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March 31, 2014 at 08:56 AM
Back in the mid-1980s, a prominent financial planner (whose name escapes me) used to call it “the dirty little secret of financial planning.”
He was referring to the fact that financial planners almost never got paid for doing financial planning—an observation that is still true today.
The first “financial planners” were commission-paid mutual fund salesmen (there weren’t any no-load funds back then). Then, when the stock market tanked and tax rates skyrocketed in the late 1970s, financial planners sold tax shelters.
When the tax laws changed in the mid ‘80s, most planners switched to selling annuities, which remained the product du jour until the stock market rally turned into a bona fide bull market and managing mutual funds in allocated portfolios for a fee finally took the “sales” out of financial planning (not that there’s anything wrong with that).
Or so I thought. Until I had a conversation the other day with a prominent financial planner who, shall we say, is not a fan of AUM fees. “Just another form of commissions,” she called them, citing the conflicts that arise when a client might benefit from taking part of their investment portfolio and paying off their mortgage, and that holding some assets, such as bonds to maturity, certainly doesn’t warrant a “management” fee.
She went on to suggest that instead of the current, flawed fee compensation model, leading financial planners today are shifting to the far more client-centered flat annual fees for financial planning.
Even though she was advocating an expanded version of financial planning — that goes even beyond George Kinder’s Life Planning — to include applying the latest research on behavioral economics and client communications, I have to admit that I did not react well to her “attack” on AUM fees.
Being ancient enough to have experienced those days when many financial planners were salespeople (again, not that there’s anything wrong with that), I have a reverence for the transformation of retail financial advice prompted by AUM fees. In my view, AUM fees have taken independent advice to the next level, in four important ways:
1) AUM Fees Solidify a Fiduciary Standard for Retail Advice-Givers There is no substitute for a legal duty to put the clients’ interests first. Even though many advisors, particularly some brokers and CFPs, consider themselves only part-time fiduciaries for each client, it’s had a dramatic effect on all financial advice, as more and more clients are asking why they aren’t their fiduciaries all the time. Even SIFMA is slowing acquiescing to a full-time standard.
2) AUM Fees Put Advisors (Mostly) on the Client’s Side of the Table Yes, AUM fees still have some conflicts, most notably the two mentioned above, and the advisor’s fee itself. Of course, this conflict exists with every transaction where one person pays another person for a service. With access to information, such as the Internet, people can check the going rates and make good decisions. We already see this happening. More importantly, advisors get paid more only when client’s portfolio grow. Is that perfect? No. But it’s waaaay better than the old days. I’ve been there.
