Monday, July 30. 2012
The inspiration for today's blog post was a recent conversation I had with a fellow planner who transitioned his practice to an annual retainer fee model... and two years later, is converting his practice back to the AUM model he had originally. "I loved the idea of it," he said, "especially to get off the revenue rollercoaster of AUM fees that went up and down with the markets. But no matter how much work I did for my clients, they really pushed back on writing that annual check."
"I'm not surprised," I replied, "that's the unfortunate problem with such a highly fee-salient business model."
The Importance Of Price Saliency
As I've written in the past, clients do not view all mechanisms of payment equally; some methods of payment make the cost more tangible and "salient" while others are less salient. The importance of saliency is that, as the research shows, more salient payment mechanisms cause people to more actively question the price that they're paying and the value that they're receiving; stated more simply, the higher the saliency of the payment, the more likely we are to question whether the cost is really worth it.
In some contexts, high price saliency is good. We tend to make more prudent decisions as consumers, and are more cost conscious, with high saliency pricing. This is why we object to toll increases we pay in cash/coins more than toll increases we pay electronically. It's why we tend to question property tax increases more than income taxes (the former is often paid by high-saliency check, the latter by low-saliency payroll deduction). The creation of Health Savings Accounts paired with High Deductible Health Insurance plans was done with the intention of raising the price saliency of the healthcare we purchase in the hopes of making us more proactive, cost-conscious consumers.
The caveat of price saliency is that while high saliency can be an effective consumer protection - by helping to make people more cost conscious so they make "better" decisions - it can also be a downside for businesses. Even if the business offers a compelling value proposition, making prospective clients more cost conscious inevitably leads some to choose an alternative that either is less expensive, or is at least less fee-salient so the cost of services doesn't feel as painful. Thus, while low-saliency pricing can sometimes lead to unjustified and consumer-unfriendly price increases, it also can be positive for businesses by making it more comfortable and less of a slap in the face for consumers who purchase the business' bona fide goods and services.
The Saliency Of Retainers Versus AUM
In point of fact, the comparison of retainers versus assets-under-management (AUM) models represents a classic example of a high versus low saliency business model decision. After all, most firms charging retainers ask clients to write an annual check (high saliency), while most firms operating on an AUM basis extract fees directly from the client's investment accounts automatically (low saliency).
Given the research on fee saliency, this suggests that even if firms charge the exact same price as what would have been paid on an AUM basis, or even a little bit less, that clients will be more likely to question the value of the firm and less likely to purchase or renew services. In fact, the impact of saliency would suggest that, in order to remain competitive with a lower-saliency AUM model, a retainer-based firm would actually have to charge less money per client for the same services just to overcome the saliency barrier!
And notably, because of the high saliency of retainer fees, clients are forced to deeply analyze the value proposition of the firm not just initially when becoming a client, but every year, because of the high-saliency fee that must be paid every year! Which means charging retainers may not only require the firm to charge less per client for the same services, but may also require the firm to do more work and provide more service just to get the same client renewal. In turn, this means retainer fees can actually still be somewhat "volatile" - if markets decline and a firm tries to keep the same retainer fee, they may simply be undercut by an AUM competitor who would charge less, for the time being, on the decreased asset base (and with a high saliency fee, the client is more likely to check around and discover this!)! Furthermore, the high saliency of the pricing can also make it difficult for the firm to raise fees over time - which, over a 5-10 year time horizon, may threaten the viability and profitability of the firm, as staff and overhead costs will potentially rise faster than retainer fee revenue.
Limitations Of The AUM Model
Of course, the reality is that while the AUM model may allow the firm to be more financially viable than a retainer model for a similar client base, the AUM model isn't capable of serving a large swath of individuals who don't have an asset base to which AUM fees can be applied. Thus, the point here is not that AUM is the only model to operate and that retainer fees can't or will never work; the point is that for clients where AUM fees can work, using a retainer model just raises the saliency of the advisor's payments, cutting down on the number of new clients, reducing client retention rates as more clients question whether it's really worth renewing the retainer fee, and putting pressure on the firm's profit margins as inflation may push staff and overhead costs up faster than the firm can raise a high-saliency fee structure.
Notably, though, the research on price saliency does provide guidance about more effective ways to implement a retainer-style approach. For instance, not all retainer billing structures are as salient as others. Furthermore, when prices are salient, they often invite a comparison to other expenditures; as a result, a good decision about pricing structure can also control the "compared to what" conversation when setting a price on planning with a client. For instance, when working with the middle market, where an AUM fee is often not feasible and a retainer fee is preferred, structuring the fee of $1,200/year may yield very different results than pricing at $100/month. From the client's perspective, $1,200/year is like buying a giant flat-screen television (ouch!), whereas $100/month is more like the monthly cost of cable - or the cost savings available by shifting from a daily cup of Starbucks to self-brewed coffee! By choosing the less salient pricing structure - such as a low, recurring, automatic pricing schedule instead of a single, "large" (relative to the client's comparison points) annual written check - and anchoring it to a cost clients can more reasonable envision themselves giving up, you can enhance the feasibility of retainer fees for clients where that is an appropriate billing structure.
