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Which is better: a flat fee or a percentage of the managed portfolio? – Ben
This question is fundamentally about value. And people measure value in different ways. If you’re looking strictly at the numbers, you can easily find the break-even point between a flat fee and a percentage fee. This is essentially the account balance at which the flat fee becomes the cheaper option (assuming your investments are going to continue growing).
But what you’re getting in exchange for an advisor’s fee is perhaps the more important question. Cheaper isn’t always better.
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Advisor Fees Explained
Financial advisor costs vary considerably across the industry. The two fee structures you’ll see most frequently are the flat fee and the assets under management, or AUM, fee.
Pros and Cons of Flat Fees
Flat fees are simple: An advisor charges a fixed one-time, annual, monthly or hourly fee in exchange for a set of services. Services can range from cash flow analysis and budgeting guidance to targeted recommendations for specific or big-picture financial decisions like buying a house. Some advisors offer comprehensive planning that addresses multiple areas of your financial life, including insurance, taxes, investments, retirement readiness and legacy planning.
Some advisors who use a flat-fee model are “advice-only,” meaning they don’t manage your investments. They can review all of your holdings and make specific recommendations, but they won’t make trades on your behalf or have any type of custodial access to your accounts.
Potential Benefits:
- Cost predictability
- Accessible regardless of wealth level
- Paid out of pocket; doesn’t directly eat into your investment returns
Potential Downsides:
- Complexity, such as business ownership or the presence of trusts, can lead to surcharges
- Might be an advice-only advisor who doesn’t manage investments directly
- Paid out-of-pocket; might require budgeting or cash flow creativity
Pros and Cons of AUM Fees
Many advisors who manage investments for clients favor an AUM fee. For example, if your managed accounts total $1 million and an advisor charges 1%, you’ll pay $10,000 annually for their services.
Some charge a blended AUM fee, where the percentage fee falls as the asset level rises. For example, someone might charge 1.5% on the first $250,000, 1.25% on the next $500,000, and 1% on the amount above $750,000. On a $1 million portfolio, your annual fee would total $12,500 ($3,750 + $6,250 + $2,500), or a blended AUM of 1.25%.
(And if you’re ready to find an advisor but not sure where to start your search, take this free financial advisor matching quiz and connect with fiduciary advisors.)
Workplace retirement plans, like 401(k)s, are often left out of the AUM calculation, since advisors may not have access to them in the same way they do IRAs and taxable brokerage accounts. But that doesn’t mean they’re ignored. A fiduciary advisor may review those holdings in the context of your larger financial goals and offer rebalancing recommendations, though you will have to do the work of placing trades.
Though AUM fees are based on the value of invested assets, that’s usually not the only part of your finances the advisor considers. Many will also provide holistic financial planning, reviewing your insurance coverage, retirement readiness, and estate plan, among other things.
Potential Benefits:
- May become cheaper as your invested assets grow
- Advisor is incentivized to grow your portfolio, as their nominal fee will increase
- Paid out of your investment balance, freeing up cash flow
Potential Downsides:
- Costs can fluctuate based on your investment balance
- Asset minimums are common and may make some services less accessible to younger investors and lower earners
- Fees are taken directly out of your investment account; could be easier to overlook
Finding the Value in an Advisor’s Fee
The best way to compare the cost of a flat-fee model and an AUM model is to do two things: calculate the break-even point and compare services.
1. Find the Break-Even Point
Let’s say you have $500,000 in investable assets and are considering two advisors. One charges a flat fee of $6,000 annually for ongoing, comprehensive financial planning, regardless of the balance of your invested assets. The other charges 1% of managed assets, or $5,000. That smaller number is probably more appealing to you.
But if your goal is to grow your balance over time, the AUM fee will grow with it. Instead of taking the smaller fee at face value, you can find the break-even point of your portfolio, or the asset level at which the flat fee becomes cheaper than the AUM fee.
Flat annual fee / percentage fee = Break-even portfolio
$6,000 / 1% (0.01) = $600,000
So, once you exceed a balance of $600,000, the flat fee becomes cheaper. Below that level, the AUM fee is cheaper. At scale, the flat-fee arrangement can result in considerable savings. For example, by the time you reach $1 million, you’d save $4,000 per year with the flat fee. That’s $4,000 that you can leave invested in your account, generating compound growth.
2. Compare Services
It’s not enough to just compare costs. You also have to consider what exactly you’re getting for your money.
An AUM fee implies that an advisor is managing some (or perhaps all) of your invested assets. If you’re someone who prefers not to wade into the muck of the market yourself, then paying an additional $1,500 to $2,000 per year to take your hands off the wheel could be well worth it.
But will they also answer your questions and provide guidance on retirement contribution percentages, insurance coverage, decisions about which healthcare plan to get and other routine financial concerns? If not, will you need to hire someone else to help? Think about the total package.
Comparing financial advisors can help you evaluate different fee structures, services and investment approaches. SmartAsset’s free tool can match you with up to three vetted fiduciary financial advisors who serve your area.
Bottom Line
You probably won’t be able to decide whether a flat-fee or AUM model is better for your situation by simply visiting a few advisors’ websites. I’d recommend setting up free introductory calls so you can get a clear idea of what exactly you’d be paying for and whether the advisor’s personality and communication style are a good fit for you. If you can provide a rough investment balance, you might even find advisors willing to run those break-even numbers for you.
As you weigh your options, consider what you’re looking to get out of the relationship and how much that is worth to you.
Tips for Hiring a Financial Advisor
- Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Look at an advisor’s professional designations, background and experience working with clients whose needs are similar to yours. Also be sure to review the advisor’s disciplinary history. Resources like FINRA BrokerCheck and the SEC’s Investment Adviser Public Disclosure database can help you research an advisor’s background.
Tanza Loudenback, CFP® is a financial planning columnist who answers reader questions on personal finance topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Tanza is not an employee of SmartAsset and is not a participant in SmartAsset AMP. She has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.
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