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There's no such thing as free financial advice

How much are you paying for financial advice?

It might seem like a straightforward question, but a majority of Americans who have a financial advisor don't know the answer.

A survey of 10,000 households that use financial advisors found that more than half of advisor clients (51 percent) thought the advice they received was either free or they didn't know how much they paid for it.

Financial Advisor
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The survey was conducted by Cerulli Associates and Phoenix Marketing International at the end of last year.

The good news is that the number of survey respondents in the dark about their advisor's compensation has been dropping since 2011, when it was a staggering 65 percent.

"The proportion has fallen from the highs we saw in 2011, but there is still a very large number of investors who don't know the dynamics or the details of their advisory relationship," said Shaun Quirk, a senior analyst at Cerulli.

It's not consumers' fault. The wealth management industry, as a whole, does everything it can to hide the pounds of flesh it exacts for providing financial advice. Some advisors make their money through fees on assets under management, others through commissions on transactions, and some employ a mix of both.

Still others receive indirect compensation from mutual fund companies, insurance providers and other investment product manufacturers that investors could only see if they combed through the fine print of very complicated disclosures. Although investor advocates have for decades been calling for a clear and simple expression of the cost of investing, the information very often remains obscure.

"People are generally not financially sophisticated, and one great way to make things easier for them would be to give them clear cost information." -Barbara Roper, director of investor protection at the Consumer Federation of America

"There's been a huge failure of regulation," said Michael Kitces, a fee-based certified financial planner. "A large swath of investors aren't aware of what or how their advisors are compensated, because it's not transparent."

Those advisors who are transparent about their compensation often suffer because of it. It seems that if costs are out of sight, they are out of mind for investors.

"The advisors who are most transparent about their fees are probably among the lowest-cost providers, but they are viewed as the most expensive," Kitces said. "Ironically, the more transparent advisors are, the more difficulty they can have getting new clients."

Along with the difficulty in determining what the costs of advice are, there are also some powerful psychological obstacles for people to overcome. Investing and financial planning is difficult for most people to understand, and they aren't willing to admit their discomfort with it.

In cases where people have been taken advantage of by an advisor, they are embarrassed and often in denial. Many refuse to take legal action even if they have a strong case.

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"It's like a rape victim," said Sheryl Garrett, founder of the Garrett Planning Network. "They don't want to go through it again."

Garrett started her career as a commission-based advisor in 1987 but quickly realized she wasn't comfortable with the model. She then worked for a couple of wealth managers with "convoluted" fee-based models based on a client's assets under management, their net worth and their earned income. They generally served only wealthy clients.

"It took a worksheet to come up with a quote for prospective clients," said Garrett, who no longer serves individual clients.

She then decided to start her own firm and charge people for her time on an hourly basis. "I wanted to be an outlet for people who needed advice but couldn't pay for it," she said. "I felt that an hourly model was the most fair and most transparent framework where people could see exactly what they were paying me."

Garrett and other fiduciary financial advisors see the recently issued fiduciary rule passed by the Department of Labor as a major step in the right direction of controlling the costs of advice to investors. It applies only to retirement accounts such as 401(k) plans and individual retirement accounts, but advisors to those accounts will now have to act in their clients' best interests.

"People don't have to know a thing about it to benefit from it," said Barbara Roper, director of investor protection at the Consumer Federation of America. "It won't matter as much that people don't understand much about investing or the cost of it.

"If advisors have to act in their clients' best interests, there won't be as high a cost of ignorance."

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The cost of investing matters. A half-percentage-point difference in fees will translate into thousands of dollars less in total return over an investor's lifetime. Roper and her organization have been prodding the Securities and Exchange Commission to improve advisor compensation disclosures for decades — largely to no avail.

She says that in today's defined contribution retirement landscape, where people are responsible for their own well-being in retirement, better information on the costs of financial advice is crucial.

"We've created a retirement system that works really well for the industry and not for individuals," said Roper. "People are generally not financially sophisticated, and one great way to make things easier for them would be to give them clear cost information."

— By Andrew Osterland, special to CNBC.com