Retainers Versus AUM Where There's A Choice
But the fact remains that for clients where an AUM fee structure is feasible, the lower price saliency model continues to outperform the high-saliency retainer model, as my friend discovered - a story I have heard anecdotally repeated over and over again in recent years, as firms shift from AUM fees to retainer fees (usually to stabilize revenues), discover the challenges of a high saliency pricing structure, and switch back after a few years of business pain. While the retainer fees are intended to be stable revenue, it becomes more difficult to renew clients and attract new ones, and some firms find they have to do even more work to justify their retainer fees and keep clients renewing, rendering the business even less profitable than when fees just went up and down with the markets!
In addition, it's worth emphasizing that retainer fee structures are not necessarily more stable, in addition to likely being less profitable. As practice management consultant Angie Herbers recently noted on Advisor One, the reality is that in economic downturns, people tend to worry about and constrain their spending - which means a subset of retainer clients may simply not renew if they are worrying about their finances in the middle of a recession. In fact, arguably the AUM model is actually better to retain clients in the midst of a difficult economic environment - where at least their fees are "discounted" while their asset values are depressed, and the saliency of the pricing doesn't shock them at the worst possible moment.
That doesn't mean retainer models are universally bad - given that they may be the only feasible way to serve certain segments of the marketplace - but the research is clear that, when offering comparable services and comparable value, businesses with higher saliency models will struggle more, all else being equal. Or stated more simply - it doesn't really matter whether retainer fees are a "more accurate" representation of the work you do for clients each year or not, if the cost is such a slap in the face they choose not to pay it at all.
So what do you think? Do you use a retainer fee model or an AUM model? Have you ever switched from one to the other? What was your experience? Do you think price saliency is relevant in your business model? Would it impact how you charge clients going forward?
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As the financial planning profession continues to grow, it also continues to struggle to reach and effectively serve Gen X and Gen Y, as most planners tend to focus their businesses on baby boomers - no great surprise, given that baby boomers both control
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The truth, though, is that's just another way of saying the opposite of 'fee obfuscation', for much of history, the de-facto behavior by the financial services industry. It's so much easier to charge clients when the billing process happens behind the scenes than when a client has to write a check or review a credit card statement.
I agree with you that the industry will continue to favor the AUM model(at least, for the high-end of the market) - but the question I ask, is how long investors continue to favor it. Better educated investors may put pressure on this model, knowing that there's not a direct correlation between higher AUM/higher fees on the delivery side of things.
Frankly, I don't find the financial services industry's history of low-saliency fees to be a coincidence. It is, for better and for worse, a testimonial to our mental preference as consumers for low saliency fee structures.
And as for the correlation between what's paid and what you get, I fail to see how retainer fees fixes this problem. Retainer fees ask clients to make the exact same payment, regardless of whether there was a lot of work for the year, or a little, whether they had a lot of needs, or very few, and applies the same charge in the coming year regardless of how much work was done in the prior year.
In point of fact, I find one of the primary problems with retainer fees is not only does it fail to provide a direct connection between fees paid and services rendered from year to year, but in fact it actually ACCENTUATES the disconnect by creating that disparity AND reminding clients of it every year with a highly salient fee!
AUM Saliency Isn’t Salient- It’s A Deflection
The question isn’t saliency relative to AUM vs Retainer Fees but transparency in your “Why Annual Retainer Fees Won’t Overtake The AUM Model.’
Quite frankly – in Clintonian terms – ‘it’s transparency stupid – not saliency.’ Transparency and assured level of competency are critical to substitute reliance and trust not comfortable fool disclosure compensation.
So what if being more transparent is a downside for business requiring proving the value cost benefit proposition being incumbent on the planner.
Who is your client, Mike, other planners and fee level protection – or the ultimate consumer for whom the business exists?
The statement that low saliency pricing…. can be positive for businesses by making it more comfortable and less of a slap in the face for the consumers who purchase the business’ bona fide goods and services’ is pure paternalistic self serving insulting protectionism not professionalism in any sense of the word.
AUM is no better than a soft commission. It is camouflage – the great compensation pretender. 1% sounds small, harmless insignificant versus the $30,000 it may represent. And planners defending AUM relative to the fact they would have to establish the value of the services over and over again – is just extreme hypocrisy. I can just see the planner in his own purchasing behaviors saying ‘don’t tell me the absolute cost, just tell me the percentage.’
