Financial advisors can be paid in a number of different ways, and with most of them, you never see a bill. It can be difficult to know how yours is paid and how much if you don’t ask.
Some collect commissions from financial products that are sold to you, like loaded mutual funds (usually with up-front fees), annuities, and insurance products like cash value life insurance. This type of model is oddly called “fee-based.”
In contrast, a “fee-only” advisor earns no commissions and only earns money from various fees. Those fees can be charged as a flat fee, an hourly rate, a tiered fee schedule based on assets or other criteria (such as salary), assets under management, or any combination. While fee-only is generally regarded as better (for the investor) than fee-based, conflicts of interest can still exist in fee-only models.
Today’s guest post comes from financial advisor, Donovan J. Sanchez, CFP®, ChFC®, CSLP®, CLU®. [I’d like to buy a vowel, please.] He started out with a fee-based firm and later worked for a fee-only practice, but that too left a bad taste in his mouth. Donovan now runs his own fee-only financial planning company at SkyviewPlanning.com.
Confess away, Donovan!
Confessions of an Ex-AUM Financial Advisor
What does “AUM” mean?
Most financial advisors are paid either from commissions earned on the sale of a product, or based on a percentage of assets under management (AUM). It’s not uncommon for this percentage to be somewhere around 1% on a $1 million portfolio.
If you have a $1 million portfolio, at 1% you’re paying a $10,000 annual fee. You may not feel the pain of that cost, however, because you don’t have to write a check. The fees are extracted quarterly from your investment account.
The question is this: Is paying your advisor based on a percentage of AUM really the optimal compensation model for you?
The problems didn’t end after leaving Northwestern Mutual. They changed.
My guest post, “Confessions of a ‘Financial Advisor’,” appeared on The White Coat Investor on May 29, 2019. In it, I alluded to the fact that after leaving Northwestern Mutual I joined a fee-only financial planning firm that charges its clients based on a percentage of assets under management. After only 10 months, I resigned.
I learned that while a fee-only compensation structure is almost certainly better than a commission or “fee-based” model, it’s not without its own shortcomings.
When I joined Asset Gatherers, LLC (obviously not the firm’s real name), I was impressed by the level of professionalism among advisors. This was striking in comparison to the sales-driven culture I had experienced at Northwestern Mutual. Advisors at Asset Gatherers, LLC focused on holistic financial planning and investment management. I didn’t hear my new colleagues boast about their HUGE insurance sales, or about how many “lives” (insurance policies) they had for the month like I had previously been accustomed to.
The fact of the matter is that fee-only firms don’t sell products. Clients pay for advice and allow advisors to manage their investments.
The difference was wonderful.
I soon became frustrated, however, because the fee structure made serving clients with no or few assets to manage very difficult.
Here’s what I mean: If a financial planning firm charges 1% of your assets, they aren’t going to make very much money on smaller accounts—1% of $10,000 is only $100 after all. For this reason, many AUM advisors will require an “asset minimum.” Don’t have $50,000 to invest? Sorry buddy, can’t work with you. How about $250,000? Depending on the advisor . . . nope. $500,000? That’s more like it.
On the other hand, it didn’t take long for me to see how inappropriate it was to increase fees for identical services simply because clients had more money invested with the firm.
Think about it this way: If your advisor is a fiduciary, they should be providing best interest advice regardless of the size of your account. Meaning that if a client has a $50,000 account, they should be getting the same best interest advice as you do with your $2,000,000 account.
The difference is that they’re paying $500 a year and you’re paying $20,000.
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When “fee-only” isn’t all it’s cracked up to be.
“The best, and only, way to make sure that you and your advisor are on the same team is to make sure that he is ‘fee-only,’ that is, that he receives no remuneration from any other source besides you. Otherwise, you will end up paying, and paying, and paying, and paying . . .” (p. 294)
William Bernstein, The Four Pillars of Investing
I believe that knowing how your advisor is paid will tell you more about your relationship with them than any other thing.
