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What You Get From a Fee-Only Financial Planner

By: Rick Kahler | November 11, 2009

What exactly do you get when you engage a fee-only financial planner?

This question seems so obvious that it is rarely asked, yet its answer is important.
Fee-only planners, much like attorneys and physicians, are compensated for their knowledge and their services. They do not receive commissions by selling products such as insurance or investments.

For many planners, the decision to be compensated only by fees is based more on ideology and career satisfaction than on profitability. They believe they can do the best planning in a client-advisor relationship rather than in a salesperson-customer relationship.

A real financial planner-as opposed to an investment advisor or financial product salesperson-takes a very broad view with clients, helping them orchestrate everything about their financial lives. This includes such areas as:
• Budgeting and cash flow
• Unbiased insurance advice
• Investments
• Planning for both financial and non-financial aspects of retirement
• Tax planning
• Estate planning in both financial and non-financial areas
• Making educational and career choices and setting life goals
• Using one’s resources to build a satisfying and fulfilling life

Advisors who receive commissions typically view the scope of the engagement very narrowly, with the focus usually on investments. Commission planning is less work and more profitable than fee-only planning.

Today, an increasing number of consumers are seeking out the services of fee-only planners. The benefit of being a client rather than a customer is the main reason. A fee-only planner owes you, the client, a legal obligation to be your advocate, to disclose all conflicts of interest, and to work in your best interests. A seller of financial products owes you, the customer, nothing but to treat you fairly.

Just to add confusion, some planners are “fee-based,” which means they are compensated in part by fees and in part by commissions. These planners are registered with both the SEC (Securities and Exchange Commission) and FINRA (The Financial Industry Regulatory Authority). They have a fiduciary duty to you as a client when they are doing planning for you, but not when you are a customer and they are selling you a product. If the planning is only tangential to the product, then they have no fiduciary relation with you.

Fee-only planners tend to cost less and deliver more. One of the most obvious cost savings is because fees are typically less than commissions. Also, fees can be tax deductible where commissions are not. Fee-only clients also receive comprehensive financial advice, where the customers of a commission salesperson typically receive only investment advice.

Clients also can save substantial amounts by following the advice of their financial planner, which is based solely on what the planner perceives to be their best interests. As an example, in a six-month period this year I may have saved some of my clients enough money to pay my fees for the next 35 years.

Here is how it worked: In early March 2009-which we now know was the bottom of the 2008-2009 market crash-about a third to half of my clients wanted to sell most or all of their stocks and go to cash. As an investment professional, I was convinced that we were near a market bottom and to sell out would mean missing the recovery that was sure to come.

I was able to persuade almost all of these clients to keep all or a portion of their portfolios in stocks. Six months later, those who hadn’t sold out were back up 35%. With money market funds paying less than 1%, that same 35% recovery might have taken 35 years had those investments been moved to cash.

As a fee-only planner, I was able to interpose my professional knowledge and experience between my clients and the financial crisis. While I wasn’t able to keep their investments from losing value in the crash, I was able to help them avoid making fear-based decisions that would have cost them much more in the long term.

Such unbiased advice-and the very real financial benefits it can provide-is one of the most important things you get from a financial planner.

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Financial Planning Fees You See and Those You Don’t

By: Rick Kahler | October 26, 2009

Not long ago I was meeting with a couple who were relatively new clients. We were going over data on a recent mutual fund investment, and I commented that I was surprised to see the fund offered a commission of 2.25%. As a fee-only financial planner, I rarely pay much attention to whether a fund pays a commission to a broker. I purchase mutual funds on behalf of my clients through a discount broker where no commissions are included in the price.

The clients asked for an explanation of my comment. I told them that commissions were common and that 2.25% was actually on the low side. It’s not unusual for equity mutual funds to charge 5.75% of what you invest. On the other hand, fee-only financial planners typically charge fees of about 1% annually.

They were surprised to learn that, had they dealt with a stock broker or mutual fund salesperson, the purchases we had made over the past few months would have cost them around $28,000 in commissions. Instead, they had paid me about $9,000 in fees for full financial planning, not just investing their money. At this point, the wife turned to her husband and said, “I guess now you will stop complaining about his high fees!”

The notion that a fee-only planner has high fees isn’t unusual. The main reason for this misperception can be explained in one word: disclosure.

Most customers of financial product salespeople don’t pay attention to how much they pay in commissions. That amount is easy to miss unless you read the fine print or ask the right questions. You will never receive an invoice for the commission or have it appear on any statement because the fund company takes commissions out of either the principal you invest or your return.