Give me a break.
So essentially, the defense of AUM is that is covers up absolute cost which is painful to the client rationalizing anti-transparency & fool disclosure. Requiring continuous establishment and reestablishment of the value of services provided (oh, the poor poor pitiful planner) is onerous and harmful to his practice. Worse is the paternalistic poppycock that via AUM, the client is more comfortable as he isn’t being reminded how specifically in actual dollars disclosed he is being screwed.
So AUM then is Vaseline for the client getting it in the tuchass.
The bottom line is the lack of bottoms in line if there was full transparent disclosure?
Again, Mike, who do your represent – clients or planners.
Maslow stated, ‘if all you know is a hammer, everything will look like a nail.’ With the compensation based to assets under management - - asset protection, income conservation, asset conservation become second class citizens to asset accumulation (and decumulation).
Behavior is a function of its consequences and so given this AUM compensation, the behavior reinforced is asset management and so called personal financial planning is a Trojan horse pretext for, in reality, being an asset manager (getting paid for premature accumulation???)
So, does a personal financial planner engage in managing goals or managing assets. In AUM – the inherent tendency is managing assets – being an asset manager.
Forget the paternalist rationalizations and justifications relative to AUM saliency. What is salient – important - is transparency and assured level of competence to earn and continue to earn substitute reliance and trust.
There’s a difference between saliency and transparency.
Many classic commission structures lack transparency. Quite literally, you couldn’t see and figure out what someone was paid if you wanted to.
An AUM versus retainer fees discussion is not a transparency issue. Both are transparent. I can point precisely to the line on their statement where the exact amount of fees I was paid, down to the penny, is visible.
And whether services are delivered competently is a separate matter, albeit one I am very passionate about. I have seen an embarrassing number of incompetent practitioners in all types of compensation models, from commissioned salespeople who don’t have a clue about actual advice to fee-only planners who in the end will give any advice that placates the client enough to come back and pay more fees in the future (a fee-compensation conflict embodied quite sadly by the ratings agencies debacle through the financial crisis).
But the bottom line is that nothing I wrote is a statement against transparency. It’s about the saliency of different transparent compensation models.
In Australia the Accounting Professional & Ethical Standards Board has proposed a new standard for financial planning. This board represents the major accounting bodies in Australia.
They have proposed a new standard under which a member of the Institute of Chartered Accountants or CPA would be prohibited from receiving commissions or setting their fees based on a percentage of the clients assets.
Whether AUM fees are charged, or retainer fees, there is likely to continue to be pressure on advisory fees going forward. At recent conferences I have heard in the halls (for the first time very often) that investment advisory services are increasingly viewed as a commodity. Financial planning, in contrast, is not viewed that way (given the disparity in client needs, as to planning).
Interesting article, and interesting discussion. Thank you, again, Michael, for bringing timely issues to the forefront.
Just one minor point here - I see little commoditization in financial planning, and little commoditization in investment advisory services overall. HOWEVER, there is a significant commoditization of index-based passive investment advisory - which is a trend driven for the better part of 30 years by Vanguard, then accentuated by some do-it-yourself investment firms, and now more recently by the "robo-advisors" like Betterment and Jemstep.
And frankly, I do find this a justifiable pressure on a firm. Why SHOULD someone pay an advisor for the same portfolio they could get from Vanguard, through Schwab, or via Betterment or Jemstep from a tiny fraction of the cost, unless there is some OTHER value being added?
The firms that are expressing the greatest commoditization/fee pressures I find fairly consistently to be the firms offering a very investment-centric service with a very passive (and commoditized) investment solution. Which to me simply emphasizes the importance and value of keeping the financial planning focus (which is not commoditized due to the nature of the individual advice and advisor-client relationship), or of having a real value-add to deliver to the investment process (active management, tactical asset allocation, selecting managers, etc., if you're so inclined towards the active management story).
But the bottom line is that's not a commoditization and fee pressure on the AUM model. That's commoditization and fee pressure on advisors who are implementing an AUM model but running a commoditized "high-cost" index solution and not delivering further value add (like financial planning) as a differentiator.
What is it about retainers that requires a check? How about billing an investment account, a credit card or a direct debit to a checking account?
Those options would remove the saliency.
For many firms, invoicing clients on a quarterly or monthly basis can create significant administrative work, and/or become a real nuisance to the planner and/or the client.
Many firms I've seen operating on a retainer model don't necessarily have access to billing fees directly from an investment account. Credit cards is certainly a possibility, although billing to a credit card eliminates the saliency of the BILLING but not the saliency of the PAYMENT (as the client still has to take a manual action to pay the credit card bill). Billing via credit cards also has a cost itself, as a 2%-3% credit card processing fee for a firm with $1,000,000 of revenue is a whopping $20k-$30k/year just to process the fees; that's a big number in a world where many firms don't even spend 2%-3% of revenues on ALL their marketing!
