I recently received the following email from a veteran financial advisor:
“Regarding your commentary in IA and online regarding the debate between AUM fees and retainer fees [see Bob Clark on Flat Fees], I think it is clear that there is no “perfect” compensation model, and I agree with you in that the AUM model is better than most, but I think you downplay the possibility that in many ways the retainer model (if done correctly) is the most fair model for clients, despite the fact that it may limit the income of many of us in the financial advice world.
“I have been in the investment/financial advice business for a little over 22 years now: working at an insurance company and a small regional brokerage firm before opening my first fee-only RIA to build portfolios of no-load mutual funds for clients, charging an AUM fee. I spent the next four years as an “asset accumulator,” and quickly learned how entrenched the brokerage mindset was with clients: spending most of my time educating people about why this compensation model made so much sense.
“It was a tough slog, and eventually I joined a large and successful ensemble RIA firm to see how they had succeeded in this space. In the 4 ½ years I was there, I learned that what they had done right was simply accumulate assets: they didn’t have any secret sauce. So, I launched my own RIA again, adopting the AUM model because it was all I knew. And I still use it today. But I have been doing my homework on moving to a retainer model for a while now and am convinced it is time to make it happen. Articles like yours, and others, have been very helpful as I have done the mental gymnastics around the transition.
“Here’s where it comes down for me: The dynamic of the client/advisor relationship is not completely about the amount of compensation. All the things you list that would affect compensation in an AUM relationship such as non-portfolio investing, advisor risk tolerance vs. client risk tolerance, debt repayment, charitable giving, wealth transfer to other family [members], etc. are extremely valid. I think clients put more value on an advisor being unbiased in those circumstances, where advice is needed.
“Yes, your point that the AUM model makes us feel the pain of market declines with our clients is absolutely true, but to me the retainer model doesn’t take that away: we all typically are invested along with our clients so we do feel it, and the misalignment is that we typically work harder when the markets decline because our clients need more reassurance. I’m not going to take any more or less calls/meetings in the retainer format, but I am also not going to be paid less for those meetings due to the performance of the markets over which I have no control.To me, the potential conflicts, real or perceived, are more numerous in the AUM format, and for that reason, I am in the process of making the switch. I feel much like I did in 1994 when I was swimming upstream making the case for the AUM model, but I feel the result will be the same, a move to a better, more aligned and more equitable arrangement.”
Here’s my reply:
I put a very high value on the thoughts and perceptions of advisors like you who are working with clients every day and making decisions that you and they will have to live with. Your points about the advantages of flat retainer fees make a lot of sense, particularly that you will feel the pain of a down market in your own portfolio.
Yet I wonder whether your clients will see it that way. Putting my retail investor hat on for a moment, I can tell you that I like the mutual interest that when my portfolio loses value, my advisor makes less as well. I know, in her case, it’s only cents on my dollars of decline, but it still feels as if she’s on my side of the table, and that she believes so strongly in long-term market growth that’s she’s betting on it alongside me.
As for the conflicts of interest that you list with AUM fees, as I’ve written, they seem to be both readily apparent to the client(s), and involve actions that require careful consideration, which can be advanced by an advisor asking if they’ve really thought it through. But ultimately, they are the clients’ decisions, and I doubt many, if any, clients are confused about that.
The other problem that advisors who have switched to the retainer model have encountered is getting a raise.
With AUM fees, the advisor gets a raise when the client’s portfolio grows, and as far as I can tell, investors are, like me, more than happy to pay more. But for retainer advisors to get a raise, they have to have a conversation with their clients every couple of years or so, which makes some advisors uncomfortable: It raises the issue of their compensation again and again in the minds of their clients.
Over the years, I’ve known many independent advisors who have tried retainer fees, only to switch back to AUM fees a few years later, for both reasons (but mostly, I suspect, over the conversation issue).
I suppose my biggest concern about retainer fees is that many of today’s advisors with whom I’ve talked seem to believe that flat retainers are a new idea.
I’ve been writing about the independent advisory industry since 1984, and in that time I’ve seen significant numbers of advisors embrace the retainer model on at least two separate occasions. In both cases, the majority of those who transitioned switched back to AUM fees after a few years. As I’ve written before, high-net-worth investors can pay for their financial advice any way they want, and they almost exclusively choose AUM fees.
There has to be a reason.
Read more on flat fees vs. AUM compensation at ThinkAdvisor’s Bob Clark on Flat Fees.