Some of those out there in the physician financial blogosphere (including two WCI Network partners) are adamant that the only pure way to pay for fee-only, fiduciary financial advice is via a flat fee or an hourly rate. (It's mildly hilarious, given that some of these bloggers accept money from advertisers charging Asset Under Management [AUM] fees). Based on the rhetoric, one would think there is a special place in hell reserved for advisors charging AUM fees (it's just down the hall from where the whole life insurance salespeople hang out). I don't agree with that for two reasons. First, a significant percentage of those charging flat fees are actually charging some type of a hybrid between a flat fee and an AUM fee. Let's look at some examples from my own recommended financial advisor list:

Fee Structure:

One-Time Services:

  • Student Loan Review – $500
  • Financial Plan – $1,000 – $4,500

Residents/Fellows:

  • Ongoing Student Loan Support – $100/month
  • Financial Planning – $225/month

Financial Planning, Investment Management & Tax

  • Early Investors (Up to $500,000 of Assets Under Management) – $450/month
  • Foundation Builders ( Up to $1,000,000 of Assets Under Management ) – $850/month
  • Financially Independent (Over $1,000,000 of Assets Under Management) – $1,250/month

Now is that really a flat fee advisor? The fees are flat aren't they? But yet they go up with the amount of assets under management, at least to a certain point. Here's another one:

Fee Structure:

  • $450/mo. for $500,000 and less in assets
  • $650/mo. for over $500,000 in assets, up to $1,000,000
  • $850/month for $1,000,000- $2,000,000
  • $1,050.00/month for $2,000,001 – $3,000,000
  • $1,250.00/month for Over $3,000,001 in assets
  • Exclusively for Residents/Fellows: For $299, pick one of the following to discuss: student loan review, insurance review, employer benefits review, how much home you can afford analysis, investment allocation or creation of a spending plan.

See what I mean? You'll never end up paying $50,000 a year with these folks (the big fear with an AUM-charging advisor), but they're not technically flat fee advisors.

The second reason I don't have a problem with recommending advisors who charge an AUM fee is that I think my readers and listeners can do math. I think it is an incredibly easy task to multiply your assets under management by your asset under management fee once a year so you can make sure you are still paying a fair price for good advice. Maybe that is too much to ask, but if so, I suspect my ability to help that person is probably severely limited anyway.

AUM fees aren't even necessarily a terrible way to pay for asset management. I mean, you pay a mutual fund manager an AUM fee. It's called an expense ratio. You pay AUM-like fees to a real estate syndicator or property manager too. Some costs actually are higher when managing $5 Million versus $500K. Liability, for instance. The problem with AUM fees is four-fold:

  1. They often start too high
  2. They rarely scale back fast enough
  3. They are not capped
  4. They are used to pay for non-investment management services

If you can solve these four issues, the AUM fee works just fine. Let's look at each individually:

AUM fees Often Start Too High

Charging 1% a year makes a lot of sense when you're managing a low six figure portfolio. Charging 1% a year when you're managing an eight figure portfolio is highway robbery. Paying 2% a year when there are high quality advisors all over the place charging 1% or less is silly.

AUM Fees Do Not Scale Back Fast Enough

Most AUM fees do scale back. Perhaps a typical scale is to pay 1% on the first $1M, 0.9% on the second $1M, and 0.8% after that. Aside from the fact that most investors do not realize that even if they have $5M they're still paying 1% on that first million (i.e. the fee is $43K, not $40K), the problem here is that it does not require 4-5 times the work or risk to manage 4-5 times the money. A more fair way would be to charge 3% on the first $100K, 1% on the next $100K, 0.5% on the next $300K, and 0.2% after that. That's far more reflective of the actual work done and risk taken.

AUM Fees Are Not Capped

Most typical AUM fees are not fair to the advisor when the assets under management are small. AUM charging advisors generally manage this issue by not taking clients with less than a certain amount, ensuring the clients have the income and disposition to build wealth quickly, or charge a minimum fee. Nor are typical AUM fees fair to the client when the assets under management are large. The classic example is paying 1% on $5 Million, or $50,000 a year — for a service you can easily find for $10,000 a year. One thing I like about the hybrid flat/AUM fee examples I used above are that they are capped. No matter how much you have, you're not going to pay more than $15,000 a year.

