And About That Free Financial Plan


Have you worked with or been approached by a financial advisor who offered you free financial planning services? It sure seems hard to beat free and is pretty easy to agree to that type of service. Compare that to the financial advisor asking you to pay for financial planning service and it’s almost a no-brainer, right? It’s a great sales pitch, but could actually cost you more while delivering poor financial advice. Consider the following scenario as explanation to why this is the case.

You walk into a hospital and can work with one of doctors. Each is given a few minutes to speak with you and explain how they offer their medical services, after which you have to choose whom to work with. Each doctor attended the same medical school, completed residency at the same hospital and seems nearly identical to the other in training and skill. The only difference you can discern from the conversation is how you will have to pay each doctor.

The first doctor discusses that he will charge you an appointment fee each time you meet. The only services included with that fee are his diagnostic services, physical examinations and treatment recommendations based on these examinations. The fee does not include any laboratory services or medication prescriptions under the treatment recommendations. All expenses beyond the appointment with the doctor will require additional payment by you. To fill medication prescriptions, you will have to select a pharmacy and pay for the drugs at that pharmacy.

Then you meet with the second doctor to discuss his services and fees. The doctor explains that you will be able to meet with him any time you wish with no cost to you. He will provide diagnostic services, examinations and laboratory services as required without any cost to you. Come for a cold, come for a broken bone…you will never be charged a penny for diagnostic work and treatment recommendations. All this doctor asks in return for his service is that if he prescribes you a treatment plan that includes medication, you visit with him in his pharmacy and purchase medication prescribed to you from him. Next he discloses that, while he is able to sell drugs from most major pharmaceutical brands, he gets paid a significantly larger commission by some brands than others. He goes on to tell you he is actually employed by one pharmaceutical company as a salesperson. He makes it clear that you are under no requirement to use his pharmacy, but that it is extremely convenient for you to do so.

As you mull over your choice, you may begin to think that the first doctor sounds like he could become very expensive. After all, you have to pay for his services and then pay for any other services as well. The second doctor does not ask for a penny, but would like you to buy your medication from him. Is there a problem with this?

That free financial plan you have been offered is very similar to the free medical advice the second doctor offered. The deal sounds pretty nice and it sure is easy to say yes to free. That free financial plan being offered is not in reality quite so free, however. As might be the case with doctor number two when providing medication treatments, a financial advisor offering a free plan will be inclined to recommend financial products for you to purchase. This is, after all, how he gets paid. If you do not purchase products, you do get a free financial plan (albeit one with recommendations that may be questionable or skewed toward a product sale.) Moreover, the products recommended under the free financial plan may end up costing you more than it would have cost to pay for planning services and products separately!  You have been told that the commissions by some brands are higher than others…which do you think the financial advisor is likely to recommend? And you pay that commission. It may not be outright in the form of a check directly to the financial advisor, but it comes out of your premium payments or money being invested. It is NOT free.

Assume now you meet with two financial advisors. One works for a large investment brokerage, and the second for an independent fee-only financial planning firm. The following comparison is simplified, but offers a representative model of the type of fees you might pay.

Assume the first financial advisor recommends a mutual fund with a 3% commission and a 1.5% annual expense. You could invest $100,000 dollars with this advisor, who then receives $3,000 of your money from the mutual fund company. Additionally, you pay an expense to the mutual fund company of $1,500 every year. If the value of your investment goes up, this figure will rise. So, the total expense for the advice the financial advisor provides and his treatment plan recommended is $4,500. If your advisor recommends changing your investment in the future, he could receive another commission at that point, as well. 

Compare this to the second financial advisor who charges you a fee for his financial plan. He charges you $1,500 for the financial planning work and 1% annually to provide ongoing financial advice and manage your investments. Then he recommends you invest in several no-load (no commission) index funds with an average annual expense of .6%.  Again you invest $100,000 with this advisor. Now your total out of pocket expense is $3,100. The financial advisor receives $2,500 total and the fund companies receive $600. AND in future years, you only pay the advisor $1,000 for ongoing financial advice and financial planning services plus the $600 mutual fund company fees (which could increase or decrease depending on how your investments perform.) There are no future commissions charged to you and the advisor is under no compulsion to recommend you change your investment plan in order for him to get paid again.

Think twice about that free financial plan. It’s really not so free and it carries with it a lot of conflicted advice. Would you choose the pharmaceutical representative who is also a doctor? Do you think the treatment plans this doctor offers might be a bit skewed? That free financial plan is very similar. I know I do not want my medication advice coming from a pharmaceutical representative and equally do not want my financial advice coming from a financial product salesperson. How about you?


4 comments:

Chad Nehring, CFP said...

Nice article that lays it out very effectively Nate!

Fern Alix LaRocca CFP® EA said...

Great post, Nate. A lot of people aren't aware what amount the commission advisor is getting which makes it hard for them to compare like you did here. Another issue is people don't have the mindset to pay a chunk of money upfront for a financial plan. Most don't understand the long term value which in today's economic environment is a necessity to build wealth.
Fern Alix LaRocca CFP®
http://www.wholeheartedway.com

Nathaniel G. Gehring, CFP® said...

Thank you for the comment, Fern. I agree with you. It is much easier to pay for financial planning without having to realize you're paying for it. Much easier to buy something somewhat tangible and get the plan free. Unfortunately, that plan is often worth as much as has been paid.

Financial planning advice said...

It is very important to recognize the basics to make your financial planning a success. Times change and your financial planning advice has to be able to change with them.

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