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Practice Management > Compensation and Fees

The Case for Charging Both AUM and Flat Fees

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In case you missed it, there has been quite a bit of discussion lately about the relative merits of flat “fees” vs. AUM fees on various sites around the industry. As far as I can tell, advisor sentiment is about evenly split. One issue that a number of advisors have raised is that as they (and I) understand the current iteration of flat fees, the firms that use them calculate their annual fee based on what they were charging in AUM percentages: so there are effectively no savings to the clients.

What’s more, they build in fee increases every couple of years or so, which means that there aren’t any client savings going forward either. Advisors who point this out usually conclude by asking: “How’s this really any different for the clients?” 

It’s a good question. In fact, it’s such a good question that it makes me wonder if making a difference to the clients is really the motivation behind the nouveau flat-fee movement. For while there may not be much of a difference to the clients, there’s certainly a difference to the advisor: when the markets make their periodic downturns, taking client portfolios with them, instead of riding down with them, advisory revenues will remain remarkably steady. Can it be that despite their anti-AUM fee rhetoric (“AUM fees are ‘commissions.’ AUM fees are fraught with egregious conflicts,” etc.) the real motivation of flat-fee advocates is that these fees eliminate fluctuating revenues in advisory firms? 

To be fair, falling revenues during market downturns is a major business problem for advisors, so you can’t really fault folks for trying to solve it. However, replacing AUM fees with flat fees doesn’t strike me as a very good solution, as it creates another major difference to the clients.

Let me illustrate by way of example: Consider a client with $1 million in AUM, paying his advisor 1%, or $10,000 a year. Now, let’s say the client’s advisor converts her firm to flat advisory fees, and by coincidence, the annual fee works out to be $10,000 a year.

Everyone’s happy for a couple of years, until the markets suffer an inevitable correction: one equally as bad as in 2008-2009. So now the client’s portfolio is suddenly worth $500,000, which as we know, isn’t a disaster unless the client panics and sells out before the market recovers (preventing this is one of an advisors’ primary jobs).

However, under the client’s new flat-fee arrangement, he is still paying an annual fee of $10,000, which is quite nice for his advisor, whose flat-fee revenues haven’t declined one penny. However, that $10,000 annual fee now represents 2.0% of the client’s AUM—a rather egregious cut, by most independent advisory standards. That percentage cut will continue as long as it takes for the markets to build themselves back up (four years, in the case of ’08-’09). This client might as well be working with Merrill Lynch. Do flat fee advocates really intend to level their revenues on the backs of their clients? 

There are, however, better applications of flat fees to smooth out advisory revenues without overcharging clients during market downturns.

I found one such flat-fee model when I interviewed Deborah Fox, CEO of the Fox Essential Planning Services, San Diego, California, for my June 24 blog (Has Deborah Fox Cracked the Millennial Code?). Fox told me that her firm was originally “fee-only,” charging AUM fees. But in recent years, she has added two “flat-fee” services: financial planning and college planning, and is contemplating adding more. 

She initially started charging a separate fee for financial planning: “Our clients tended to focus only on asset management, because that’s what they were paying for,” she told me. “So we added an annual financial planning fee, to get them to think more about that, too.” She charges a higher fee for the initial financial plan, and then a lower annual planning fee in addition to her AUM fee.

But to make that work—to keep the client from paying an annual planning fee—she takes a novel approach to financial planning: she provides actual, ongoing planning.

“We view financial plans as an ongoing process,” Fox said. “People change, plans change, circumstances change, the markets change and the world changes. So, we work with our clients every year to effectively create a new financial plan for their new reality. This often includes a new direction: What do they want to work on this year?”

In addition to the financial planning fee, Fox’s firm also offers a fee-paid college funding service for families that don’t qualify for financial aid. That service has become so popular with her own clients, and the clients of other advisors, that Fox spun it off into a separate business.

“We sort of stumbled into that business,” she said. “We had a couple of clients, who, despite their ‘affluence,’ were struggling to send multiple kids to college. So we started looking into available grants and scholarships, etc. We quickly developed an expertise in this area, which is quite complex. So other advisors would rather send their clients to us than spend a lot of time recreating the wheel.” 

The takeaway here is that rather than convert her business from AUM fees to flat fees, Fox simply added flat-fee services that made sense for the clients. That way, she gets paid for doing “out of the box” work, her clients get the additional services they need, they take financial planning seriously and she has additional revenue streams that support her AUM revenue during down markets.

It seems to me that this is a much better business model—combining AUM fees with additional flat fees—than rigidly charging just one kind of fee or the other.

See Bob Clark’s prior blog postings on the AUM vs. flat-fee revenue model:


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