In our intra-industry debates about compensation models, there is an emerging view that one of the challenges of charging for assets under management (AUM) is that by charging based on investments, your clients will become investment-centric. The prescribed cure to this is to use another compensation model, such as charging a flat retainer fee, or an hourly fee. That way, clients will not always have their attention drawn to the portfolio that derives their fee, and the planner can help to focus them on other aspects of planning. Yet this raises a fundamental question: does charging AUM fees cause clients to be investment-centric, or are clients investment-centric and therefore preferring AUM fees?
The inspiration for today's blog post comes from a recent article by industry commentator Bob Veres on the Financial Planning magazine website, entitled "Planning or Planning the Portfolio?" In the article, Veres notes this often-stated view by planners about AUM compensation: "...and, since they are paid based on the asset they manage (the AUM revenue model), naturally their [clients'] attention is drawn to the client's portfolio rather than to the client him/herself."
The implication here is that clients would be more focused on themselves, their planning needs, and other parts of the financial planning process... if only planners didn't charge based on assets under management, causing their clients to constantly re-direct attention away from the rest of the financial planning spectrum and towards the portfolio. If only planners charged more "holistically" using retainer, hourly, or other similar non-asset-based compensation models, clients would be more focused on all the other aspects of financial planning. In short, if clients were charged more evenly for all aspects of financial planning, they would perceive more value in the holistic financial planning experience.
I will grant that there's some logical appeal to this viewpoint. Financial planning is an intangible service, unlike any other, so it's hard to put a clear value on it. In fact, it's often difficult to understand how clients perceive the value of financial planning until you ask them what they're comparing it to. So there is probably something to be said for the fact that many clients are "guided" to understanding what is and isn't valuable about financial planning by the pricetag that we set to it.
But at the same time, it's a fundamental business reality that clients pay for what they value, and won't pay long for what they don't value. And for a compensation model as maligned as AUM so often is, it seems a remarkable reality to me that the overwhelming majority of clients continue to be content paying their AUM fees for their wealth management relationship. If AUM fees represent such a misalignment between how clients are charged (based on their portfolio) and where they find value (in the comprehensive financial planning process), then shouldn't the popularity of AUM fees be declining, while the popularity of retainer, hourly, and other similar compensation models flourish?
Because in reality, the exact opposite seems to be occurring. The AUM business model has been growing by leaps and bounds over the past decade, as both the number of firms using AUM grows and so does the average size of the firms themselves. So if clients aren't actually very investment-centric, and we're only "making" them pay attention to the portfolio by charging AUM, and are causing clients to under-perceive the value of the other aspects of financial planning... then why are AUM firms thriving?
Simply put, I think the answer is that it's because clients are investment-centric! After all, while I'll be one of the first to extol the virtues of all aspects of financial planning, the truth is that all of our long-term financial planning is predicated on long-term investment success, and if the investments don't work in the long run, neither does the plan. In other words, at the end of the day, we're talking about FINANCIAL planning... so how can the investments, the assets, the finances, the actual dollars, not take the center stage in the process? And accordingly, isn't it only logical that fees tie to those finances? That's certainly what clients seem to think, given the dramatic growth of AUM financial planning firms over the past decade (and that's despite the fact that the decade has been plague by major financial events that have led to one of the worst investing decades in a century!).
So what do you think? Do AUM business models really cause clients to be investment centric? Or are clients perhaps more investment centric than we give them credit to be (or perhaps, more investment centric than we wish they were)? Is the longing for a non-AUM driven business model because we think client's don't want to be charged based on their finances, or because we don't want to be reliant on our clients' investment success for our own business growth?