AUM Fees are a Dumb Way to Pay for Financial Planning

It is reasonable to pay an AUM fee for investment management. Rick Ferri thinks a fair price to manage a seven figure portfolio of index funds is 0.2-0.3% per year. However, paying AUM fees for financial planning is a little bit kooky. Nobody ever seems to want to pay for financial planning (or sometimes assistance with taxes.) But the advisors know that financial planning matters even more than investment management and that investment management only makes sense within some sort of financial plan. So they wrap it all together and raise the fee.

That's probably fine that first year, when the advisor is doing comprehensive financial planning with you. But if you need a brand new comprehensive financial plan every year, something is very, very wrong. Why should you keep paying for a service you're not getting? And since assets under management go up every year, paying MORE each year for a service you no longer need. It doesn't make sense. Better to pay a flat or hourly fee for financial planning and a separate asset management fee. I wish that set up were more common in the industry.

Talking Price With Your Advisor

So in the beginning, it is very common to hire an advisor charging you an AUM fee. You do the math and the price is fair. You like the advice and service and over the years develop a relationship with the advisor. Each year you do the math and agree you are still paying a fair price for good advice. Until you aren't. Now what?

This point will come at a different time in your career depending on how much you earn, how much you save, and how well your investments are doing. But let's say you're 15 years into your career and now have a $2 Million portfolio. Your advisor has been charging you 1% a year, a fee that is now up to $20,000. And you just realized there are at least two fine advisors on the WCI recommended list who never charge more than $15,000 per year. What do you do now? Well, now it is time to negotiate.

You don't need to be a jerk about it. Up until this point, you had been getting good advice and service at a fair price. Worst case scenario, you're going to have to go find a new advisor. That's a bit of a pain and hassle, but for $5K+ a year moving forward, it's not a bad use of your time. But you like the advisor and the advisor has been treating you well. The only problem you have is with the price. So why not negotiate a lower one?

financial advisor negotiating

The Negotiation

So how do you do that? Well, in any negotiation the person who wins the negotiation is the one with a better BATNA- Best Alternative To a Negotiated Agreement. Your BATNA is the advisor down the street providing similar services for a lower price. The advisor's BATNA is that ENT at your hospital who has no problem paying them $20,000+ a year for services.

Most financial advisors close their practices once they get 50-100 clients. If they're providing good service, the rate of attrition is pretty low and can be replaced just with client referrals. But they still don't want to see $20,000 walk out the door. They will likely offer you some sort of concession to stay.

Likewise, you don't want to start all over telling your life story and goals to a new advisor, much less shop around for another one you like. You are probably willing to pay a little more to stay with your current person. If you've been paying attention and doing the math each year, you are hopefully having this conversation at a point where there is still room for compromise. Why not give the old advisor the chance to match the new advisor's price? The conversation might look like this:

“I have really enjoyed working with you over the years, but the AUM fee is starting to get pretty high. I have been looking at a couple of highly recommended advisors out there and I see that they cap their advisory fees at $15,000 per year. I'd like to stay with you, but as you've taught me, fees really matter over the long run. If you can match their price, I'll stay with you. Would you be willing to continue our current relationship for a flat $15,000 per year?”

They may say no. Or counteroffer. Or maybe they'll just decide their time is limited and they're confident they can fill their practice with clients who are much less fee-sensitive than you are. They're business people and entrepreneurs too. So you'll have to go to that new advisor. But that certainly beats paying $20K this year, $25K the year after, and $30K the year after that. You don't need to feel guilty. While a friendship has developed (as you would expect), this is primarily a business relationship and both sides understand that price and value drive most business decisions.

Now obviously all advisors are not created equal. Some have more experience than others. Some offer more services than others. But when you see a whole list of people willing to be your financial advisor for $5-15K/year, you probably really need to ask yourself why you would be willing to pay 2-3 times that. The answer is you don't, but you may have to switch advisors to ensure you are still getting good advice at a fair price.

My entire recommended advisor list is composed of fee-only, fiduciary advisors. They all give excellent advice. Some of them charge AUM fees. As your assets move into the seven figure range, I expect you to have this discussion with them. They should expect it too. As these discussions become more common, the good guys in the industry will flourish, the bad guys will go out of business, uncapped AUM fees will become less common, and you will get a fair shake on Wall Street.

What do you think? Do you use an advisor charging an AUM fee? Have you had to renegotiate fees? How did it go? How much do you think is fair to pay for good advice and service? Why do you think some investors dramatically overpay for investment management?