investing

How a financial planner is compensated

Don TaylorQuestionDear Dr. Don,
Is there a standard range of fee rates, based on the amount of money managed, that a financial planner charges?
-- Dick Differential

AnswerDear Dick,
There are four basic compensation models for financial planners: assets under management, or AUM, an hourly or set fee for work performed, a retainer model or a commission based model. There's not one right model for everyone, so the goal is to find the model that's right for you.

An asset under management model has the financial planner receiving a percentage of the wealth he or she manages for you. The percentage fee is typically on a sliding scale with larger accounts paying a smaller percentage of AUM. Small accounts are often discouraged through a minimum annual fee. Here is an example of a sliding scale fee structure:

Assets-Under-Management fee structure: Yearly fee of 1.5 percent for AUM under $500,000, 1.25 percent for AUM between $500,000 and $1,000,000, and 1 percent for AUM over $1,000,000.

One problem with the AUM model is it encourages planners to try to hold on to assets. Paying cash for that second home by liquidating part of the portfolio could be discouraged.

An hourly fee model has you paying for the time the planner spends on your account. Hourly rates vary but expect to pay $150 to $300 per hour for basic financial planning. The Garrett Planning Network has made this method of payment its niche in providing financial services, but you can also find fee-only financial advisers using the National Association of Personal Financial Advisors, or NAPFA, site.

The retainer model is the up and coming approach to paying for financial planning. The planner charges you a flat fee and for that fee you receive an agreed upon level of service over the contract period. This model, like the hourly fee model, avoids most conflicts of interest.

Finally, the commission based model has the planner compensated based on money he or she receives as payment for selling you financial instruments like stocks, bonds, mutual funds, insurance, limited partnerships, etc. This model has the weakness of requiring you to be sold something for the planner to be compensated for his or her time.

I urge you to read " The Future of Fees" by Nancy Opiela writing for the Journal of Financial Planning in its August 2006 issue for additional depth on this topic.

One good rule: Don't pay 1.5 percent AUM to invest in a mutual fund that charges 1.5 percent management fees. Paying 3 percent to invest in a mutual fund makes it hard for your wealth to grow.

Not to denigrate the advice I've provided here, but you should expect to pay for sound financial advice. But you also get to choose how you pay for that advice.

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