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What Do Advisors Really Do Anyway?

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In my last blog, I promised that my next blog would be about how flat fees can work in tandem with AUM fees to create better advisory firms, but I’m afraid that will have to wait. One of the comments to my last blog (“Are Flat Fees Better for Clients—or for Advisors?”) simply cries out for a response.

It’s not clear to me why many proponents of transforming the independent advisory world into “flat fee only” often talk as if they are completely unaware of the many client benefits of an AUM fee model. Can it be that they are so caught up in the euphoria of “taking financial advice to its next level” that they’ve forgotten the myriad reasons independent advice evolved into AUM fees—and why that’s transforming the entire financial services industry as you read this?

The comment in question came from Derek Tinnin, who posted a lengthy response to my blog, including the following passage about one of the primary benefits of AUM fees that I had cited: “As for giving the advisor ‘an incentive to grow my portfolio,’ that’s just a flawed view of the advisor’s role, at least it is within the passive philosophy camp. That may be a correct way to view the role of active managers, but where’s the data to support the theory that they are capable of growing your portfolio in the first place? The idea that a percentage fee puts the adviser ‘on the same side of the table’ assumes that 1) they are the source of performance; and 2) it eliminates conflicts of interest. Both are false. Markets produce performance, not advisors […].”

My first response to Derek is my customary “really?” But I’ll refrain from that. Hopefully, you can already see why I find this reasoning misguided, but just in case, I’ll explain. In my view, there are three major benefits for someone engaging a professional (read: fiduciary) financial advisor:

1) Advisors protect clients from themselves. As virtually every financial advisor on the planet knows, if left to their own devices, most people would make one financial mistake after another, starting with failing to save enough or any at all, and including buying at the top of bull markets, selling at the bottom of market corrections, and investing in every “hot” stock or tax shelter they hear about from their golfing buddies or brothers-in-law. If all a financial advisor does is instill some rational discipline into a client’s financial actions, they will have earned whatever their fee was many times over.

2) Advisors protect their clients from the financial services industry. Now, before I get a flood of angry emails, I know that there are many “client-centered” financial services firms out there. But with that said, I think we can all agree that there are powerful financial incentives to charge high fees and loads, and other hidden costs, in order to generate more profits for their shareholders. And some firms do succumb to these pressures—especially when the vast majority of financial consumers are both trusting and woefully ignorant of how the business really works. Again, if a financial advisor does nothing more than keep the costs of their clients’ investments and other financial products on the low side of the spectrum, they will have more than earned their fee.

3) Advisors try to prevent clients from making one or more devastating personal financial mistakes. I would have said that advisors offer “two primary benefits,” but years ago, Columbia, North Carolina financial planner (and former NAPFA chair) James Wilson shared with me his insight that the three most financially devastating events for clients are: divorce (the client loses half their assets); dissolution of a business partnership (they lose half or more of the equity and earning power they’ve spent their life building up); and investing in high-risk, passive “business” opportunities. Of course, no financial advisor can prevent their clients from taking any of these actions. But according to Wilson, simply laying out the effects that each of these potentially would have on a clients’ financial future is often enough to keep them from taking these decisions lightly. And you really can’t even put a price on that kind of advice.

So, while Tinnin is right that “markets produce performance,” he has completely overlooked the fact that clients can only benefit from that performance if they are a) in the markets; b) not reducing their performance through excessive fees and loads; and c) not decimating their investment portfolios through poor life decisions. What’s more, from this perspective, even his (and many other flat fee proponents’) assertion that viewing AUM fees as incentives for advisors to grow client portfolios is “flawed” loses steam. While an AUM fee advisor certainly has a conflict when asked by a client about investing directly in a “business opportunity,” that’s not a bad thing because most business opportunities are bad ideas. Even if an advisor’s response is a knee-jerk “don’t do it,” at least that might get the client to make absolutely sure they want to make that investment: Where’s the harm in that?

The bottom line here is that AUM fees put advisors on their clients’ side of the table in many ways: to capture market performance; to keep costs and expenses down; to refrain from making major life decisions lightly; and to think twice about risky private business ventures. This is why the wealthiest investors happily pay AUM fees and why advisory clients should, too. Frankly, I only wish my other professionals—doctors, accountant, dentist, etc.—got paid on their performance, rather than the same amount no matter how my life turns out. And I promise I’ll talk about “good” flat fees next time.