As I tried to note in the article, there are some slightly less salient ways to deal with retainer fees, but many of those solutions are still a lot more salient than the AUM structure.
And of course, even if you figure out a low-saliency way to set up the fee for the year, it's still a high-saliency conversation every time the client needs to renew, especially if the firm wants/needs to increase fees to keep up with costs (or because the client's situation has become more complex, or income went up, or whatever other factors the firm uses to manually set retainer fee levels).
The issue I believe is one of transparency and a willingness to stand up for the value of one's services. And if an advisor is doing more than just managing assets, isn't charging a fee that reflects the comprehensive nature of that service a great way to emphasize the added value to the client?
The caveat is that you still may have to have a conversation with the client every year when you need to update/set/change/increase the retainer fee.
If ERISA created our industry, won't new ERISA 404(a)(5)disclosure rule eventually force high saliency pricing?
I suspect any pricing model subject to random market volatility and with weak connection to value of services will at some point (probably portfolio size) fail fiduciary standard of care and test of "reasonableness".
ERISA will certainly force transparency, which has been sorely lacking in much of the 401(k) space, but full transparency isn't necessarily the same thing as slap-in-the-face high saliency of the fees themselves. Not to say one is better or worse than the other; I'm simply pointing out those are related but different issues.
That aside, for firms that really DO manage money, in addition to everything else they do, I'm not clear why we insist this is a "weak connection" to value of services.
We have a multi-trillion-dollar investment fund industry that already charges on an AUM basis, providing only investment value for their cost.
Why is delivering EXTRA services on top of that automatically a degradation of that model? Why isn't it an enhancement?
Are we going to suggest that Vanguard's model is broken and that they're violating the fiduciary standard because they charge the same fee on the last TRILLION of AUM that they do on the first trillion?
Most retainer firms are performing an hourly service in an investment review, preparing taxes at a rate 10x what a CPA would charge, and that's about it. Client turnover is high. Client service is low since the advisor often is not placing a value on the investments (the reason the client came to you and not a CPA). I witnessed so many mistakes with investments, so many places the advisor didn't think to make recommendations... didn't matter, it didn't affect what they got paid.
And where they did press their value was in areas that were sketchy at best, more likely harmful. This firm belonged to a national group of retainer advisors. They advocated as a part of their 'difference' in advice: 1) buying as much home as possible and upgrading, 2) buying 20 year Treasuries (there's no bubble), 3) deductions most professional sites have discredited - taking their fees on SchD, taking their fees at all since they are mostly planning and tax, taking their fees from IRAs so they would make sure they were paid.
Once you get a full client load, since the business is stictly about you it's hard to grow or create business value. What I saw was clients got the short end of that. While the pitch was that we know everything about you, the advisors were in so many meetings, they didn't know the names of the people coming in to see them. Many complaints from clients that saw the advisors that they didn't remember their names.
The above isn't to say all retainers would work this way. It is to say we shouldn't listen to just a few advisors who don't have full client loads on how righteous their model is. We should look at the services provided in actual full practices, and the incentives of the advisor to justify fees, to see if this model truly provides a better client service. I found for the wealtiest clients, maybe, if you ignore the fact they aren't getting ongoing investment services. For the just about every client, no, they're better off with an hourly planner and a CPA. Or an AUM service because clients value having someone regularly in touch with their investments, and that is a service they are willing to pay for.
1) They claim their fee is deductible by the client... and YET their own ADV forms list that they no AUM. They list the dollar amount of investments based on their financial planning services in Part 1B of the ADV. This is not an investment fee, it's a planning fee. They list their fees as being inclusive of cash flow, insurance advice, etc. And yet on their websites have no qualms saying it's deductible!
2) They also use this number to tell media outlets their AUM. I believe SEC and FINRA regulated firms would get into hot water for making these statements if it's not an accurate AUM number. I see many listed in 'top advisors' polls with non-AUM numbers being compared to firms that do manage AUM. Clearly it is not the same thing to list advice on all client assets and AUM, and could be false advertising.
I'd be interested in hearing a response from those that know more if I'm right on the above. I make it a point to review the ADVs of those I'm reading / responding to, and I've just found this curious.
1. The SEC's definition of "assets under management" leaves much to be desired. It requires "continuous" "supervisory" services. As a result, in my own practice I tend to advertise "assets under advisement" rather than AUM. (I utilize passive mutual funds for the most part, and rebalance semi-annually or upon major asset class valuation changes, and don't accept discretion).
