High EQ Can Lower Your Financial Planning Costs

One of my constant themes is the value of working with financial advisors who have a fiduciary duty to put your interests first. These most often are fee-only financial planners who earn their income from fees for their services. They do not have a conflict of interest due to earning income from commissions on selling products. 

Financial planning and investment advising are not the same thing. An investment advisor deals with the “how” of investments, helping you to maintain a diversified portfolio that will give you good long-term returns. Someone who does comprehensive financial planning deals with the “why” of your relationship with money: your life goals, what gives you meaning and fulfillment, and the complex emotional factors involved in financial decisions and planning. Many advisors are somewhere on the range in between. They may call themselves financial planners and many do some financial planning, especially around retirement. 

Because anyone can describe their services as financial planning, it takes some work on your part to make sure that an advisor is a fiduciary planner who works for you rather than for a company selling financial products. You need to interview them and ask a lot of very specific questions to sort out what services they actually provide and how they are paid. One place to begin looking for fee-only fiduciary advisors is Napfa.org.

How you pay your financial planner will make a big difference in your financial health, especially if you end up overpaying for the services you get or paying commissions on financial products that do not serve you well.

To objectively understand and analyze an advisor’s fee takes some emotional intelligence. Here is why. Financial planners and investment advisors are typically compensated in one of three ways. The first is “commission based”, a commission on the sale of a product, paid to the advisor up front or sometimes annually. The second is “fee-only”, a direct fee paid to the advisor, either a flat fee or a percentage (1% is common) of assets or net worth. The third is “fee-based”, a combination of commissions and direct fees. 

If you receive an invoice and pay it directly, your advisor is probably fee-only or fee-based. If you are unaware of paying any fees, the advisor is most likely being compensated by commissions. Fee-based, where you will pay some fees directly and also be charged commissions that you don’t see, is the most difficult to figure out.

Here’s where the emotional intelligence comes in. Commissions often range from 3% to 8% a year or as high as 30% up front, while fee-only planning fees are normally about 1% to 1.5%. You would think consumers would be flocking to fee-only advice.

Not so. And, like other seemingly illogical financial behaviors, this one is not about the money. I find three cognitive biases that might explain why consumers elect to pay more in unseen fees than in lower fees that are seen even when both are clearly disclosed. Those are Loss Aversion, Status Quo, and Ostrich Bias.

Loss Aversion occurs when one’s decisions are swayed by avoiding short term potential losses. For example, a 1% fee on $100,000 would be $1,000. A 3% commission on $100,000 would be $3,000. Yet writing a $1000 check for a fee is an immediate loss, more painful than being told 3% percent will come out of your investment later. 

Status Quo bias finds that people are often resistant to change. They will stay with the seemingly safe choice over the uncertainty of a new choice. Given the option to write a check for a much smaller fee, which is a change that will have a big positive financial impact, people still default to the status quo that they’re familiar with. 

The Ostrich Bias is where we choose to ignore what we view as negative information. If we see numbers to demonstrate that unseen commissions cost significantly more than directly paid fees, we may ignore that in hopes that the information is wrong or things will work out. It’s a case of “Don’t confuse me with the facts.” It’s emotionally painful to acknowledge a negative reality, especially if we feel shame about having overpaid in the past.

Countering biases like these requires emotional intelligence, awareness, and courage. And it matters, because how you pay your financial advisor matters to your financial wellbeing.

Check out The Financial Therapy Podcast by Rick Kahler concerning this topic.

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