Am I a fad? I mean, I consider myself a trendsetter. Heck, I was wearing obnoxious socks all the way back in high school (I even had a sock fan club, although there was only one member in it). Look how they have caught on now. What I am referring to is how I operate under a flat fee model.
The reason I ask this question is I have seen a few articles recently advocating how important it is to have an advisor who is paid a fee based on the amount of assets he manages for clients. You know, the AUM (assets under management) model. If you have read my stuff for some time, you know this is how I used to operate. At least until I realized there was a slightly better way for my clients.
The crux of the AUM defense is it “puts the advisor on the same side of the table as the client.”You know, they both have “skin in the game.” If the client’s account goes up, the pay for the advisor goes up. The opposite is true too for when the accounts lose value (yes, even though we have been in a 10-year bull market this does happen).Let me share a few quick thoughts:
- Being paid based on AUM means the advisor is focused on gathering and maintaining assets.You have heard my story about the advisor who said “I cannot lose those assets” when a client wanted to withdraw money to do some charitable giving in memory of a loved one. Whose interest was the advisor working for in this situation?
- No advisor controls the market. This assumption is as strong as thinking your local weatherperson controls the weather.Heck, even Warren Buffett doesn’t know what the market will do on a day-by-day basis. Why pay for something out of your control?
- Here’s a line I used to hear at Merrill Lynch - “If you tip your waiter 20%, wouldn’t you pay your advisor 1%?” I won’t do the math, but 1% on a $1,000,000 portfolio certainly is different than 20% of a $40 food bill. And remember Jack Bogle’s quote of -“Let’s assume the stock market gives a 7% return over 50 years. If you get to 7%, each $1 goes up to $30. If you get to 5% (that would be 7% less the industry’s typical 2% all-in costs), you get $10.”
- What about clients who don’t have significant assets to manage? You know, a new physician starting out who has a rather complex financial life but no asset yet. Or, someone who has worked at the same company for decades, still is a few years from retirement and all their assets are in their 401k.
In my world, my clients think there is a slightly better way to connect the value of a financial planner through a flat fee. Plus, I like to keep things simple. Not everyone in this big financial services industry feels the same. A couple quick nuggets to share:
- I read recently Edward Jones’ fee disclosure document is 48 pages long.
- One person told me someone tried to sell her an annuity and the document was nearly 100 pages.
I do believe there are some advisors worth their fees. My contention is there is a more forward thinking method for charging for the value of financial planning. If you ever want to test your advisor, ask him my favorite question below.
- You – “I pay you 1% on the $200,000 you manage for me, right?”
- Advisor – “Correct. That 1% is $2,000 annually.”
- You – “"I am getting ready to retire and you want to manage my $800,000 401k balance at the same 1% fee. This would increase the fee I pay you 5 times from $2,000 to $10,000 annually. Explain to me in detail how you will increase your services 5-fold."
- Advisor - …
A final thought on this. I saw recently the average advisor at a wirehouse (large firm) adds roughly 2 new households a year. I average this a month and odds are I will be soon instituting a waiting list. Seems like there is quite a bit of demand for a flat fee model to me.