If the commission is taken out of your principal (called a front-end load) you will simply receive fewer shares than the total amount you invested could have purchased. It’s like paying $100 to Safeway and only receiving $95 worth of groceries because $5 went to the cashier.

A commission taken out of your return (called a back-end load) is even harder to spot. For example, if your brokerage statement shows a fund had a return of 5% in any given year, that return is always stated after deducting expenses and commissions. In this example, the fund really earned 7.5% and paid 2.5% in expenses and commissions-not an uncommon amount. You then netted the remaining 5%. To find out what the fund paid out in commissions, you would have to dig deep into the prospectus.

This lack of full disclosure is one reason why so many customers of financial salespeople think they don’t pay their advisor anything. They never get an invoice or see a statement where the commission is deducted. The only way to know exactly what fees they pay is to ask and insist on getting a clear answer.

Contrast that method of payment with that of a fee-only advisor. All of a fee-only professional’s clients know exactly what they pay annually. Most of the time, they must write a check two to four times a year. Even when clients prefer to have the planner’s fees deducted from investment returns, they receive invoices clearly stating the amount of the fees.

This disclosure ensures that clients know what they’re paying. That total amount can seem high, even though it is less than a broker’s commissions would be. Commission salespeople count on the fact that, to the unknowing customer, a fee you don’t see is always easier to stomach than a fee you see.

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Who Benefits Most From an Annuity?

By: Rick Kahler | August 10, 2009

 A new client recently asked me, “Rick, you’re one of four financial planners we interviewed. Why are you the only one who didn’t tell us we needed an annuity?”  

Actually, this couple had really interviewed only one financial planner and three annuity salespeople.
 
Annuities are a hot financial product in the market place these days. I rarely use them. There are some good things about annuities, especially the fact that earnings grow tax deferred until distributed. Their negative aspects, though, include their high fees and the high surrender charges one must pay for taking money out early.
 
A client recently had a chance to buy an annuity supposedly guaranteeing him, in his words, “the greater of a 6% return or whatever the stock market went up.” I told my client if this was true, I had $100 million of client money to put into that annuity. Of course, after several phone calls I found out “the rest of the story.”
 
First, the 6% guarantee was only for the first 10 years. From then on this “guaranteed” balance (I call it the funny money account for reasons to become obvious shortly) never would grow. You could elect to receive a 4% annual payout on that balance for life. If you ever wanted all your money, however, you could only withdraw the amount you would have had based on the market returns, less all of the 4% withdrawals.
 
Upon your death, your heirs wouldn’t get the “guaranteed” balance, either. They would receive the greater of your original investment or the amount it would have grown in the stock market, less any withdrawals.
 
For the privilege of basically receiving the same returns as if you had invested in the stock market, you would pay 3.25% a year in fees. Had you just bought an index fund from Vanguard, the annual fee would be 0.10%.
 
Let’s assume you invest $100,000 in this annuity and the stock market returns an average of 6% annually over the next 10 years, a reasonable assumption. Your investment will grow at only 2.75% (6% – 3.25%) and be worth $131,165 in 10 years. However, since that return is less than the guaranteed 6% rate, the funny money balance will be $179,084. The account will be frozen at that balance unless the return earned in the stock market finally exceeds it, which at a 2.75% return would happen in the 21st year.
 
If you invested the money in a retirement account instead, assuming again a 6% return, you would have $349,572 in 21 years, or $170,488 more than the guarantee.
 
If you chose to take the 4% withdrawal after 10 years, you would withdraw $5,426 a year, for life. If in the 21st year you either died or wanted your money, the payout would be $179,084, minus the sum of the 11 payments, or a total of $119,398.
 
If you put your money in a retirement account, withdrew the same amounts, and died or wanted your money in the 21st year, the payout would be $253,844, or $134,516 more than the guarantee.
 
This is another reminder that there is no free lunch. The annuity would cost investors $3,250 a year, for 10, 20 or 30 years. What would they get? Basically a meaningless promise, designed to make them feel better in the short run, that left them poorer at the end.
 
Most annuities are expensive investment vehicles that benefit the salesperson and the company far more than they benefit you. If you are thinking of buying one, make sure you get advice from someone other than the annuity salesperson before signing on the dotted line.
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Looking (or Not) for the Next Financial Guru

By: Rick Kahler | August 4, 2009

 At least one new financial guru is about to rise from the ashes of the current global economic bloodbath. This will be a financial advisor who accurately called the market top and went to cash, and then called the market bottom and bought back in.

