How Financial Advisors Are Like Pablo Picasso

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).

Having ruled out commissions, hourly fees and AUM fees as adequate compensation methods, Ron concludes that “project or flat fees appear appropriate,” as they “disconnect from time,” and can be set to compensate for one’s years of training and experience. What’s more, Rhoades believes “we may be coming to a time when ‘financial life planning’ fees are segregated from ‘investment advice’ fees… …as some aspects of “financial planning” have [little] direct relationship to investment advice.”

Once again, I have to disagree with Ron and others who suggest that financial planning and investment advice have little overlap: it is the growth of the investment portfolios that “funds” financial plans. What’s more, over the years, many advisory firms have tried to separate planning from investment fees: only to find that after a few years (during which their financial plans changed very little), most clients dropped their “planning” service, but continued to receive asset management—at the discounted rate.

Finally, Rhoades offers, in my view at least, his best insight: “It is likely that there is no ‘perfect’ fee structure out there; all possess advantages and disadvantages. And different fee structures might be more attractive to particular clients, or better suited to serve their needs.”

For folks with modest retirement portfolios, the Garrett Planning hourly comp model makes a lot of sense. And at the other end of the spectrum, folks who exceed the unified estate tax exemption need a broad array of services, for which they can pay separately.

In the middle are the majority of independent advisory clients who will benefit from both the identity of interest between advisor and client that comes with asset management fees, and from a sound financial plan that tells them how much to invest, and what other steps they should take to protect their financial future.