Part 1 - Why I am opposed to AUM fees for moral reasons

3/8/2018

Recently I had a tax client ask about their investments with another advisor, particularly advisor fees. The advisor's website, nor their required Form ADV (the disclosures with a clear explanation of fees an investment advisor is required to give to clients) had a clear explanation of fees. I called the advisor and asked "what are your fees ". Their response was it depends on the client and their  situation. 

Read that one more time - it depends on the client and their situation. What this means in advisor terms is the fee is based on clients wealth or assets under management. The advisor then described their fee structure for the client - 1% base minus a discount for family/friends/high net worth. Thus, a $200,000 client would pay $2,000 per year, a $1,000,000 client would pay $10,000, excluding discounts. There are a number of methods to calculate the fee - all based on assets under the advisor's management or based on net wealth. 

My wife is a music teacher and charges a rate per hour worked. We think it is a fair rate, one the market will support and one that does not overcharge the clients. For those low-income students there are scholarships available if they apply and meet certain requirements. If she structured her rate based on a AUM/net worth rate, the rate would be one of the following: What is your net worth? We charge 1% of net worth per services, regardless of how much work we actually provide.

Would anyone do this? Perhaps the lowest income earners, but it would not be equitable to middle or high income earners. 

Asset under management fees are based on exactly that - assets under management. The fee has nothing to do with the amount of work the advisor provides. To an advisor, the amount of assets often has little to do with work provided - in fact it is often the opposite. Does it take any more time to review a $2,000,000 portfolio than a $200,000 portfolio? No it does not! In fact when I give potential clients quotes, my quotes are based on complexity, not AUM, net wealth, or any other factor not linked to how much work I will need to put it. 

Many advisors state they are fee-only. There are professional advisor organizations for "fee only". These advisors are "fee" only as in they receive no outside compensation, such as commission or sales fees. A better question is what is that fee based on. Is it based on net wealth? AUM? Flat rate? Hourly?

Sherman Financial will never charge AUM or net wealth fees. Yes, I might charge wealthier clients more due to them having additional work (often business interests, trusts, accounting needs, AMT issues, etc), however it is never based on the funds invested. A client with over $1 million in assets could be simpler to manage than one with $200,000. Does the fact they have more money mean they should be charged more? Not based on work provided.

Some of you may be thinking that a flat fee means you have to pay high hourly rates for advisor services. This may be true - I'll admit I have a fee you must pay. If you have little or no assets then you very well may be better off at a AUM advisor. Thus there is a point where I cannot compete with low-sized portfolios, and I'll accept that. 

That's enough ranting for today. The next post will be on how AUM fees may not be providing information in your best interest.