Financial advisors can be useful in your long-term planning, but you should be aware of a few things before agreeing to do business with one. We asked three of our analysts what investors should know that financial advisors don't always tell their clients. Here's what they had to say.
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: Financial planning can be a big, scary task, and it's understandable that many people want an expert to help them make the best decisions. Unfortunately, many of the professional advisors out there have a major conflict of interest: They're paid commissions on many of the products they offer you.
Don't get me wrong: I spent more than a decade in outside sales, so I understand the value of expertise that commissioned sales experts can provide. However, when you're paying someone to advise you, and that person is recommending a product, such as an annuity or insurance plan, how much the advisor gets paid will absolutely affect what he or she may recommend, whether it's really the best option for you or not. Trust me -- I've been on both sides of that table.
Unfortunately, the vast majority of financial advisors aren't going to tell you up front how they're paid. It's your money, and you have every right to know. If they aren't telling, you need to be asking.
: Following up on Jason's point, while many people know that financial advisors are compensated for selling funds, annuities, or other financial products, many don't realize that financial advisors get yearly fees for keeping people in mutual funds.
These fees are known as revenue-sharing agreements and can range anywhere from 0.06% to around 0.5% of assets under management per year.
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In a hypothetical example, two similar mutual funds both charge you 1% a year. However, one fund has a revenue-sharing program that gives your advisor of 0.1% of any assets placed in the fund ($10 per $10,000), and the program at the other one gives your advisor 0.5% ($50 per $10,000). You can guess which fund your advisor will suggest to you.
While these fees don't cost you anything extra compared with buying the same fund on your own, they are a conflict of interest many investors aren't aware of.
Patrick Morris: I in no way intend to belittle financial advisors, but one thing that must be recognized are not just the fees themselves, but also the opportunity costs and lost income resulting from those fees.
Let's use the example of Bill and Becky, a 33-year-old couple who had a retirement portfolio worth $50,000 and wanted to retire in 30 years. Let's say Becky stayed at home with their newborn twins, and Bill worked as a software analyst making $70,000 a year, and they saved 5% of that amount for retirement.
If Bill's salary grew by 3% each year, and the market delivered a total return of 8% annually, then by the time they retired, they would have $1.2 million saved.
But let's say that for peace of mind, Bill and Becky enlisted the help of a financial advisor who charged a 1% assets-under-management fee and their portfolio delivered the same 8% return.
A little math reveals that a 1% fee charged every year would result in their paying roughly $110,000 during those 30 years. So would they have $1.1 million when they retired? No. They'd have even less. In fact, a lot less.
In addition to the fees Bill and Becky paid, there is also the opportunity cost of the money paid to the advisor that isn't compounded and grown into future earnings.
Instead of having $1.2 million after 30 years, they'd have a quarter of a million dollars less -- thanks to the fees themselves and the earnings they didn't generate -- and their savings would fall to roughly $950,000.
Again, financial advisors aren't bad, but it's critical to understand that a simple fee can at times be much more complex and costly than it first appears.
The article 3 Things Your Financial Advisor Isn't Telling You originally appeared on Fool.com.
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