How Do Financial Advisors Charge Their Clients?
There are several ways that a financial advisor commission is charged. There is no perfect structure for financial advisor commissions or fees. Each has its pros and cons, and some are better suited to certain types of investors than others.
What are wrap fees?
AUM fees, also known as wrap fees, are charged as a percentage of the assets under management, typically between 1% and 3% of a client’s entire portfolio. Usually, the higher the value of the AUM, the lower the percentage that is charged.
For example, a client with a portfolio of $1 million would be charged $10,000 for the year if the wrap fee was 1%.
Investors who choose wrap fees usually want to make use of a brokerage’s full gamut of services. Theoretically, a brokerage that charges wrap fees would be more incentivized in making a client’s portfolio grow but this is not necessarily the case. If a $1-million client loses $100,000 in a year, reducing his or her assets to $900,000, the brokerage still pockets $9,000 for the year despite the $100,000 loss on the client’s side.
Review wrap fee contracts very carefully before agreeing to this type of financial advisor commission structure.
Be Aware of Reverse churning
“Churning” is an investment term for when a broker buys and sells excessively on a client’s account without that client’s best interests at heart, and only to generate commissions for the broker.
Reverse churning means when a broker engages in no trading at all and yet charges a wrap fee for its services. Reverse churning can be a problem when dealing with unethical advisors and brokers who charge a wrap fee.
Monitor “other Fees”
Wrap fees are supposed to be all-inclusive. It is part of their appeal, especially for high-volume investors.
Investors should be particularly aware of broker-dealers who charge additional transaction fees when their pricing model is based on wrap fees. Take these transaction fees up with your advisor or broker immediately if you suspect or notice them.
Can Financial Advisors Charge Clients for Every Trade?
Yes. Another fee structure is charging only a transaction fee per transaction. The most common risk with a transaction fee structure is the possibility of a conflict of interests where the broker carries out transactions simply to earn their fee.
Transaction fee structures can lead to churning—the buying and selling of securities simply for the sake of earning a transaction fee or commission, and not for the best interests of the investor.
May Result in Mark-ups or Mark Downs
Cover markups are when the dealer charges the client a higher price than they are getting on the inside for the dealer to pocket the extra change and cover expenses.
Markdowns are when the dealer charges the client a lower price, thereby stimulating trading. The additional trading adds to the overall transaction fees they accumulate, leading to a net gain for them.
Some dealers charge on a commission basis. This is a similar structure as charging a transaction fee except that they’re not charging the investor for each transaction, but rather pocketing a commission from third parties. This likewise can lead to churning, cover markups, and markdowns. This is the way broker-dealers are paid for sales of private placements and annuities.
It might be more difficult for investors to spot foul play when they’re on a commission structure. In a transaction fee structure, at least the investor gets to see their final bill at the end of the month.
If your advisor has you on a commission structure, look closely at the gains (or lack of gains) your investments are making, and be particularly alert to churning.
Some advisors charge a flat hourly rate for their services. This can be a popular option for DIY traders who simply need a bit of advice occasionally on the best place to put their money.
Hourly rates vary, generally starting from $100 to $400 per hour. When charging purely an hourly rate, the advisor has no vested interest in the number of transactions, and the investor can also decide how much advice they need and so keep their costs down.
At the same time, the hourly rates can quickly skyrocket over what the investor might pay in a wrap fee. Investors should be wary of this type of financial advisor commission structure.
Con: Not results-based
Unfortunately, all fee structures chosen by advisors are not results-based, meaning that the advisor gets their fee or commission regardless of whether the investor’s assets go up or not. This is simply the nature of the beast.
But the hourly fee has the added con that, the longer an advisor takes to provide a service (such as an estate plan), the more they earn. Not only is an hourly fee not results-based, but it also tends to reward slow service.
Another popular option for DIY investors is the flat fee structure. Advisors provide a list of services that they offer, with a fixed price for these services. There is no risk of churning and investors can keep their overall costs low.
Self-directed (DIY) investors might choose to use a flat fee advisor for more complicated asset structures.
Flat fees are more likely to encourage results-based production than other structures. Firstly, the advisor is motivated to work efficiently. And if a flat fee advisor’s advice results in a gain for the investor, that investor is more likely to return and purchase more flat fee services.
But the costs can quickly surpass those of wrap fees if the advisor is called upon regularly.
What to do if you feel your advisor’s fees are not transparent or merited
The first thing to do is to put your complaint in writing to the advisor and their immediate senior.
If this does not resolve the issue, you can file a complaint with FINRA if that advisor is registered with them.
Finally, if all else fails, you can call a securities lawyer to assist you with ensuring you don’t become a victim of financial fraud.