Registered Investment Advisor Fees

Understanding Different Wealth Management Fee Schedules

Calculating Investment Advisory Fees
There are several popular investment advisory fee methods used for financial advisors, wealth managers, mutual funds, index funds, exchange traded funds, and other advisors. Understanding how each works can give you a better understanding of exactly what you are paying, both directly and indirectly. aphrodite74 / Getty Images

As many of you know, I am in the middle of setting up a global value investing firm that will be a registered investment advisor to affluent and high net worth individuals, families, and institutions who want to invest alongside my own family.  Those with $500,000 or more in investable assets may be able to participate.  I thought this would be the perfect opportunity to provide a sort of "inside baseball" overview of how different investment advisors charge fees, whether it's an index fund from a place like Vanguard or an incentive-based arrangement with a hedge fund.

 This is especially true now that I've introduced you to how registered investment advisors work, and you know four things you should look for in a registered investment advisor.

Please note that in this article, we're only going to look at so-called "fee-only" registered investment advisors who make money by charging a percentage of your overall portfolio value rather than by selling you products such as annuities, earning commissions in the form of mutual fund sales loads, or generating a profit from every buy or sell stock trade you make.  To be blunt about it, this is the only type of registered investment advisor I would even remotely consider for my own family and I think you'd be wise to do the same.  (Be sure not to confuse them with the similar sounding "fee-based" advisors who have hybrid business models.)

Specifically, we are going to examine:

  1. Flat investment management fee schedules
  1. Tiered investment management fee schedules
  2. Fees assessed by asset class on invested balances
  3. Hourly based fees
  4. Flat fees combined with annual management fees

Ready?  Let's dive right into it.  My goal is for you to walk away with a better understanding of what you're being charged, how different investment fee schedules work, and how the actual wealth management fees are calculated.

Flat Investment Management Fees

Under a flat fee schedule, fee calculation is ridiculously simple.  On the measurement date, whichever asset band your account relationship falls into is what you pay.  It strikes some as unfair because it means richer investors pay lower fees on lower amounts (though it isn't, really, considering the pricing breaks are available to everyone).  It encourages clients to deposit more money to receive the breakpoint but it creates valleys for the advisor in that there are points at which they make less money for managing more assets until the discount has been recouped.  When you dive into a mutual fund expense ratio or prospectus and pick out the actual investment management fee, it's almost always a flat rate; all assets in the fund are charged a single rate payable to the advisor.

  • Less than $2,000,000 = 1.50%
  • $2,000,001 to $5,000,000 = 1.25%
  • $5,000,001 to $10,000,000 = 1.125%
  • $10,000,001 to $25,000,000 = 1.00%
  • More than $25,000,000 = negotiable

Tiered Investment Management Fees

With a tiered fee schedule, different asset levels are assessed different fees.  This way, everyone, regardless of account size, pays the same rate on the same deposit level lending a sense of fairness to all clients.

 For example, a typical tiered fee schedule might look something like this:

  • First $250,000 = 1.75%
  • Next $750,000 = 1.50%
  • Next $4,000,000 = 1.25%
  • Next $5,000,000 = 1.00%
  • Next $15,000,000 = 0.75%
  • Amounts Above $25,000,000 = 0.50%

Imagine an investor comes in with $50,000,000 in assets he or she wants managed.  The tiered fee calculation would break down as:

  • $250,000 x 1.75% = $4,375
  • $750,000 x 1.50% = $11,250
  • $4,000,000 x 1.25% = $50,000
  • $5,000,000 x 1.00% = $50,000
  • $15,000,000 x 0.75% = $112,500
  • $25,000,000 x 0.50% = $125,000

Total Fee = $353,125, or 0.70625% per annum.  However, fees are paid quarterly, so it would be assessed as $88,281.25, or a bit less than 0.18%, with a recalculation every three months to reflect changes in market value (e.g., if the market has declined, the absolute fee declines, too, and visa versa).

