One of my failings is that when someone explains something to me starting with statements that strike me as patently ridiculous, I tend to discount the rest of their thinking. (For example: “In the richest country in the world… ,” as if relative wealth means unlimited wealth.)
Over the years, I’ve come to realize that people can have something valuable to say, even if their supporting arguments are hopelessly flawed, so I try not to react until I’ve heard all of their idea.
With that said, I have to admit that when, about a year ago, a financial planner raised the latest argument for flat fees with me, I wasn’t very receptive after her opening statement: “AUM fees are commissions.” That’s unfortunate because I do think that “flat” advisory fees have some advantages over AUM fees under certain circumstances. But the current “all or nothing” thinking that advisors have to be either 100 percent flat fees or 100 percent AUM fees obscures these advantages.
For example, in a comment to my May 2 blog, “Bob Veres is Wrong About Flat Fees,” a planner anonymously wrote:
“None of these arguments change the spirit of the flat-fee position. […] This piece still doesn’t explain why collecting more money for managing $2 million, the exact same way an advisor would manage $1 million, is justified. Assuming advisors should be compensated for 1) actual work (time) put into a case and 2) performance of the solution, how is the AUM fee a rational conclusion? If $2 million is managed the same way as $1 million, why the additional fees? The difference in effort is zero and performance is the same. Why should the $2 million client pay more?”
This comment is exactly what I’m talking about: In his or her zeal to defend flat fees, the author ignores the reasons behind the current shift of virtually the entire retail advisory world — including financial planners, brokers, insurance agents, bank reps and accountants — to managing assets for a percentage fee.
Here, the author is essentially making the same argument that Veres made: that it is unfair for clients with larger portfolios to pay more in actual dollars than clients with smaller portfolios. As with most of the recent criticisms of AUM fees that I’ve seen, this author at least appears to believe that AUM fees are a new idea, invented by independent advisors.
As most of us know, this is far from reality. Based on my work 20 years ago, writing the “Worth Guide to Private Banking,” I can tell you that wealthy individuals and families (with portfolios measured in the hundreds of millions of dollars) have paid AUM fees for a least a couple of hundred years. And those folks don’t tend to be dumb about their money. (Not that wealthy people are smarter than anybody else, but their lawyers and accountants tend to be.)
So, we can safely say that the “smart money” has no problem paying more in actual dollars to have their money managed.
Speaking for what I believe to be the majority of AUM fee compensated advisors, another anonymous author tells us why in a comment to the same blog:
“Assuming I’m managing efficient portfolios for my clients, the larger accounts stand to benefit much more in dollar terms than smaller accounts, so I think the AUM fee is fine. It’s proportionate to the value I add for my clients. You can always adjust the fee percentage down for larger accounts anyway. With the AUM model, you can also consider how high maintenance a client may be and any other factors when considering fee reductions, which you wouldn’t be able to do in a flat fee model. I don’t charge directly for financial planning, but I really do when I consider any fee reductions for a client. I like the flexibility of the AUM model and my clients are fine with it as well.”