The Strangest Thing About Financial Planning

The financial planning industry is very unique. Most people think of it as a service-based industry where you give some of your hard earned dollars to a person or a firm and in return, they give you financial planning services.  This is true but there is one very, very strange nuance to a big portion of the industry that I find to be very curious.  The strange thing?  Rarely do people know the price they are paying.

Can you imagine going to a lawyer for an estate plan or an accountant to get your taxes done and upon completion, you have no idea what you paid to that lawyer or accountant?  Can it be that these professionals paid for and endured years of education and training and are not being compensated?  Of course not.  They are being compensated as they should.  The difference between those industries and a big portion of the financial planning industry is clarity.  With most attorneys and CPAs, you know exactly what you are paying when you write that check or bill that credit card.  But with most investment costs, you usually don’t know exactly how much you are paying and that should raise a big red flag.  So am I saying price should be the most important aspect when paying for advice?  Not at all.  I believe value for services rendered is the most important thing.  But to judge that, one must know the price.

To illustrate, when I initially meet with potential clients, we walk through their current financial situation, discuss their approach to managing their finances and at a high level, talk about their goals for the future.  If we agree that my practice and their family would be a good fit for a formal planning engagement, we have a follow up meeting where we detail the scope of the engagement (which goes well beyond “portfolio management”) and of course, the price for my services.  To me this is a critical piece of the value judgment because as every consumer inherently knows, price sensitivity is a crucial part of the value proposition.   However, if my price on the surface “seems too high” one thing I often ask them, “Well, how much are you paying now?”  The answer:  (insert cricket sounds).  Realizing this hole in the value equation, how can a family make a reasonable assessment and judge the value of the service?  The answer is: They can’t.

Despite this issue, I think it is possible for people to get a general idea of what they are paying for in investment fees but keep in mind, these metrics usually address costs to invest only and usually does not factor in the holistic approach I take with my practice, in which I advise on asset allocation, integration of taxes, insurance, estate planning, retirement planning, etc.

So for someone to calculate a rough estimate, you need to assemble all the statements from your various accounts and do a little math.   (As an aside: I am happy to do this for new clients to illustrate how we can save money on investment expenses).  Once you have your statements, you’ll want to look up the “ticker” of each mutual fund you are invested in, then multiply your balance in the fund it by the annual expense ratio.  For instance, if you have $50,000 invested in the Invesco European Growth Fund Class C (Ticker: AEDCX, randomly selected) you would find its annual expense ratio (gross and net as of 4/30/2013) is 2.23%.  This means if your balance is around $50,000 in that fund each year you would be paying $1,115 during the year for the privilege of owning this mutual fund.

Run through this exercise for each of the funds you are invested in and you’ll find expenses add up quickly.   In fact, I wouldn’t be surprised if you were to find you are paying about 1.5% of all your accounts each year because someone recommended or you picked those funds.  On $500,000 of total investments that’s $7,500 per year of expenses. In addition to those expenses, we could also look at trading costs, up front, one-time commissions when buying into a fund (“load”) and additional AUM fees (“assets under management”) if that is how your financial advisor charges.

If you are using a financial advisor, it may be simpler to sit down with him or her and simply ask the direct question:  “How much am I paying for investment advice each year?”

So am I saying financial planners should not be compensated for their services?  Of course not- it’s how I make my living and feed my family.  I expect to be paid for my professional advice like any other.  In addition, I am NOT saying that financial planners who get paid by commissions or by assets-under-management are unethical.   There are many, many ethical financial planners who do a great job for their clients who are paid this way. However, I happen to put a high priority on clarity in client relationships and for me personally, it is important for all my clients to know exactly what they are paying me for my services.  It is also crucial for my clients to know that it is only my clients that are compensating me as I am receiving no “incentives” (i.e. payments) from mutual funds companies or insurance companies to recommend an investment.

Now some folks will think this article is a self-serving given how I model my practice and I won’t deny that, but I truly believe clarity is crucial.  This is why I choose to operate in a fee-only model.  In many cases, we can usually lower client investment expenses by choosing passive investments (i.e. index funds), thereby helping to offset a portion of my fee.

Ultimately, I believe the best thing for my clients will yield the best things for my business and for us to have a productive, long-term relationship, I believe my clients need to be well-informed consumers who buy-in to the value proposition.  This can’t happen without knowing the price.

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