Wednesday, March 3, 2010

The Right Model for Financial Advice?

I recently received a request from a reader to sit down to look at his financial situation. I get these from time to time, but I’m not comfortable acting as an untrained financial advisor, and I’m not even sure whether it is legal. But, it got me thinking about what model makes sense for financial advisors.

The dominant model that exists right now is based on hidden commissions from the products sold to clients. This works well for many financial advisors, but few clients would be happy about it if they understood how much they were paying and how much better their investments could perform with less expensive products.

If I felt the need to get advice, the model that would make most sense to me is something close to what is often called “fee-only”. However, I would only be looking to pay an advisor for the time he spends talking to me. I wouldn’t be interested in paying for several extra hours of the advisor’s time to produce a written plan for me.

I could envision bringing in documents containing all my financial details and talking to an expert for a couple of hours to get his opinion of what should be changed. Then I would go away and handle the changes myself. Every so often I would come back for another hour to discuss further updates.

For this model to work, the advisor would have to charge a high hourly rate. Perhaps $200 to $400 per hour would make sense depending on the advisor’s skill level. Even 3 hours at $400 per hour would be much cheaper than mutual fund MERs for portfolios over $100,000.

Are there any readers who have used an advisor on this type of basis? Was the advisor helpful or did he use the face-to-face time to pitch an arrangement that would get him more money? Did you follow up on the advice or was the cost of the meeting wasted?

13 comments:

  1. Good questions.

    I encourage anyone with such experience to respond.

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  2. I get most of my financial advice while playing pool and drinking my hosts alcohol, which seems to be an excellent fee system.

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  3. I am totally in this position. My wife and I have a decent-sized portfolio all in active funds and I do wonder if getting a second opinion is a worthwhile. The problem as I see it is this: I'm pretty certain I could go to 5 different advisors and get 5 different opinions so how is the average investor supposed to know who's providing the best advice?

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  4. Steve: A good starting point is to avoid obvious conflicts of interest. If your advisor gets paid by mutual fund companies, then he has an incentive to pick the funds that pay him the most. Going for "fee-only" is a good starting point, but is no guarantee. I've learnt by experience that some people who get paid by the hour are strongly motivated to maximize the number of hours. I've had physiotherapists who saw me as part of their retirement plan, but the best one I've found fixes me up in just a few visits. I would start by looking for an hourly advisor and moving from one to another until I found the one I like.

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  5. These types of planners are hard to come by. I looked into it and I could only find one in my area. I know they are more prevalent in larger cities like Toronto. The guy I found seemed to focus on clients with a large amount of money to invest or people who had received some kind of lump sum payment and were wondering what to do with it. He was charging $3000 -$4000 for a long term written plan.

    I think the biggest need is for basic education on how investing works, what options are available, and even basic personal financial management. People with a low net worth need help too.

    With regard to Steve's point about different advice, I guess the best advisor would provide education and options and allow the client to choose the products that fit their situation and risk tolerance.

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  6. 2 Cents: It makes sense that there would be fewer fee-only advisors because we wouldn't need as many advisors if all of them worked this way. It's too bad that there don't seem to be any in your area. We need a separate term for the type of advisor I think makes sense. It sounds like your advisor's main goal was to sell a higher-priced written plan. This may be the best thing for some people, but I would just want to pay for the time the advisor spent with me. Maybe there just aren't many willing to work this way, possibly because few investors seek this type of relationship.

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  7. Defenders of the current model will say there's a reason commissions and fees are paid this way. Many retail investors would not buy product if they had to pay commission upfront. The mutual fund industry isn't stupid. There is a reason why this model exists. They can obtain more customers by removing a barrier to sales.

    With respect to a billable hour model, the legal industry is moving away from the billable hour at a time many in the financial sector believe advisors should move towards it. Large companies no longer see value in paying external counsel by the hour and, much like the financial industry, there's a grind down on fees due to preceived value.

    In other words, there may be no perfect model. I believe people do not like the current model because of (i) precevied lack of disclosure and (ii) fees are too high relative to value.

    Thus, is the question not about structure but value (are you really worth $200/hour? are you really worth a MER of 2%) and do some members of the public have unrealistic expectations of cost vs. result?

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  8. Thicken: There are definitely two points of view in this debate. I don't expect advisors to change to a new model if the current one pays the bills. The best model from the advisor point of view is different from the best model from the client point of view. Putting myself in the position of a potential client, I would want to pay by the hour and get efficiently delivered solid advice in a couple of hours. Done well, this could easily be worth $200 per hour or more. Only the best advisors could survive with such a model. I expect the vast majority of "advisors" to continue to sell mutual funds to the ignorant.

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  9. @Thicken My Wallet: what model is the legal industry moving toward?

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  10. Hi there,

    I started getting suspicious of my "trailer fee" advisor when she recommended liquidating my mutual funds and purchasing a wrap portfolio.

    While researching that, I discovered index investing on sites like yours.

    When I asked my advisor about it, I got a polite dismissal along the lines of "you can't beat the market with that".

    That led me to contact a fee-only planner in Ottawa. Getting straight answers to my investment questions was well worth the money.

    And as an added bonus, what I've saved in trailer fees since then has more than paid for that unbiased advice.

    I plan to go back to the same fee-only advisor for a sanity check later this year.

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  11. Patrick: You are seeing a wide variety of different compensation schemes. You have project based/flat fee, success fees (% of IPO raise, % of class action lawsuit), discounts on early payment, retainer based (I pay you $X a month, if you do more work then you absorb the loss, if you do less work, you keep the difference).

    Mike: A lot of legal industry experts believe the future is a hallowing out of the middle class law firm given the assault on fees. You will have top firms doing top work and then retail firms doing retail work. Your propsal could probably see the same thing happen. You would have investment counsel for high net worth clients and then franchised street-side shops like Edward Jones for the masses.

    $200 per hour may be too low of a billable rate to maintain infrastructure in a large urban area unless the advisor is working on a mass quantity model. One would be surprised the burn rate of maintaining an office and staff. I would actually be interested to know from an advisor how much they would consider to be a fair hourly rate for one off or two off clients.

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  12. TMW: Edward Jones has a nice "street-side" feel, but their commission structure is just as hefty as the bigger houses. They are recruiting heavily right now.

    I know someone who has been approached repeatedly. He has no financial experience whatsoever, but is a proven salesman. Enough said.

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  13. Friend of mine recently started doing this. I'm not sure if there is a large market for this sort of services...

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