The Overpriced Fiduciary.
Revisiting How We Pay for Financial Advice
The practice of paying a financial advisor a percentage of
assets under management (AUM) on top of other fund investment expenses—is an
outdated model that should be retired. There are reasonable alternatives to
obtain professional advice for financial planning and investment management at
a lower cost, regardless of one’s personal asset level.
Investors typically pay a flat advisory fee that ranges from
1.0% to 1.5% of AUM. That price is becoming progressively harder
to justify. Some financial advisory firms have differing rate structures based
upon portfolio size, but they still peg their fees to AUM.
Kitces research noted
last year that a full 86% of financial advisory firms continue to use the AUM
model to bill for advisory services.
Advisors that charge for their work by using a percentage of
client AUM can and do provide valuable services. However, many of these same clients
could save by doing research and thoughtful vetting in order to hire
professionals on a fixed project fee or hourly fee basis. Typical advisory
services include, but are not limited to:
- Asset allocation and fund selection
- Periodic portfolio review, rebalancing
- Household budgeting and cashflow projections
- Tax planning strategies
- Retirement income planning
- Estate and legacy planning
Parsing the Advisors Label
I cringe after hearing commercial pitches like: "We
do better when our clients do better". Anyone can be a fiduciary
and still overcharge for a professional service because the industry permits
fee calculation even if it is uncorrelated to actual hours worked.
An advisor operating under the AUM model gets paid even when
portfolios underperform or service delivery is substandard. In up markets advisors
get paid more, even if they have done less work than they did during a year
with a significant drawdown. There’s too much opacity regarding what services a
client receives and what effort was expended to deliver services on their
behalf.
The Jane and Claude Comparison
Some believe that the AUM model is fair because the percentage
charged by the advisory firm is the same for similar clients. Consider two
investors using "Joe Advisor" and each investor is subject to paying a
1.00% AUM fee for services:
|
Client |
Portfolio Value |
Annual Advisory Fee |
|
Claude |
$1,000,000 |
$10,000 |
|
Jane |
$2,000,000 |
$20,000 |
All other factors equal, has Joe Advisor done twice the amount
of work for Jane to justify a $10,000 difference in fees?
Of course, significantly larger portfolios and the clients
associated with them have complex needs that require more advisory time and
customization. Advisory firms that migrate to a clean and transparent hourly or
fixed dollar fee structure can justifiably bill these clients for comparatively
more hours and do so at higher hourly rates for specialists.
When the Playing Field Began to Level
After the advent of Exchange Traded Funds
(ETFs), the advisor’s "insider" advantage of providing access to
exclusive investments or obtaining lower effective share prices went away. Institutional share classes that come with lower expense ratios are not commonly available to everyday
investors because they require high
investment minimums – often millions of dollars. Thus, ETFs recommended by
hourly advisors come with the same expense ratio as the one recommended by a pricier
AUM advisor. Only the way that they charge for their services differs.
Robotic Players
Robo-advisors provided by firms like Betterment, Fidelity,
Schwab, and Vanguard also charge significantly less for investment management —typically
0.20% to 0.30% of AUM— than their human counterparts. They are not going
away.
These algorithmic platforms require investor responses to a
slate of questions that automatically inform an asset mix consistent with
investor goals, time horizon, knowledge level, and tolerance for risk and
volatility.
According to Grand
View Research, adoption of Robo-advisor platforms equated to advisory revenue
of $6.61 billion in 2023 and it is expected to reach $41.83 billion by 2030.
When Paying a % of AUM Matters Less
There are exceptions. The question of whether an investor is
overpaying for a service by paying a percentage of AUM for services becomes
more negligible when:
- Clients
who want absolutely nothing to do with personal financial matters and are
happy to outsource everything, even paying a premium to do so.
- Clients
who require significantly more "handholding" and advisory time and
want a professional to control their assets.
‘Summing’ Up
For a significant portion of the investing public, the AUM
model is an overpriced service. Whether one chooses a Robo-advisor for
automated, diversified index fund management, or leverages an hourly or fixed
fee professional but makes their own trades – or a combination thereof, less
expensive options exist. Doing personal research and thoughtful vetting can
help investors who take the time to understand what they need and source
expertise from advisors that charge clients equitably.
Resources for Investors:
- The Advice-Only Network: This
platform is strictly "Advice-Only" and unlike some fee-only
advisors who still charge using the AUM model, the professionals here don’t
control your assets. They provide the plan, and you manage your accounts.
- NAPFA (National
Association of Personal Financial Advisors): Fee-only
advisors committed to transparent retainer or hourly models.
- Garrett Planning Network
the GPN Alliance Inc., Pioneers of hourly, advice-only planning to
help investors avoid ongoing AUM fee commitments and product commissions.
Disclaimer: The information provided in this article
is for educational purposes only and does not constitute financial, investment,
tax, or legal advice. While the author has extensive experience in the
professional services industry, he is not a registered investment advisor (RIA)
or a certified financial planner (CFP). Investing involves risk, including the
loss of principal. Mention of specific firms and websites do not constitute endorsement.
From the Author: Thank you for taking the time to
read my article. I watch trends and developments that shape how we
live, work, and play—and I try to share insights that are genuinely useful, or
at a bare minimum, interesting. If you find value here, I invite you to follow
along for more analysis and practical perspectives in future posts.
