ETF Investing Guide: Financial Advisors

The scourge of asset-based fees is not limited to brokers. Many independent financial advisors, who pride themselves on objectivity and delivery of genuinely valuable advice to their clients, also charge asset-based fees.

The justification for this is not entirely clear. True, it’s hard to stay in business as a professional without sources of recurring revenue. Charging by the hour doesn’t do that: the advisor needs to convince the client to come in for a “financial check-up” each time, whereas asset-based fees are charged regularly and automatically. But let’s be honest: lawyers, doctors and accountants bill by the hour, so there’s no reason why financial advisors shouldn’t. If the amount of advice required scales with the size of the client’s assets, then there’s no reason why a financial advisor shouldn’t bill by the hour. If more assets mean more advice (personally I don’t believe that’s the case, but let’s suppose…), then the advisor will charge for more hours. And if the amount of advice required doesn’t scale with the size of the client’s assets, then there’s no justification for asset-based fees.

Remarkably, many independent financial advisors who pride themselves on their objectivity fail to recognize the disastrous impact on investor returns from asset-based fees. Perhaps self-interest blinds even the best people. Take Larry Swedroe, for example, who is principal of Buckingham Asset Management. His excellent book Rational Investing in Irrational Times perceptively discusses asset allocation, actively managed mutual funds, stock picking, and the problems with commission-based brokers. It’s well worth reading.

But look at what Swedroe writes about asset-based fees for financial advice:

“A fee-only relationship is the only way in which you can be sure that the advisor’s interests are aligned with yours… Most fee-only advisors work on a fee that is based on a percentage of assets under management, in which case there is total alignment of interest… Their only incentive is to help you grow the value of your portfolio.”

What did Swedroe miss? He didn’t state that the financial advisor is delighted with the recurring income from asset-based fees, is not sufficiently incentivized to work hard for the client, and is therefore more incentivized to prospect for new clients. And he didn’t admit that payment of asset-based fees could seriously impact his clients’ investment returns. In particular, Swedroe correctly advocates index funds, careful asset allocation, and tax-loss selling. But that approach, which I’ve recommended you implement with ETFs, should result in relatively little account activity. And in light of that, charging quarterly fees as a percentage of assets under management seems ridiculous. Better to do it yourself in an online brokerage account.

So if you want or need financial advice, avoid asset-based fees even from an independent financial advisor. Better to ask the advisor to quote you an hourly rate instead.

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Comments

[Larry Swedroe:]

I did not miss anything

First I refuse to work with an attorney or accountant based on hourly rates. that makes the basic error of confusing efforts with results. I pay for value added not work effort.

Why would I care how long it takes someone to give me an answer.

The same is true of investment advice. The fee IMO should be related to the value of the service. If someone saves you 25bp per annum and you have $10mm in assets did not that add more value than if you had $1,000 in assets?

There are other reasons why IMO an hourly relationship is not in the best interests even of the client. I know many people would not pick up the phone to get advice on issues they are concerned about because the meter is ticking. And I believe that there is also great value in developing trusted relationships based on getting to know the person---that doesnt happen when you have hourly relations because the client is watching the meter.

2007 Dec 21 07:55 PM

[Long-Short Guy:]

Methinks the commenter above is a broker or financial advisor.

:-)

2007 Dec 25 06:57 PM

[StatingTheO...:]

ya think?
it is larry swedroe ...

2008 Feb 06 11:01 AM