Yet, for purposes of Form ADV, Part 1, where advice is given on rebalancing, etc., on a basis which is not at least quarterly, it would be proper to list AUM as outlined above as "zero" - given the definition of AUM for reporting purposes. (I do have clients that grant me discretion, and management for their portfolios which include muni bonds is more continuous in nature, hence my AUM is not reported as zero.)
2. On the issue of fee deductibility, I believe it is proper to break down fees, where both investment advisory and financial planning services are provided, into components for a client, on each statement of fees (or year-end summary, provided for tax purposes):
(a) Investment management and advice (deductible)
(b) Tax planning (deductible)
(c) Estate planning and asset conservation (deductible)
(d) All other financial planning services (NOT deductible)
3. While some have observed one or more firms charging retainers with questionable investment strategies and financial planning advice, I have observed many such firms with excellent advisory services - and high retention rates. I believe it is unfair to cast all retainer-based firms, or all AUM-based firms, or all hourly-based firms, into groups and characterize them all as "good" or "poor."
4. As alluded to above, the fiduciary standard of conduct requires fees to be reasonable, relative to the services provided.
Some state regulators have taken the position that total fees and costs of higher than 2.5% annually (inclusive of a fund's annual expense ratio and the advisor's AUM fees) are "unreasonable" for a fiduciary to charge.
There is a general view by many that one should "charge what the market will bear." A large RIA firm charges 1.8% (even for large clients) - indicative of what the market will bear, if the marketing for the firm is correct.
Yet many advisors, including myself, believe that a significant way to add value in investment services is to keep fees and costs low. Many academic studies point to the causal relation between higher fees and costs and lower investment returns. Over decades the effect of such higher fees and costs become greatly amplified. Hence, many advisors are turning to lower AUM fees. I've seen some advisors charge a flat 0.7%, or a flat 0.25%, of AUM.
Other advisors are turning to retainer fees. I've seen advisors charge a flat $10,000/year for all financial planning / investment advisory services, to all clients. Others that charge retainers from $5,000/year (min.) to $20,000/yr (clients with assets under management of $5m or greater). Others that charge a flat retainer of $2,500 a year, regardless of client size.
Other advisors charge hourly fees. These often result in the lowest fees to the client. (I personally dislike hourly fees, as they don't adequately compensate, in my view, for the expertise obtained over decades of practice. But there are some very successful practices that charge hourly fees, or a flat fee for the initial planning and hourly fees thereafter.)
5. I have come to the conclusion that there is no "perfect" way of charging fees. Each fee model presents certain conflicts of interest, which must be addressed and properly managed. Each has its benefits and limitations, from the perspective of the advisor or from the perspective of the client.
In the end, an advisor must determine to either:
- charge what the market will bear; or
- charge a reasonable fee, given the value of the services provided (and many advisors underestimate the value of their services).
I'll assume from your and Michael's comments you do not approve of firms that are overseen by state regulations, that may advise on $15M of transactions, that these servies that provide advice on cash flow, insurance, etc, ARE NOT AUM deductible services. I again will state that there are firms that are IMHO fringe firms that pass their opinions on in these conversations, and meanwhile serve 5-20 clients, at $4,000 per client, and have no experience in working with a full slate of clients.
I appreciate you want to respond for other individuals, and make up fees for those firms, but I review those ADVs of clients that respond, and question why these people have a hardcore response to their own business models, and yet those models are truthfully not sustainable. 10 clients at $4k, and telling media you have AUM (when you don't), is not a practice that fee-based firms approve of.
I tell firms my AUM, despite the fact I ignore hourly advice. I've found that's not the case many retainer firms engage in, and they do it strictly for marketing, ignoring regulations. I wouldn't support it. They are fringe planners, whether or not media will report their names. Having $15M of transactions over 10 clients is not significant. Let's not discuss that POV b/c that advisor will change their POV when they actually become busy.
It's very true that if a planning fee is "comprehensive" as a retainer, it is NOT deductible. Fee deductibility under current tax law applies only if the fee is for tax or investment advice. Although there's no bright line test for when an "investment fee plus additional [financial planning] value" crosses the line to being more than just a deductible investment fee, it would certainly be hard to argue that more than just a portion of a flat retainer fee could possibly be deductible for investment advice.
I would add one point. There is something magical that goes on when I client sits in front of their advisor and writes a large check. It's as if a light-bulb goes off in their head, and they truly realize the value of the services they have received. These clients are really engaged in their financial and investment plans. If a firm can provide and prove to their clients they can provide true value, I am a believer in the retainer model. It certainly isn't the easiest model, but the best things in life usually are not the easiest.
Just remember, looking at the subset of people who especially enjoy paying for your services is not necessarily a representative sample or a sign of the efficacy of the model, as you're not including all the people who decided they didn't want to pay the fee and chose not to engage you.
