular performance reporting. Some provide in-person or online meetings for clients regarding investments. Automated investing services (so-called “robo” advisors) and many of the industry’s approximately 14,000 Securities and Exchange Commission (SEC)-registered and state-registered investment advisory firms who work with families and individuals operate this way.
Other firms provide additional services, including financial planning. Financial planning is offered along a continuum of depth, from superficial to extremely detailed. Some firms also provide tax planning and/or tax preparation services, some assist with small business planning, and some provide equity compensation planning. Many firms provide these additional services at no extra charge under the AUM pricing model. For example, Parkworth provides investment management, financial planning, tax planning, equity compensation planning, and other services on an ongoing basis under the AUM pricing model.
When comparing firms’ fee schedules, it’s important to understand what services are provided for those fees. There is little to no standardization of services within the industry, even though the fee schedules across firms look similar. The services provided by two different firms for the industry standard fee of 1% on the first $1,000,000 (i.e., $10,000) of assets to be managed can be quite different. Financial planning-oriented fee-only advisory firms often charge an up-front fee of a few thousand dollars to cover initial financial planning work before clients progress to ongoing services under the AUM pricing model.
Other pricing models
While AUM is the most common pricing model, some fee-only financial planners use other pricing models, including:
Hourly billing – Primarily offered for short-term financial planning-only engagements, this model typically does not include investment management. Many firms offer this as an add-on to investment management services; other firms may offer only financial planning services and use hourly as their main pricing model. Hourly rates vary widely based on the credentials, experience, and expertise of the advisors involved. Hourly rates for financial planning commonly range from about $150 per hour to $350 per hour, and more.
Project-based – Similar to hourly billing, project-based fees are primarily offered in the context of short-term financial planning (i.e., not ongoing) and do not include investment management. These fees can be an add-on to services under AUM or the primary pricing model. Total project cost is typically estimated based on the expected number of hours to complete the work multiplied by the hourly rates of the advisors performing the work (which can be multiple people at different hourly rates). The amount of time needed to complete a project, and thus its total cost, depends on the scope and complexity of the project. For example, a project might include anywhere from one to about 16 common analysis topics, such as required retirement savings, stock options/restricted stock units, tax planning, investment/portfolio, or college savings.
Retainer – In this model, ongoing fixed fees are typically determined annually (and paid quarterly) based on a set of financial inputs that seek to capture the complexity of a client’s situation. For example, the retainer fee might be calculated based on a combination of net worth, taxable income, and services to be provided. The retainer fee may include investment management, along with a variety of other services, including financial planning. Firms that offer retainer pricing typically do not also use an AUM model.
Subscription – As you might expect, this model involves a recurring fee often charged monthly for ongoing access to an advisor and a fixed (usually limited) bundle of services. This model is typically used with younger clients who are early in their careers and do not have significant assets or income. However, some firms have adopted a subscription pricing model for a wider swath of client financial situations.
Hybrid – Recently, some advisory firms have explored using a combination of the above models. For example, some firms have experimented with a pricing model that includes a combination of AUM fees for investment management plus an annual retainer fee for financial planning-related services.
As you can see, fee-only financial planning is offered in a variety of pricing/service models. The AUM model is most common and has served both clients and advisors well for decades, providing the ongoing advice and accountability clients need, while allowing advisory firms to remain financially healthy and able to serve their clients over the long term.
When determining which advisor or firm to work with, it’s important to understand how different types of compensation work and what they mean for you and the services you’ll receive. This isn’t an area to skip any steps—do your homework, ask questions, make sure you understand all elements of the pricing structure, and then make the informed choice to work with someone you know you can trust.
Parkworth Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests. If you’re considering getting a financial health checkup with a fee-only financial planner, schedule a complimentary consultation.
