How much should you pay for financial advice? Robo advisors are cheap but not for every portfolio

How much should you pay for financial advice is a question with more than one answer. Not all financial advice is equal, and as with most things in life, we tend to get what we pay for. Of course, some financial advice can be great value. It can also be very poor value. But as a general rule, the more complex our financial situation, the more we should expect to pay for good, actionable, hopefully profitable, investment guidance.

The market for financial advice approximately reflects that. Simple, general investment advice that applies to broad categories of investors, should be cheap. If that’s all you need, it’s important not to overpay. More expensive advice may not be needed and if that’s the case, all paying for it will do is eat into eventual returns.

On the other hand, if paying more for financial advice will ultimately lead to you making more money, enough to compensate for the upfront and ongoing costs while leaving a reasonable profit, then it’s a worthwhile investment, in your investments.

Unfortunately, we can never know in advance how well investments will work out. But it’s still possible to set some general guidelines for the circumstances in which paying a little more might be worthwhile. For example, if you have a more valuable, complex portfolio, need help with retirement planning or tax mitigation.

But with financial advice ranging from up to £500 or more an hour with a financial adviser, to advice generated by the algorithms of a robo-advisor costing as little as £25, how do we know what’s most likely to be the right kind of advice for us personally?

When does it make sense to keep advisory expenses as low as possible? When does it make sense to invest in more expensive advice? And when is the middle ground most appropriate?

Ultimately, the answer to those questions will depend on personal circumstances. And we’ll broadly define different categories of common personal financial circumstances. But what is clear, is that by not investing at all, holding cash instead, savers are likely to lose out in the long term.

Historically, long-term investments that broadly track the main financial markets in a low-risk way, have yielded average annual compound returns of 6%-7% over any given 20-year period. Current interest rates on cash held in savings accounts tend to run below inflation, meaning cash savers actually see their wealth eroded over time, not grown.

That’s a problem being stored up by the than a third of consumers with £10,000 or more of spare funds who keep their money in cash saving accounts.

So, if you do plan to take the plunge and start to invest in stock markets in 2021, or have already started but are still wondering, this guide will help clarify what and when financial advice is worth paying for.

Controlling fund management and platform costs just as important as advice costs

Before discussing in more detail the cost to benefit ratio of different kinds of financial advice, it’s important to first address another, often neglected, cost of investing. Unless small investors are going overboard on paying for investment advice, it is actually the impact of these charges which is more likely to hurt returns over the long term.

They are also predictable costs we can fully control. Neither a cheap robo-advisor nor the most expensive human financial advisor you can find will be able to tell you with any certainty if particular investments will prove a success, or to what extent. But investment charges are set, so predictable.

If a combination of platform fees and buy and sell charges add up to an annual 2.5% cost on the value of an investment portfolio, that will wipe 50% off expected returns over 30 years. That’s calculated on the basis of average compound growth of 6% a year. Even at charges amounting to 1% a year on portfolio value, that will swallow up 35% of profits over 30 years.

Which is why it is important to keep an eye on these costs and choose the right fees and charges model, and level, for your portfolio. For example, online investment platform AJ Bell charges up to 0.25% a year on the value of investment accounts it hosts. Rival Interactive Investor charges a flat fee of £9.99 for its basic service. Up to a value of £49,000, the 0.25% fee works out cheaper. Over that and you’d save by switching to Interactive Investor’s flat fee.

Budget investment platforms like Lloyds’ Iweb, charges nothing for the use of its platform, but a flat £5 is charged on every trade. So could work out as very attractively priced for someone with a mid-sized portfolio who only makes a few trades a year. But would be more expensive for someone who trades quite regularly.

As a percentage, investment fees can make a real difference to smaller portfolios, especially over the long term. And for those lucky enough to have investment portfolios worth healthy six-figure sums and above, choosing a cheaper platform fee, preferably a capped % or reasonable flat fee, can make hundreds to thousands of pounds of difference.

Make sure you put in a little research and consider how often you plan to trade when choosing a host for your investments.

Ordinarily (but make sure you confirm), there are no ongoing fees for holding individual shares on an investment platform. But if you hold them in a wrapper like an ISA or SIPP, there usually is.

And if you invest in managed funds, you can expect to pay between 0.75% and 2% in annual fees, on top of platform charges, and any advice you may pay for. Some managed funds do well, but over the past 10 years or so they have, on the whole, statistically underperformed cheap, passive index trackers, which also nicely spread risk and offer exposure to numerous companies.

Low-cost index tracking funds, like ETFs whose goal it is to track the performance of the FTSE 100 or S&P 500, can cost 0.1% or less. Vanguard’s FTSE 100 tracker charges just 0.06% per year.

Despite the added platform costs, it usually does still make sense to invest via an ISA or SIPP, as these wrappers come with significant tax benefits.

When might it make sense to pay for a financial advisor to construct your investment portfolio?

While pricing varies, it might typically be expected that a professional financial or investments advisor would charge up to 5% of portfolio value to construct one you will then pay into regularly, with instalments equally spread across investment weightings. After the initial construction, an annual 0.6% a year charge is about average for ongoing tweaks and advice.

That adds up to around a year’s worth of average compound growth. As a one-off, that might be worth while over the long term. Especially if it offers peace of mind. However, the FCA has recently warned that as many as 9 out of 10 advisors automatically opt clients into annual reviews. It might be better for you to ask to be opted out, and pay for a view just once every few years, or when you feel is necessary. For example, if your personal financial circumstances have changed or you are approaching retirement within the next decade.

If you have been paying into investments such as funds, chosen for you by a financial advisor, since before 2013, there is also a chance you could still be paying trailing commissions. These can also really eat into returns over the years so make sure you double-check if there is a chance you are paying such commissions, and ask for them to be stopped if they are still active.

Advisors are no longer allowed to receive such commissions and are now obliged to charge upfront and transparent fees. So at least now you know what you are paying for and how much. And don’t be afraid to ask for a better offer than the first offered, when it comes to both initial and review fees. The worst that can happen is that you’ll be politely declined.

When might robo-advice be better for you financially than a human advisor?

The past few years have witnessed the rise of robo-advice investment services. Robo-advice is based on algorithms spitting out a suggested portfolio structure based on what you tell the machine about your personal financial circumstances, investment goals and time scale.

The fact that there is no human involvement to robo-advice means it is generally cheap. Robo-advisors also tend to focus on index-trackers, which also keep costs down.

Robo-advisory services are usually a good choice for beginner investors who are starting out with their investment portfolio and still have uncomplicated, long-term investment goals, like saving towards a retirement that is still many years away. In most cases, that means investing in cheap, index trackers is the best way to start. And the strength of robo-advisors is putting together exactly that kind, of simple, general portfolio.

When to use a robo-advisor and when fork out for a human financial advisor?

As is probably becoming clear, the general rule is that cheap robo-advisory services are usually a wise choice for simple, standard, long-term investment portfolios. For example, in the case of a 30-year-old just starting out as an investor and planning on making modest, monthly contributions, it probably wouldn’t make financial sense to pay for more expensive financial advice.

However, for higher net worth individuals, or those in later life with high value portfolios and more complicated financial affairs, like children, divorce, starting or selling a business, tax mitigation and pension planning, the additional expense of human advice could well pay for itself.