Is there such an advisor? Absolutely. The law of mathematical probability dictates that someone, somewhere, will get lucky. Perhaps even two or three someones. Each of them is primed to make a mint on newsletters, books, and new clients for the next 20 years.
 
That’s what happened 30 years ago for an advisor named Joe Granville.
 
In the 1970’s and 1980’s it was Granville who rose to investment guru fame for his bear market calls. He strongly predicted the stock market was heading for imminent collapse. Thousands of investors signed up for his newsletter, The Granville Market Letter, and his investment speeches were well attended. Granville was quite the showman, often emerging from a coffin to start his speech.
 
Unfortunately, those who followed Granville’s advice for the next 25 years didn’t fare so well. Joe never called a market turn right again. According to the Hulbert Financial Digest’s rankings for performance over the past 25 years, Joe has lost his readers 20% per year on an annualized basis. Ouch!
 
Still, the recent market crash has produced a fresh batch of people who are vowing never to listen to the “buy and hold” guys ever again. Bill O’Reilly of Fox News is one of them. Many investment advisors are among them, too. Those disillusioned investors and advisors are in search of a new investment philosophy and will be happy to line up at the door of those who “got it right” in hopes of earning back what they’ve lost.
 
Of course, it will take them years to realize that their newfound guru of market timing has feet of clay. While they watch the “buy and hold” investors recover from the losses, the chances are they will watch their own losses continue to mount. Eventually, the gravy train will stop for the new gurus when their dedicated disciples become dismayed with their annual returns and realize that the gurus have never hit a market top and bottom again since their great calls in the Global Market Crash of 2008.
 
Market timing is a loser’s game for most who play it. However, probability dictates that someone will always make the call to get out at a market top and get in at a market bottom. There will be others who got close enough for bragging rights who will cash in, too.
 
Whoever the new gurus are, they will in no way acknowledge that their success was just pure, random luck. They will vehemently argue it was produced by the way they sliced and diced various investment data and their proprietary formulas. They will explain in great detail how they “saw this coming.”
 
Of course, their timely advice going forward can be yours, at a price. The newest profit prophets of investment prognostication will be born.
 
Being a buy and hold investment advisor, on the other hand, isn’t racy or exciting to the news media. You will never see a buy and hold advisor’s hottest new picks featured on the cover of Money Magazine.
 
Trust me, if I knew a market-timing formula that would work, I would be using it right now. But I don’t. Neither, as far as I know, does anyone else. Exciting or not, charismatic gurus or not, buy and hold is still the wise way to go.
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Spam or Not, Baloney Is Still Baloney

By: Rick Kahler | July 27, 2009

An acquaintance asked me while ago, “Do you know anything about investing in alternative energy sources? I got an e-mail about buying stock in this startup company that seems like a great opportunity.”

I gave him my standard answer, that I never recommend buying stocks directly. “Besides,” I added, “Any e-mail offer like that is nothing but spam.”
 
“Oh, I wasn’t going to answer the e-mail. I figured I’d find out the name of the company and buy stock through an online broker. That would be safe enough, wouldn’t it?”
 
No, it wouldn’t. A foolish investment made through a broker is still a foolish investment.
 
The role of a broker is to facilitate your investment transactions. A full-service brokerage firm offers investment advice, charging higher fees as a result; a discount broker has lower fees but does not provide advice. In either case, brokers are paid by the firms they work for. Their primary concern is not necessarily that you make the investments that are wisest for you. You are a customer, not a client.  
 
It’s not really much different from going shopping. If you go to a big discount store and buy a shirt that makes you look like a reject from a horror movie, no one is going to stop you. The checkout clerk might think it’s the ugliest garment ever made, but she’ll still ring up your purchase. If you go to a high-end clothing store that offers more service, the clerk probably would try tactfully to persuade you that puce and chartreuse stripes weren’t your best colors. If you really wanted that shirt, though, you’d walk out with it. You have the right to buy whatever you want, because you’re the customer.
 
To get the best advice, you could hire a consultant to go shopping with you and tell you what looked good and what didn’t. He or she would have no interest in the cost of the shirt, just your welfare. You would be the client.
 
Going through a reputable investment broker should protect you from out-and-out scams. It does not turn a poor investment choice into a good one, and it does not guarantee that you are a client rather than a customer.
 
