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Portfolio > Portfolio Construction

Flat Fees Again: Hey, It’s Not My Fault!

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Now, before you start warming up your computer to post another comment criticizing me for beating the flat-fee vs. AUM fee horse even further to death, let me point out that one of the two rather lengthy comments to my last blog on that subject (The Dead Horse Bounce. And Another Thing About Flat Fees…), came from Elliott Weir of III Financial (who two weeks ago posted a comment suggesting that I had, at that time, beaten the flat fee debate at least into unconsciousness), so I’m taking his more recent comment as an editorial “get out of jail free” card to continue the discussion. (Thanks, Elliott.)

I should also point out that the two new comments to last week’s blog referenced above were both thoughtful and insightful, and consequently warrant repeating and further discussion. I’ll start with Elliott Weir’s comment because I was impressed and encouraged that he concluded his remarks with this statement: “Please accept that neither model has a monopoly on ‘best for all clients,’” he wrote. “In some cases, AUM [fees] would likely be the way to go, but there is plenty of evidence that a fixed-fee model benefits many clients as well.”

While that comment strikes me as a significant departure from the current flat-fee party line that “AUM fees are so riddled with conflicts as to be the spawn of the devil,” Elliott does go on to make a few other comments that cry out for a response, to wit: “The article you cited about the Mercer report said nothing about firms moving from a fixed-fee back to an AUM model: am I missing something?”

The short answer is “no,” Elliott did not miss anything: The Mercer report did not say anything about firms switching back to AUM fees. In fact, the authors gave no indication that they considered researching that phenomenon at all. That may not be all that surprising considering the report was largely a polemic about the evils of AUM fees. Instead, my basis for referring to “firms that have switched back to AUM fees over the years,” comes from conversations dating back over 30 years with advisors who have done so, and from conversations with consultants to advisory firms who recounted the experiences of their clients. (Yes, Virginia, that does mean that there’s nothing new about flat fees.)

Weir then went on to raise the issue of client account size vs. client account complexity, in reference to my comment: “I have never talked to an advisor who uses the same number of stocks/bonds/mutual funds/ETFs/separate accounts, in all of their model portfolios, regardless of size.”

He responded: “For accounts that have $1 million to $2 million, yes, my models are the same and thus they require the same amount of work, reporting, etc. Now you have talked to one…”

I must apologize if I wasn’t clear. When I referenced “portfolios, regardless of size,” I was thinking of perhaps $5 million or $10 million portfolios compared to, say $500,000 portfolios—which typically would involve vastly different expertise and workloads. To my mind, $1 million to $2 million portfolios are essentially the same size, and I’d expect them to typically involve about the same level of attention. 

Elliott then goes on to explain: “When the wealthier do have more complex situations, then a different service level is required. That doesn’t require an additional pitch any more than your cell phone provider requires a chart of what each level gets and the client can choose.”

I suspect that Elliott may have missed the point here, too, and again, it’s probably my fault. As I understand it, the problems with flat fees don’t arise on the initial client pitch: as Elliott points out, that’s easy. But over time, assuming the advisor does her/his job and/or life’s good to the client, their portfolio will grow, possibly substantially. Through sound investing and job raises, bonuses, stock options, inheritance, house sales, etc., an initial $1 million portfolio might grow to $5 million or even $10 million nest egg, along with all the additional services a larger portfolio entails.

And at some point along that growth curve—and possibly at multiple points—a flat fee advisor will need to have a conversation about higher fees.

That creates a decision point for the client: ‘Am I really happy with this advisor? Are they worth more money? Would someone else be better for me now,’ and so forth).

AUM fee advisors, on the other hand, don’t have that problem: their dollar amount automatically increases along with the client’s financial complexity. What’s more, not only do they not have to have a conversation about raising fees, most AUM advisors find themselves in a position to actually reduce their percentage fee as a client portfolio grows.

In the other comment to my above mentioned blog, Scott MacKillop (whose comment to an earlier blog was the subject of that blog), also sounded a surprisingly conciliatory note: “I think posing the issue as a ‘better vs. worse’ choice is the wrong way to look at this question,” he wrote. “Advisors should understand the pluses and minuses of both models and make a choice that works best for their practices. I would suggest that the two models could be combined under the same advisor’s roof for different services or service levels. ‘True believers’ on either side of the debate do not do justice to this issue. The AUM model has served the industry well and will continue to play an important role. But to remain competitive, advisors need to objectively consider all of the alternatives and pick the one that is best for them.”

Again, that’s a refreshingly different tone from the flat-fee advocate who told me awhile back that “AUM fees are just another form of a commission.” (Apparently, she didn’t find the whole fiduciary duty thing to be important.) And in the spirit of harmony and brother/sisterhood, I’d really like to grab onto that olive branch: but I just can’t bring myself to do it.

As a long-time observer of the independent advisory business and a representative of the lower tiers of advisory clients, I just don’t believe that flat fees are better for either clients or advisors (even though some advisors think they are). As many advisors seem to base their flat fees on what the AUM equivalent would have been, and anticipate raising those fees as portfolios grow, there doesn’t seem to any client savings.

And, as I wrote in my last blog: “Seems to me that giving an advisor a stake in growing one’s portfolio creates a greater chance of getting sound financial advice than paying an advisor the same amount every quarter no matter what happens.”

I’m sure that many advisors are looking forward to smoothed-out flat fee revenues being better for their businesses during declining stock markets. But I suspect that the resulting disconnect from the experience of their clients will weaken those relationships.

It’s ironic that flat fees, then, are more like commissions: creating a situation in which after a sale, the broker has no stake whatsoever in the outcome for the client.


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