I never meant to imply in this post that there wouldn't be people who don't value planning and/or won't write a check for it. The point, though, is that almost by definition of the fee saliency research, there are more people who would pay the same amount for the same quality service if able to pay for it in a less salient manner.
Maybe that's what we should be striving for as an industry.
AUM is easier for most clients because: 1) they cannot convert a percentage to a dollar amount so 1.5% sounds less than $15,000/yr (which is why the new 401k disclosures require both numbers); and 2) most clients can't or don't read their brokerage statements so they are never aware of how much they are paying. To me, this just doesn't square with a true fiduciary relationship.
The fundamental flaw that I see again and again when clients switch over to us is the huge conflict of interest when it comes to asset allocation. Obviously an advisor who charges 1.0% or 1.5% AUM cannot charge this on cash and bonds. So they charge less, like 0.5% or 0.75%. So their clients almost inevitably end up overwieghted in stocks -- because the advisor makes twice as much on stocks as bonds!
One 'comprehensive financial advisor' with Raymond James who I confronted about his 97% stock allocation for a client who was retiring that year explained it this way: "Well, how would I know how much he has in accounts in other brokerages?" Clients of AUM advisors know better than to reveal all their assetss to their AUM investment advisor, so asset allocation at best is done in the dark.
If this kind of 'saliency' is what we want to acheive, we should just charge a hidden commission...like selling annuities.
I am sure many advisors do have a problem charging fees that clients are willing to pay. I also know many advisors who charge an annual retainer comparable in amount to AUM which their clients gladly pay. I would rather conclude that an advisor is not trained or experienced enough, or not able to communicate value -- than to think that obfuscation is the answer.
Bert Whitehead, M.B.A., J.D.
Cambridge Connection, Inc.
Franklin, MI 48025
248-737-7090 Ext. 6
Thanks so much for contributing to the discussion!
I would make a distinction between "saliency" and "transparency" - and notably, obfuscation is a transparency issue, not a saliency issue. Classic insurance commissions would be an example of a low-saliency, low-transparency (i.e., obfuscated) compensation structure; AUM fees represent a low-saliency compensation model, but not low transparency, as the fees are entirely disclosed, clear, and have a standalone line item that can clearly be identified for the cost to the advisor (at least as appropriately practiced; I'm sure someone can come up with a way to obfuscate anything, but the point here is to look at best practices, not worst practices). Similarly, many firms I know explicitly send an invoice to clients for the amount of fees swept, which addresses both the dollar-versus-percentage amount you expressed concern on, as well as the issue that some clients don't read their statements.
Regarding allocation, this is certainly an issue for some advisory firms, although it does depend on the investment approach for the firm. Generally, firms that are passive tend to have differentiated fee schedules to buy-and-hold fixed income versus buy-and-hold equities, which does create a fee schedule conflict for asset allocation. However, there are firms that view part of their value proposition as delivering more active investment management, and charge the same fee uniformly on all assets, because the decision about which asset classes to own and when is itself a decision and responsibility which the client pays for holistically. So while the presence of this conflict varies by firm, I will absolutely agree that a differentiated fee schedule by asset class presents additional, unique, and material potential conflicts of interest to the client situation. I would not characterize that as a uniform flaw of the AUM model, though, but only of a particular (albeit not uncommon) implementation of it.
But the bottom line is that there's a difference between saliency and transparency, although the two are related. I don't believe AUM fees are effective as a business model because they obfuscate and lack transparency, but simply because they reduce saliency.
And in point of fact, the saliency discussion itself is a very slippery slope, if we're going to imply that some advisors are morally or ethically inferior because of where they draw the line on saliency. In a similar vein, we might claim that retainer fees should never be paid via electronic funds transfer or credit card, because they too is a far lower saliency payment mechanism than writing a check. And writing a check is a lower fee saliency than paying cash. In the logical extreme, we could make the case that anyone who doesn't require client fees to be paid with Sacagawea dollars - so clients can literally feel the "gravity" of their fees - is engaging in a lower saliency model and not making it conspicuous enough what the advisor really costs the client. It's not clear to me at all about whether there is a clear moral/ethical guidepost for where we're supposed to draw the line on the spectrum from Sacagawea dollars to cash to checks to credit cards/EFT payments to recurring billing to AUM fees to whatever other low-saliency options may exist - assuming, of course, that we're choosing from transparent low-saliency models.
It is not only fees that we need to consider but SERVICE. Clients see annual retainers that only provide service annually as one step removed from an hourly service that costs a whole lot more.
Mr. Whitehead's comment that AUM does not apply to bonds is a comment on a recent phenominon, and is not true. Should we hold Mr. Whitehead at fault for saying in his books that the way to wealth is to buy as much real estate as possible? Should we hold him at fault to say that a 15 year ladder of Treasury securities is not appropriate? These are the recommendations he details in his book, and yet I do not know that this 'information' provided to all clients is quite the same that an advisor providing ongoing service to a client in managing their portfolio, and making different investment assumptions given different client circumstances based on AUM is the same.
