Executive Summary
In recent years, as more and more planners have shifted their businesses to an AUM model, it has become increasingly popular for the media, when quoting planners, to note the firm's AUM. In response, a backlash has also begun to emerge, as many planners justly point out that the magnitude of the firm's AUM does not necessarily correlate with the quality of the firm's financial planning advice or how "good" the planner really is, and consequently suggest that the media stop quoting AUM statistics in articles. Yet while I agree with the criticism - AUM is not likely a very effective measure of how good a planner's advice might be - I still think it's highly relevant. Not because I'm trying to understand the quality of the planner's financial advice, but because it provides immediate insight into the nature of their financial planning practice and the relevance of the challenges the planner may face.
The inspiration for today's blog post comes from an article I read last week on RIABiz entitled "Next-gen advisor breaks the standard RIA mold to grow with her young clientele -- many with $100,000 or less of assets" regarding a 30-year-old planner who, as the title indicates, is building a financial planning practice with younger clients that don't have a lot of assets. Given the ongoing efforts of the profession to create financial planning firms that serve a wider swath of middle America, I was intrigued. At least, until I got into the details of the article, and saw that the firm runs $6 million of AUM.
The point here is not that Blair Hodgson, the subject of the article, isn't trying to build something interesting with her practice targeting higher income young professionals who don't necessarily meet the minimums of other planning firms. The point is that at $6 million of AUM, and a practice that by Hodgson's own admission is just managing to keep her head above water with a combination of asset management fees, hourly fees, and some ongoing retainers, it's not entirely clear yet whether she will really "break the standard RIA mold" or ultimately find that to grow her practice to a more economically viable level, she has to adopt a more "traditional" AUM model with different minimums and a different target clientele.
By contrast, imagine reading an article about a firm that was "breaking the standard RIA mold" and was running $600 million of client assets, many with $100,000 or less of assets. That would imply a firm with upwards of 6,000 clients, which means even at 150 clients per planner, the firm would have a whopping 40 financial planners (not to mention the staff infrastructure required to support them) working in an integrated business to deliver financial planning to the middle market. Now that kind of firm would really appear to be a rarity, and one that truly has "broken" the mold and successfully grown and scaled a business with a less-than-traditional target clientele. There could be some powerful lessons, from how the firm manages to serve clients profitably with a relatively modest revenue per planner (at least compared to more "traditional" firms), to how it provides an infrastructure to the planners that doesn't destroy the firm's economic viability, to how it manages to market itself to get 6,000 middle market clients in the first place!
Of course, I realize that not all firms operate on an AUM basis, and/or the AUM billing doesn't necessarily represent all of the firm's revenues. Hodgson's own practice apparently includes a component of hourly and retainer fees that wouldn't be represented by the $6M AUM figure alone. Other practices may include various forms of commissions or trails that also bring revenue to the firm, not conveyed by knowing the firm's AUM alone.
Nonetheless, I still find it relevant to ask firms about their AUM, and I still like to read what a firm's AUM is anytime the media writes about a practice management issue. It's the single best and easiest statistic that instantaneously conveys information about the firm's approximate revenues. If I also know approximately how many clients the firm has, and its number of staff, I can immediately understand most of the firm's key metrics, from average revenue per client, to average clients per advisor, to average revenue per staff, to an estimate of gross and net profit margins.
In turn, I can begin to more fully understand what the firm's service model may really be, and understand how it delivers its services in the context of its practice metrics. A firm that says it provides extensive planning services to its clients with $200 million of AUM and a staff of 22 probably has little to no profit margin at all, and while its planning quality may be rich due to its extensive staff support, its economic viability as a business is at serious risk in the next bear market and its service model isn't sustainable. On the other hand, a firm that says it provides extensive financial planning services at $200 million AUM with a staff of 4 has radically different metrics; either they must serve clients with a very high average net worth (allowing them to reach $200M with relatively few clients to serve), or they have too many clients per staff member to possibly be delivering the depth of planning services they claim, and while the business may be sustainable (given the profits of $200M of AUM and only 4 staff members), it questionable whether it is delivering on its financial planning promise.
In the end, what all this means is that while AUM doesn't directly speak to the quality of a particular financial planner and the quality of his/her advice or expertise (in fact, I see no reason to cite an AUM statistic at all when someone is discussing a technical planning issue), it does speak volumes about the nature of the planning practice itself, especially when followed up with the two additional key metrics, number of staff and number of clients. Those details, in turn, help to clarify the scalability and efficiency of the practice, and whether it's capable of even delivering quality financial planning in a sustainable manner. Which is especially relevant if we're trying to understand a firm that is doing something unique and noteworthy in the media and might be "breaking the mold", or might just be trying to do so with a yet uncertain future (although I certainly wish Blair the best of luck!). Plus, I suppose asking about AUM has the added bonus that it's just a bit more socially acceptable than asking "how much profit did your firm make last year?"
So what do you think? Do you find it relevant to understand how a firm is structured when discussing practice management issues? Is AUM a relevant point for the media to cite, at least when discussing a practice management issue? Do you ever ask about AUM when meeting another planner and learning about their business? If you don't think AUM is a good metric to ask about, is there an alternative you think is better?