Does your advisor offer “free advice” but is constantly pushing insurance products, and asking you for referrals? Your advisor is a commissioned salesperson.
Does your advisor seem overly concerned with the amount of money in your 401(k), or that brokerage account with another financial institution? You’re working with an advisor that gets paid by extracting fees from your investment accounts.
So while it’s vital to work with a fee-only financial advisor (if you’ve decided to work with an advisor in the first place), it’s also crucial to understand how your particular advisor’s compensation model works. You see, there are differences between one fee-only advisor’s compensation model and another’s. For example, fee-only advisors can be paid on an hourly basis, annual retainer, per-project fee, monthly subscription, or a percentage of assets under management.
Prior to my leaving Asset Gatherers, LLC, company leadership hired a new manager to oversee some of its advisors. One of his “big ideas” for improving the firm’s bottom line was to have advisors compile a list of all client assets not being held with the firm. The manager would use this list as a way to track these assets so that we could go after them.
You see, Asset Gatherers, LLC, like other AUM firms, struggles with the fact that as people enter retirement, they actually want to spend their money! So an AUM firm needs to have a constant inflow of new assets just to keep up with the assets that are being spent by clients. Are you sensing a potential conflict of interest here? AUM firms suffer when the amount of money they manage goes down.
In The White Coat Investor’s Financial Boot Camp, Dr. Jim Dahle writes:
“Also, be aware that even fee-only advisors can have biases and conflicts of interests. For example, if the advisor is only paid on a percentage of assets under management, they may recommend an IRA rollover that is ill-advised (which would increase assets under management), recommend against paying off student loans or mortgages (which would decrease assets under management), or recommend against investments that they would not manage such as real estate.” (p. 116)
Good financial advisors provide a valuable service . . . but is it worth $10,000 (or more) per year?
Does everyone need an advisor? I don’t think so. I believe that those with enough desire, time, and dedication can learn to do their own financial planning and investment management.
The same can be said for fixing your car, doing your taxes, or remodeling your home. But don’t forget that time spent on one thing precludes your ability to spend it on others. So if you really don’t like financial planning or investment management, I see no reason to feel guilty about outsourcing to a professional who can offer you independent advice for a fair price. Doing so frees you up to focus on things that bring you joy and fulfillment in life.
So do I think that independent advice is worth something? Of course I do. But the price really does have to be fair.
Some firms still charge AUM fees for investment management alone. What does this get you for the fee? Generally speaking, here are some of the services you can expect:
- Investment selection
- Asset allocation and portfolio construction
- Ongoing monitoring and rebalancing
- Asset location (for tax purposes)
- Behavior and accountability coaching in fluctuating markets
Due to the rise of index mutual funds and “passive” investment strategies, many advisors find themselves needing to provide financial planning services in order to justify their 1% fees. So when you hire a financial advisor who offers investment management and financial planning, what additional services do you get? Firms differ, but here are some ideas of what you might receive:
- Tax planning
- Retirement planning
- Education planning
- Cash flow management
- Debt reduction planning
- Insurance planning
- Estate planning
- Student loan planning
If you’re in need of the services listed above, it can make sense to partner with a good advisor. But here is why choosing an AUM advisor may not be the best fit:
- Don’t have any money to invest with the firm? With an AUM advisor, don’t be surprised if you’re given a smile, some general advice, and then shown the door.
- Have $1,000,000? Your bill comes to $10,000 per year.
- $2,000,000? Please pay $15,000 to $20,000 per year.
Bottom line: Under the AUM model the more you have, the more you pay. And for what? The exact same service.
(To be intellectually honest, it should be noted that if you have an account between $0 – $500,000, an AUM advisor’s fee may not be a bad deal—if the advice is good. But as your account grows, you should start to question whether you’re getting good value for the fees being paid.)
What AUM advisors argue.
AUM financial advisors argue that if the service they provide helps their clients put their financial house in order and avoid catastrophic mistakes—such as selling during a market downturn—then they deserve every penny you pay them.