Let's involve SERVICE rather than simply dumb down planning to INFORMATION that is readily available in books. Yes, we can all charge a lot for information that clients don't need, but it's the ongoing service and expertise to realise that real estate and treasury bond bubble do happen that makes us valuable as planners.
Can you comment on the conflicts of interest that can occur in the AUM model--clients wants to take out a large chunks of assets to pay off mortgage, gift to kids, donate to charity/DAF, etc thereby reducing advisor fees.
Full disclosure--I'm am a member of ACA and use the retainer model. I've been a member for 5 years and most importantly have been a client of ACA member for 10 years.
I sit on both sides of the desk. I see the value as a client under this fee model and financial planning approach. I also see the value as an owner of financial planning firm under the ACA umbrella providing sound advice to our clients and being fairly compensated for various tasks we perform that are not directly tied to their investments--should I refinance? buy or lease a car? how much life insurance?, etc.
Sorry - saliency isn't really a word. Salient is. And Whitehead is correct. Really AUM is a transparency issue - and the ladies are protesting too much
From my blog part II and III
Assets under Management (AUM) ‘Fee Only Planning Compensation’ Conflicts: Part II
(Jim so) Assets under Management (AUM) compensation is like federal tax withholding – less painful than writing a check every quarter. You don’t feel it as it’s ‘taken out.’
A former client reacting AUM Part I
…but with less probability of refund
I didn’t realize that the phrase assets under management was a synonym for fee anesthesia, & from planner having to justify the value of his services less often than a monthly check written by a client on a monthly retainer.
I recall in the early 90’s many a commission (transaction compensated) and fee and commission ‘financial’ planners asking me, ‘how do I transition to fee only planning with my existing client base?’
I had two answers that I would suggest – tell the client
1. In one year, I shall go to fee only compensation. You are more than welcome to continue the same compensation method for a year – or change now, but in a year my practice will be compensated fee only. It’s your choice. OR
2. I’ve been screwing you all these years, and I’ve finally decided to go legit.
No one took me up on option #2 to the best of my knowledge which would have been refreshing.
Nearly all of these planners who made the transition choose to be compensated on a basis of assets under management. Some have tried to have it both ways (BI-Financial Planners?) – AUM for assets manage plus an charging an additional small flat fee for the planning. The fee plus AUM reinforces the point of AUM compensated personal financial planning as a Trojan horse for being asset managers camouflaged as a personal financial planners.
We do what’s inspected rather than expected and focus on what is compensated.
It is time for asset under management compensation planners to fess up and NAPFA to make a full disclosure note with biographies of its members of how they are compensated: hourly, flat fee, retainer, fee and commission, assets under management etc.
The above said, regardless of compensation method, the real question is doing an audit of the progress, you the client, is making towards or maintaining his personal financial goals (which is in both editions of my book Enough: A Handbook for Your Personal Financial Planning – out of print but probably you can get it for 99cents on the web).r entries on this blog). The Personal Financial Planning Audit should be done upon engaging the planner (to establish a baseline), quarterly at a minimum the first year of the plan engagement, and at least annually thereafter to monitor progress.
Set up a chart: with goals down the left hand side. For example:
1. Providing adequate income upon total disability
2. Providing adequate income upon partial disability
3. Minimizing capital depletion due to illness
4. Minimizing capital depletion due to nursing home/home health care
5. Providing for the kids education
6. Providing for 100% of income from passive sources (retirement)
7. Providing for 50% of income from passive sources (slow down) for some period prior to retirement)
8. Minimizing liability: unintended creditors, personal guarantees etc
9. Becoming independent of your independent business
10. Providing adequate income for your spouse upon your passing
11. Aligning your life goals with your personal resources
12. Healing personal financial anxiety putting money in its place to transcend to significance
13. Knowing what ENOUGH is
14. Knowing what ENOUGH is versus MORE
15. Etc etc.
Horizontally, have a scale from 1-10 (1 being lowest, 10 being highest) and grade where you are at now (if about to engage a planner). If you already have engaged a planner, think back and grade where you were before planning and do a first ranking (baseline and date it as of the beginning of the planning engagement). Next do the ranking again (separate sheet of paper and date it). The questions then become for comparison REGARDLESS OF COMPENSATION METHOD - has there been progress advance/ maintenance towards satisfying your goals or has there been retreat and or failure? (You might also note if retreat – has there been a concurrent increase of good lunches the planner has taken you to – to message your bottom and bottom line on goals?)
Comprehensive personal financial life planners manager goals; asset managers manage assets (and are typically compensated by YOUR ASSets under Management.
