In a very thoughtful—and lengthy—comment to my Sept. 7 blog (If You Can Commoditize Asset Management, Will Advisors Be Next?), Ron Rhoades recounts this Pablo Picasso story:
“Legend has it that Picasso was sketching in the park when a bold woman approached him.
“It’s you — Picasso, the great artist! Oh, you must sketch my portrait! I insist.”
“So Picasso agreed to sketch her. After studying her for a moment, he used a single pencil stroke to create her portrait. He handed the women his work of art. “It’s perfect!” she gushed. “You managed to capture my essence with one stroke, in one moment. Thank you! How much do I owe you?”
“Five thousand francs,” the artist replied.
“B-b-but, what?” the woman sputtered. “How could you want so much money for this picture? It only took you a second to draw it!”
To which Picasso responded, “Madame, it took me my entire life.”
As my blog was about the value of financial advice and the effects of technology on that value, picture me slapping my forehead for not using that story as the lead in. In part, I was responding to the notion that “It doesn’t cost any more to manage a million dollar account than it does a hundred thousand dollar account. It didn’t seem fair or logical that larger accounts would pay more than smaller accounts.” And Rhoades’ story is much better than my analogy about the value of a doctor taking five minutes to determine that you have allergies rather than the lung cancer that was diagnosed in urgent care.
Ron goes on to make a number of touching points about the value of advice, and the best ways for advisors to charge for it. For starters, he points out that as a former estate and tax attorney, he learned the flaw in hourly fees for professionals: “As you get more experience, you don’t have to spend much time doing research. You can often provide an answer to a client that may save hundreds of thousands of dollars, or millions, or more, in a short period of time. You don’t get compensated for the expertise you have developed.”
He then applies that insight to compensation for financial advisors, observing that: “Often the wisest course in managing an investment portfolio is to ‘do nothing.’ But commission-based structures don’t encourage this. And the accumulated expertise an expert investment adviser possesses—from studies of investment theory and the capital markets, from experiencing different markets, from increased understanding of the relationships between risk and return (or their non-relationship in some instances), etc.—is not compensated by hourly advice…. …Financial planning is similar.”
Which brings him to AUM fees: “[They] remain predominant because they are ‘easy’; Clients are more easily sold to pay AUM fees. 0.50% of $300,000 sounds like a little, while $1,500 sounds like a lot. For this reason, AUM fees will likely be around for a while.” First, I have to admit that there is probably some truth to his contention that AUM fees are the easiest to “sell:” To most people, “half of one percent” sounds pretty insignificant. What’s more, because the fees are deducted directly from their investment accounts, most people probably don’t notice them.
But I should point out that Ron ignores the fact that AUM fees are the only currently used compensation method that aligns client and advisor interests (to grow client portfolios), and that to my knowledge, all custodians require advisors to calculate and submit the dollar amount of their quarterly AUM fees (which are then posted on the clients’ quarterly statements). Which is why AUM fees are the preferred investment compensation structure for all but the very wealthiest people (who can afford to hire their own investment managers).