It's time for financial advisers to rethink the AUM fee — fast. Charging a percentage — usually 1% — of assets under management has long been considered the most ethical, and profitable, way to get paid for delivering
financial planning and investment advice to clients. That explains why 95% of investment advisers set fees based on AUM, according to the 2014
InvestmentNews Financial Performance Study of Advisory Firms.
It also explains why fee-only financial advisers have long commandeered the moral high ground over their commissioned brethren when it comes to touting the virtues of their respective compensation models.
But, as more clients shift from accumulating assets to spending those assets down in retirement, it is fast becoming clear that the AUM model has conflicts of its own. One of the biggest is that it encourages advisers to hold on to assets. That raises the possibility that a client might be discouraged from liquidating an investment, let's say, in order to buy a second home, because the move would not be in the adviser's best interest.
LIMITING THE REACH
Another problem with the AUM model is that it discourages financial advisers from reaching beyond high-net-worth individuals into the middle class when they prospect for clients. By ignoring modest earners, advisers are closing themselves off to a large segment of the market — possibly to the detriment of their own practices.
Finally, the AUM model faces an even bigger problem. That problem stems from the fact that it places advisers in the position of charging too much for investment advice and too little for financial planning. As a result, it encourages clients to value advisers for their ability to invest assets in the markets, rather than for helping them achieve long-term financial goals.
With the emergence of so-called robo advisers, which offer investment advice for 35 basis points or less, that's a precarious position for advisers to be in. After all, why should clients pay a financial adviser 1% of assets under management, when an electronic advice platform can manage the same assets for a fraction of the cost?
PLANNING BASED
The answer, of course, is that financial advisers do much more than dispense investment advice — at least, the good ones do. In addition to basic financial planning, good advisers keep clients from making stupid mistakes — such as socking away too much money in college funds and too little in retirement accounts, or bailing out of the markets at the worst possible moment.
So how do these advisers get clients to recognize — and more importantly pay for — the work that they do beyond managing their investment portfolios?
The answer is to transform their practices into ones that offer services based on financial planning and to assign a hard dollar value to those services. Not only would such a transformation help advisers generate new revenue, it would force them to pay close attention to the value, and level of service, they deliver to clients.
It would also require them to incorporate other pay models into their practices. Those models would run the gamut from annual retainers to a la carte pricing to hourly rates and even subscription-based services. Adding other pay models would make it easier, and more profitable, for advisers to reach the middle class and the all-important millennials.
Let's be clear: We are not advocating for the demise of the AUM fee.
Just like the commission-based model makes sense for some investors, so does the AUM model. That's especially true when it comes to high-net-worth investors — many of whom pay far less than 1% on their assets due to the size of their portfolios.
Our point is that clients should have the option of paying for financial planning and investment management in a way that makes them most comfortable and makes sense for their stage of life. The prevalence of the AUM model means that these alternative models — though they are out there — are more difficult to find.
Reduced dependence on the AUM model is also good for the advice industry. The rise of robo advisers calls into question the future of advisers who base their value solely on investment management.
Financial advisers who take seriously the fact that pure investment advice is being commoditized, and expand and fairly price financial planning services they provide, will not only prosper but will better serve their clients.