And that is a Salient fact.
Assets under Management (AUM) ‘Fee Only Planning Compensation’ Conflicts: Part III
AUM Inherently MORE, MORE, MORE MOREon Personal Financial Planning
More, better, now has a habit of becoming less worse later
Alas quoting myself
Sacrificing what we need for what we don’t need isn’t personal financial planning but the pursuit of ‘more for more’s sake’ which is ‘the ideology of the cancer cell’ according to writer Edward Abbey. The usual motivation for more (at the expense of enough) is comparative valuation of worthiness by ‘net worth.’ The result all too often: more, better, now becomes less worse later.
Assets under Management (AUM) reinforces this self destructive behavioral pattern of relative comparison to others, to indexes (Dow Jones, S&P) rather than measuring progress or lack thereof relative to each individual personal financial goal.
In the D. H Lawrence’s story, ‘The Rocking Horse Winner,’ the family of little boy Paul is living way beyond its means. Paul mysteriously discovers by rocking faster and faster – the names of winning races horses come to him. Of course, the spendthrift family parlays these tips into its bankroll. (Rock ‘n Bankroll?) However, to get more, and more, and more winning names – Paul has to rock the Rocking Horse faster and faster – until Paul dies of exhaustion.
‘More, more, more –what are we all more-ticians’ – e.e. cummings.
More, more, more - Assets under Management.
AUM pays off on the ‘more’ assets under management not ‘enough’ assets to meet the goals with the least risk. The more assets under management – the more AUM pays. Inherent in this compensation is often taking ‘more’ risk than necessary for the goal. And more risk – more leverage (i.e. keeping a larger mortgage so as to have more available assets in the market) cuts both ways – especially on the downside.
AUM is inherently The Rocking Horse Winner approach which too often causes a lot of whinnying, the Dow Jones becomes the Downer Jones, and Mr. & Ms. Planner lose clients especially in down markets.
A test of AUM’s focus: In down markets do clients ask:
• How did I do relative to the Dow, S&P etc OR
• Do I still have ENOUGH?
Odds are the former not the latter.
Therefore, is AUM the most or least consistent compensation method relative to the mission of personal financial planning: aligning clients personal resources (financial or otherwise) to support their life goals and values or really primarily a Trojan Horse for Assets under Management gathering?
They swayed about upon a rocking horse, And thought it Pegasus.
-John Keats, 'Sleep and Poetry
I'm confused why you say "saliency" isn't a word and salient is.
Salient is an adjective. Saliency is a noun.
The definition of saliency (noun) is the quality or state of being salient (adjective).
Salience is an alternative noun form of saliency, although in point of fact saliency was the original word in the language, and salience as an alternate spelling came about almost two centuries later.
Noun 1. saliency - the state of being salient
prominence - the state of being prominent: widely known or eminent
conspicuousness - the state of being conspicuous
visibility, profile - degree of exposure to public notice; "that candidate does not have sufficient visibility to win an election"
Based on WordNet 3.0, Farlex clipart collection. © 2003-2012 Princeton University, Farlex Inc.
Yes, finally I found saliency
And Michael, salient has everything everything per the above to do with transparency and AUM even upfront is at best FEE ANESTHESIA.
Also, Mike you avoid the whole issue of the inherent conflict and motivation of AUM to assets management at worst and modular planning (at best - which quite frankly violates the concept of comprehensive planning).
A little history.
At the first Continental Congress of Fee Only Planning set up by SIFA (the Society of Financial Advisors) which Underwood, Sestina and myself initially funded to get it off the ground, some apologists, sanitizers, spin doctors with silver tongues and counterfeit throats tried to include commission and fee advisors.
I did - unrehearsed - a Patrick Henry on stage - and kicked those phonies out.
Yes, other fee methods have problems - but none like AUM - with its Trojan Horse motivation not towards planning but assets under management , mike, regardless sanitize, spin, apologize for it - and argue off the salient point.
Furthermore, AUM inherently goes towards More rather than Enough per goal with lower risk -
And as much - just like the commission and fee and commission planners - try to obfuscate it like Bert stated - AUM gives a higher for sale value to the practice - which is not an insignificant factor and motivation.
It is time for fee only to take the next step - unlike kicking out those fee and commission pretenders at the beginning - put a red scarlet letter on AUM.
Finally, an old trick the fee and commission phonies tried -- have one firm for the planning and next door for the implementation (commissions). While different in degree - the firms that do a planning fee and AUM are in effect doing the same thing only LITE...
As a side note give me your point of view.
I've worked hard saved and invested my money and have grown it to (pick a $). Why all of a sudden should I give you my money (hit your AUM level) when you wanted nothing to do with me prior? What additional over the top value are you going to provide for that 1% ($2,500 or 5,000 or 10,000 per year).