How advisory fees are billed: in advance or in arrears, deducted or invoiced

Two firms can quote the same rate and charge different amounts, depending on how and when the fee is billed. Item 5 of a firm's Part 2A brochure has to say. Here is what to look for, and what the words mean.

What Item 5 of the brochure covers

• 5.A, how the firm is paid. Its fee schedule and whether fees are negotiable.
• 5.B, how fees are collected. Whether the firm deducts its fee from your account or bills you, and how often.
• 5.C, other costs. Other fees and expenses you may pay, such as custodian fees and the expenses of the mutual funds and exchange-traded funds in the account.
• 5.D, fees paid in advance. Whether you pay before the period begins, and how a prepaid fee is refunded if the contract ends partway through.
• 5.E, sales compensation. Whether the firm or its people are paid for selling securities or other products, which is a conflict of interest to weigh.

In advance or in arrears

An asset-based fee is a yearly rate charged in installments. In advance means each period's fee is charged at its start, on the account's value then, and refunded in part if you leave mid-period, as Item 5.D explains. In arrears means it is charged at the end, on the value then or an average over the period. Neither is better in itself; what matters is that you know which applies and how a departure or a large deposit is handled.

Deducted or invoiced

Asset-based fees are often deducted directly from the account, with your written authorization. The custodian, the bank or broker that holds your assets, sends you its own account statement, which shows the deduction. Under the SEC's custody rule, the authority to deduct fees counts as custody of client funds, one reason the statement comes from the custodian and not only from the firm. Hourly and fixed fees are often invoiced instead.

How a tiered schedule is applied

Many schedules step down as assets grow: a rate on the first dollars, a lower rate above a breakpoint, and so on. Read the notes to see how the steps work:

• Tiered: each rate applies only to the assets within its band, so the overall rate falls gradually as the balance grows.
• Whole-balance: one rate applies to the entire balance once it reaches a level, so crossing a breakpoint lowers the rate on every dollar.
• Householding: some firms add up related accounts, such as a couple's, to reach a breakpoint. The brochure says whether the firm does.

A minimum annual fee, if the firm has one, sets a floor that works like a minimum for smaller accounts. See what financial advisors cost for what brochures state about rates and minimums.

Checking your own bill

Take the yearly rate, divide by the number of billing periods, and apply it to the account value the brochure says it uses: the start or end of the period, or an average. Compare the result with the deduction on the custodian's statement. A difference is worth a question; the firm should be able to show the calculation.