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?
Bill Winterberg says
Imagine the following conversation:
*Client:* Wow, your services sound terrific! How much do you charge?
*Advisor:* We charge 1% of your investable assets.
*Client:* Oh, ok. That’s simple.
Now how about…
*Client:* Wow, your services sound terrific! How much do you charge?
*Advisor:* Our fees are based on the complexity of your planning.
*Client:* Huh, what does that mean?
AUM fees are enticingly simple to communicate, calculate, and collect.
But the byproduct, as you stated, is the clients’ tendency to then correlate the value of financial planning services (of which a portion is investment management) solely to the value of their portfolio.
And finally, you wrote “shouldn’t the popularity of AUM fees be declining, while the popularity of retainer, hourly, and other similar compensation models flourish?”
In my opinion, the industry has a supply and demand problem. What other choice do most clients have over AUM billing? There just simply aren’t enough firms out there assessing fees through different means to reach the tipping point where clients vote with their dollars and move their accounts.
Michael Kitces says
You say: “In my opinion, the industry has a supply and demand problem. What other choice do most clients have over AUM billing? There just simply aren’t enough firms out there assessing fees through different means to reach the tipping point where clients vote with their dollars and move their accounts.”
I don’t know if I can agree. If the model was so wildly successful, it wouldn’t take long to switch. If the demand really is there, the firms that do it would explode. They’d hire more to do it to. Competitors would look at making a shift.
And frankly, all those things have been happening over the past 10 years. Except they’ve been happening to make AUM a bigger, more popular, compensation model, not detracting away from it. Look at how rare AUM firms were a decade ago compared to now. The change can happen fast.
It’s just that people don’t seem to be running AWAY from AUM. Quite the opposite, in fact.
Bill Winterberg says
We know how the majority of AUM-based revenue firms grow; by referrals from existing clients. So I don’t believe new clients have much choice. The firm down the street likely also charges AUM, so might as well go with the firm referred by a trusted friend. There’s little alternative to run TO.
Consider clients who leave advisors because they feel fees are too high for the value they receive. Do they switch to a less expensive advisor?
I’m going to guess and say no; they likely do without ongoing planning until a significant life event occurs in the future.
Do others have any real evidence of what happens?
Michael Kitces says
But all these clients that AUM advisors generate by referral are still coming from somewhere.
I’m assuming not every new client to an AUM firm over the past decade showed up as a do-it-yourself’er who never had a prior advisor!
Dan Moisand says
From what I can tell it isn’t the compensation approach that has the most influence on the client’s perceptions. What drives it is what the planner says and does. If all you do is focus on investments, that’s what the clients will likely do. If your messaging and behavior indicates that the investments are part of an integrated whole, clients are more likely to view investments that way.
I know many people that charge a retainer who got all sorts of grief when the markets tanked becasue they were getting paid the same for managing a smaller portfolio. I also know quite a few that didn’t get that pushback from clients. The difference seems to be how the planner behaved before the bear growled. The one’s that got grief had drifted to an investment dominated interaction and those that didn’t have any issues had been largely more comprehensive.
Jude Boudreaux, CFP® says
Michael, I wrote a recent blog post on this topic (http://www.upperlinefinancial.com/2011/04/12/financial-planning-is-not-all-about-investments/). I think that clients and advisors both bear some responsibility in this one.
I think advisors are often afraid to talk about what clients are actually paying, so it’s easier to say that they get paid 1% rather than say exactly what that amount is. After all, 1% of $1M sounds like a lot less than $10k, even though they’re exactly the same amount. It also generally builds in a raise for advisors, without having to go back and have a discussion with the client about whether that raise is warranted or not. And yes, I understand that sometimes a pay cut happens too. All the more reason to have a more stable compensation model.
First commissions were “much maligned”, now it’s AUM fees. I think charging a $12,000 flat/retainer fee instead of AUM should be “much maligned”. Many of these “fee-only” snobs do not serve the middle class, which can’t afford to pay a $6,000 per year minimum, or more. And to be truthful, NAPFA, many of these planners also charge AUM, which isn’t truly free of conflict of interest, is it? Every compensation method is fraught with conflict of interest. Fact is, AUM is easy for the client and it’s easy for me. The CPA in my office is always waiting for checks – who wan’t to pay bills, right? My client’s have their fees paid out of their accounts and they go about living their lives. But because anything over 1% is now considered highway robbery by some, I now charge up-front fees for planning work instead of including it in a one-fee-covers-all arrangement. My larger clients still get it all, but not the smaller ones. Oh, and yes, I still get a commission for helping my clients buy the right life insurance or LTC policy, or the very occasional annuity. I guess if I were charging $12,000/year I wouldn’t have a problem sending clients off to buy insurance elsewhere, but when I’m getting a lot less than that it seems unfair to do all the work of planning and let an insurance agent make the $2,500 commission for my work. And my clients are glad that I am helping them instead of throwing them to the wolves. When you serve the $100k-$2mm market, you need to be more practical/less of a purist. At the end of the day, it isn’t so much about how you’re compensated, but did you help your client and make their life better? Do they sleep better knowing that you are in their corner? Why is it that our industry is so hell-bent on cutting our own compensation? I really don’t see Attorneys or other professions moaning about how they should be charging less for their services. Personally, I would like to see Bob Veres try to make a living in our profession instead of just pontificating from the sidelines.