If you have some money to invest, put it into mutual funds that are spread over five or more asset classes: cash, US stocks, US bonds, international stocks, natural resource stocks, real estate investment trusts, market neutral funds, and international bonds. In each asset class, select an appropriate index fund. At the least, you could select one asset allocation fund that does some of the asset allocation for you.
 
That may not be as exciting as a venture into alternative energy research, but it is far wiser. Then, if you want to be involved in alterative energy sources, maybe you could go pump up the tires on your bicycle. 
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Ask Tough Questions Before Choosing a Financial Planner

By: Rick Kahler | July 6, 2009

If you’re looking for a financial planner, it’s a good idea to interview several. Here is a list of questions, in no particular order, that you may want to ask the planners you interview.

1. What are the characteristics of your typical client? If a planner serves a very narrow niche, such as specializing in employees of a large corporation, and you are a small independent business owner, you may not have a good match. Ask them what types of client they do their best work with.
 
2. What is your education? You want to know what colleges prospective planners attended, whether they have master’s degrees or doctorates, and especially whether they have earned the CFPÒ designation. Find out if they have attended any courses on coaching or counseling or hold any certifications in these fields.
 
3. What is the process you use? How long does it take? What should I expect? All planners work differently, even those with similar qualifications. Don’t be afraid to ask questions as planners explain their processes. Make sure you leave with a good understanding of what to expect.
 
4. What are the terms of your engagement agreement? Most planners will have an engagement agreement, and all fee-only planners are required to give you full disclosure documents. If you haven’t received these ahead of time, ask for them. Ask the planners what their procedures are when clients leave them. Find out what the planners consider to be their responsibilities and what they consider to be yours. Ask about conditions under which they would refer you to another planner, an accountant, an attorney, or a therapist. Make sure each planner goes over the agreement thoroughly and that you understand all the terms and conditions. As always, ask questions.
 
5. What is the average size of your clients’ accounts? This information is often obtainable, even for planners who do not participate in the annual survey in Bloomberg’s Wealth Manager that lists several hundred planners and their average account sizes. Why would you ask this? Because if the planner’s average client has an account size of $10,000,000, and your account is $200,000, you may not have the best fit. The same is true if you have an account size of $10,000,000 and the planner’s average account is $200,000. Certainly, you will want to consciously explore the issue with the planner.
 
6. Can you give me the names of three clients I can call as references? In order to protect clients’ privacy, planners do not routinely give out clients’ names without permission. Still, be a little leery of planners who will not give you any names as references. Most planners do have several clients who have authorized the release of their names and phone numbers to prospective clients. Even if it is their mothers, their sisters, and (on good days) their spouses, all planners should be able to come up with three people who can tell you something about their character.
 
7. How will information be delivered and meetings be conducted if we can’t meet in person? Because of modern technology, you don’t necessarily have to be in the same geographical location as the planner. Many planners have websites where data can be uploaded and viewed easily by clients during phone conferences.
 
8. Will you describe what you consider to be a fully diversified portfolio? Ideally, the planner’s definition of a diversified portfolio will come close to the one found here.  Asset class diversification is an important factor in successful long-term investing, and you deserve a planner who both understands and practices it.
 
9. How do you charge for your services?  This is an essential question to ask. Some financial planners are commission-only, which means they do not charge fees to clients but earn their money solely through commissions on products they sell.  They are financial products salespeople first and financial planners second. Others are fee-based, which means they operate on a combination of commissions and fees. Others are fee-only, meaning they sell no products for commission but charge clients directly for the services they provide.  I highly recommend staying with a fee-only planner, who will have a fiduciary responsibility to you, the client.
 

 

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Investor Watch Dog is a weblog designed to inform investors about hidden risks when they invest assets based on the recommendations of financial planners, financial advisors, money managers, insurance agents, and investment sales representatives. Some of Wall Street's biggest investment risks result from Ponzi Schemes, investment bubbles, conflicts of interest, bad advice in bear markets, lobbyist activities that promote industry interests, bad investment products, and anti-investor business practices. While some of these risks are worthy of front page headlines, millions of investors assets are much more frequently exposed to less newsworthy but exponentially more harmful investment scams, financial fraud, illegal investment products, bad financial advice, bad investment recommendations, misrepresentation, omission, abuse of trust, deceptive sales practices, and breach of fiduciary duties. The role of Investor Watch Dog is to shine a spotlight on legal and illegal business practices that undermine the financial interests of investors, retirees, business owners, professionals, executives, and other types of consumers who rely on Wall Street and its financial professionals for the advice and services they need to achieve their financial goals.