But if there’s a comparable advisor charging $5,000 per year, why should you pay more for the same service?
AUM fees don’t make sense with passive investment strategies.
In the past, people who hired financial advisors and investment managers felt that they were paying someone to pick and choose winning stocks so that they could somehow “beat the market.” Even though this mentality is dying a slow death, it still seems to me that many investors believe that their gal or guy is one of the lucky ones that is going to do it.
What they may not realize is that many fee-only financial planning firms are adopting a passive investment strategy. So here’s my question: If your advisor isn’t actually trying to “beat the market,” and you’re exercising a buy-and-hold strategy, why should you pay them on a percentage basis?
Let me provide an example to illustrate my point. Hedge funds actively attempt to beat a predefined benchmark, and people pay them based on a compensation model for just that purpose. Hedge funds are often paid on a “two and twenty” model. They charge you 2% of assets under management and 20% on profits they earn above the benchmark. With a hedge fund, at least you understand that the ridiculous fees you’re paying are because you want your gal or guy to have an incentive to try to beat the benchmark.
Personally, I think engaging in this behavior is a waste of money. So please don’t take this example the wrong way—I’m not advocating that you invest with hedge funds. (Check out the hilarious first three lines from this CNBC article titled “Hedge funds squeak by S&P 500, topping the benchmark for the first time in a decade”.)
Unlike hedge funds, a passive investment strategy attempts broad diversification and returns similar to those being generated by the indexes being tracked. In this case your advisor does not try to actively beat the market. Intead, your advisor adds value by selecting the indexes, rebalancing, tax loss harvesting, asset locating, and continuously monitoring the portfolio. That’s a service worth paying for if you aren’t interested in doing it on your own.
So why not just pay a flat, fixed fee?
The last straw.
I had been working at Asset Gatherers, LLC for the better part of a year when my manager asked me to join him for a video conference. For weeks I had been drafting and sending him proposals to explore alternative fee structures whereby we could serve people who would be willing to pay for advice, but didn’t yet have the required $50,000 to be managed by the firm.
At the conclusion of our conversation, my manager told me that what the company really needed was for me to get out there and win $250,000 accounts. My heart sank. So it really was about asset-gathering after all.
Though I loved the increased professionalism and reduced conflicts of interest at Asset Gatherers, LLC, after this conversation I knew that my time with the firm would come to an end. About two weeks later I put in my notice of resignation.
Not long after the conversation with my manager, I listened to an interview with Michael Kitces and James Osborne where James talked about his flat fee financial planning firm. (You can find the interview here.) It’s hard to describe the “eureka moment” I had while listening to James and Michael converse. I had finally found a compensation model that made sense. James’ structure became the inspiration for the flat fee only financial planning and investment management firm that I launched in February 2019.
Some final thoughts.
I can’t think of a better way to close this discussion than with Dr. Dahle’s words from The White Coat Investor’s Financial Boot Camp:
“No matter how you are paying your fee-only advisor, be sure to add up the total annual fee you are paying and then determine whether you feel you are getting that much value out of the relationship. Since high-quality financial advice and investment management services can be obtained for a four-figure amount per year, if you find you are paying $10,000 or more, I highly recommend you negotiate a lower fee with the advisor, switch advisors, or learn how to manage your own investments.” (p. 116)
Having worked as an “advisor” at a national insurance company being paid on commissions, then as a professional financial advisor at a fee-only firm that charges clients based on assets under management, and now under a flat-fee only retainer model, I’ve experienced an “inside” perspective on each of these fee arrangements. I believe that few things impact the client-advisor relationship like the way you choose to pay for services provided.
Even though my crystal ball is quite cloudy, I think the client of the future is going to want a more equitable fee arrangement—one that isn’t tied to product sales or the amount of investments the advisor manages, but based on the worth of that advisor’s time and service.
Time will tell.
These are the honest thoughts of one voice in the financial advisor community.
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