Investment Management Fees Assessed By Asset Class on Invested Balance

Another fee system assesses charges based on asset classes.  This sometimes means the client pays low or no fees on cash reserves built up within the client portfolio.  The approach tends to be favored by value investors who spend years sitting on large cash reserves only to deploy them rapidly when something crosses the radar but there does seem to be some question among some quarters about whether or not such arrangements represent a conflict of interest in the post-Labor Department ruling that requires BICE (Best Interest Contract Exclusion) agreements on certain accounts due to the fact it might, theoretically, be an incentive that could cause the adviser to act contrary to the client's best interest due to the fact the portfolio manager could increase fee revenue immediately by making an investment and reducing cash levels; something only time and further clarification will settle.

An invested balance fee schedule might look like this:

  • 1.50% on invested equity
  • 0.75% on invested fixed-income
  • 0.00% on cash (or some other nominal fee - I've seen 0.20% too)

These fees apply regardless of asset level - doesn't matter if you have $5 million or $100 million.  Here's how a calculation might work.  Imagine an investor with $25,000,000 had 15% of his or her portfolio in cash, 25% in bonds, and 60% in stocks.

  • $15,000,000 invested equity x 1.50% = $225,000
  • $6,250,000 invested fixed income x 0.75% = $46,875
  • $3,750,000 parked in cash reserves x 0.00% = $0

Total fee = $271,875, or 1.0875%.

The advantage to the client is that during build-up times, or following large deposits, they aren't paying much, if anything, on their cash.  If an account was sitting on something like 30% or 50% cash as the manager looked around for intelligent things to do, the effective fee might be much lower than they would likely otherwise pay, which then gets balanced by the higher fees later.

Hourly Investment Management Fees

Some registered investment advisors charge hourly rates for certain services, many of which are frequently pre-packaged for the sake of convenience.  For example, if you aren't going to have your assets managed by the firm, you might still want them to look over your holdings and give a review of your existing plan.  They might charge $250 or $500 an hour with a basic package starting at 3 or 5 hours.  They might agree to special mandates that require very little time or ad hoc projects that you require.  When you get into this territory, it's largely two people sitting at a table negotiating for a specific, end purpose.

Flat Fees Combined with Annual Management Fees

In other situations, you might end up paying a combination of fees that requires you to do a little math to determine your annual outlay as a percentage of assets.  For example, if you open a $500,000 trust with Vanguard, you'll pay a $4,500 base annual fee + a $2,500 sole or co-trustee fee + the fee on the underlying mutual funds they help you select (ranging from 0.05% to less than 1.00% depending on the specifics).  By the time all is said and done, you're really laying out, directly and indirectly, somewhere around $7,850 if you select a decent mix of domestic and international funds.  That's an effective annual fee of 1.57% on assets; a fairly good bargain if the trust fund instrument has simple instructions and doesn't require holding certain operating assets such as real estate investments.

Make Sure You Do the Math on Stacked Fees for Wealth Management Advisors That Put You In Mutual Funds or ETFs

If you work directly with an asset management company, the odds are decent you are solely paying them their fee.  That's it.  You've gone directly to the source, so to speak.  You'll have a few other costs - your custody agent, brokerage commissions, but if you're working with a firm that is on the up and up, it should be transparent; you should know precisely what you are paying.  However, many wealth management firms and financial planners charge fees like this only to turn around and put the client in third-party mutual funds, ETFs, or other pooled investment vehicles that also charge a management fee.  Be very careful about comparing the fees of these firms to asset managers.  They are intermediaries; helpers who are gathering assets and then steering them to the asset managers.

For example, it might be more attractive on an after-tax basis to pay a 1.25% annual management fee directly to an asset management company in an individually managed account than it to go to a wealth management firm that advertises a 0.75% annual fee but puts you in funds and ETFs that charge a 0.50% fee, which you don't see (but nevertheless pay) unless you read the fine print.  You're getting better service and more control.