Definitions and arithmetic
How advisers charge, and what a 1 percent fee compounds to
Every SEC-registered adviser discloses its compensation arrangements by checkbox on Item 5.E of Form ADV, and each firm page on this site renders those checkboxes as sentences. This page defines the six arrangements and then does one piece of arithmetic, correctly and with its assumptions shown, because percentage fees are quoted in a unit (1 percent per year) that hides what they cost in dollars over decades. Nothing here is advice about what you should pay; it is what the words mean and what the numbers do.
The six compensation arrangements on Form ADV
A percentage of assets under management Item 5.E(1)
The dominant model. The firm bills a percentage of your account value, commonly around 1 percent per year at retail account sizes and stepping down at higher balances. The fee rises and falls with your balance, which aligns the firm with growing the account and also means you pay more every year the market rises, for what may be the same work. The compounding arithmetic below is about this model.
Hourly charges Item 5.E(2)
You pay for time, like a lawyer or accountant. Common for one-time plans and second opinions. The meter is visible, which keeps the engagement scoped; the trade-off is that nobody is monitoring anything between engagements unless you book more hours.
Subscription fees Item 5.E(3)
A recurring flat amount, monthly or annual, decoupled from account size. Newer firms use it to serve clients with income but modest portfolios, whom the percentage model prices out. Compare the annual subscription against what a percentage fee would cost on your balance; at small balances the subscription is often the larger number, at large balances the smaller one.
Fixed fees Item 5.E(4)
A quoted price for a defined deliverable, most often a financial plan. Like hourly, it caps your cost in advance; like hourly, it includes no ongoing management unless you buy that separately.
Commissions Item 5.E(5)
The firm or its people are paid by product providers or through transaction charges when you buy something: a fund with a sales load, an annuity, an insurance policy. You may pay little or nothing directly, which is exactly why this model deserves the most questions: the compensation arrives from a third party whose product was just recommended to you. Disclosed commission compensation is legal and common; the useful follow-up is which products pay the firm and how much.
Performance-based fees Item 5.E(6)
A share of gains above some benchmark, on top of or instead of other fees. Advisers Act rule 205-3 restricts these to qualified clients, wealth thresholds the SEC adjusts for inflation every five years, so most retail accounts will never see one. Where they exist, they reward risk-taking with your money on the upside without a matching penalty on the downside; the disclosure documents must describe how that conflict is handled.
Item 5.E(7) is a free-text "other" category. Firms checking it describe the arrangement in their brochure (Form ADV Part 2A), which is where every fee schedule lives in full. How these checkboxes relate to the "fee-only" label is covered on the fiduciary page.
The worked example: 1 percent, 30 years
Assumptions, stated so you can check the math: a $500,000 portfolio, a 6 percent annual return before fees, 30 years, and an advisory fee of 1 percent of the year-end balance, assessed once each year after that year's growth. No contributions, no withdrawals, no taxes. The 6 percent is an assumption chosen to make the arithmetic concrete, not a prediction; change it and the dollar figures change, but the shape of the result does not.
| Scenario | Yearly growth factor | Balance after 30 years |
|---|---|---|
| No advisory fee | 1.06 | $2,871,746 |
| 1% fee on each year-end balance | 1.06 × 0.99 = 1.0494 | $2,124,226 |
The no-fee balance is 500,000 × 1.06 raised to the 30th power, which is 500,000 × 5.74349, or $2,871,746. The with-fee balance compounds at 1.0494 per year (grow 6 percent, then pay 1 percent of the result), so 500,000 × 1.0494 raised to the 30th power is 500,000 × 4.24845, or $2,124,226.
The gap is $747,520, about 26 percent of the no-fee ending balance, from a fee quoted as 1 percent. The gap is deliberately larger than the fees the firm actually billed: every dollar paid in fees also stops compounding for the remaining years, and the SEC's own investor bulletin on fees makes the same point with a smaller example (a 1 percent ongoing fee on $100,000 at 4 percent growth costs roughly $28,000 in fees plus $12,000 in forgone growth over 20 years).
What the arithmetic does not say: whether the fee is worth it. An adviser can earn a fee many times over through planning, tax decisions, and stopping a panicked sale at the bottom, or can earn nothing beyond what an index fund would have done. That question has no public dataset behind it, which is exactly why this site does not rank advisers by results. The arithmetic only says: know the number, because the unit it is quoted in is designed to feel small.
Sources
- The compensation-arrangement checkboxes and their categories: SEC, Form ADV Part 1A, Item 5.E.
- Performance-fee restrictions to qualified clients: 17 CFR 275.205-3.
- Fees compounding against the portfolio, including the forgone-growth effect: SEC Office of Investor Education and Advocacy, Investor Bulletin: How Fees and Expenses Affect Your Investment Portfolio.
- The two compound-growth figures above are this site's own arithmetic from the stated assumptions; anyone with a spreadsheet can reproduce them.
Advisor Rulebook is an independent educational site and is not an investment adviser, a broker, or a law firm. Nothing here is legal, financial, or investment advice, and nothing here recommends any firm.