One of the most important aspects of choosing a high-quality financial advisor (a catch-all term I use for a financial professional who functions as a financial planner and/or an investment manager) is to make sure they are a fiduciary, FEE-ONLY advisor. These are critical (although not sufficient) aspects of ensuring you are obtaining good advice at a fair price. There are four methods of paying for financial advice:
- Asset Under Management (AUM) Fees
- Annual or One-time Fees
- Hourly Fees
The Problem with Commissions
I do not believe it is wise to hire an advisor who charges commissions. I feel the conflict of interest is simply too great, even for a really good person, to allow for good advice under this model. In the short-run, this is often the least expensive way to pay for advice, but in the long-run, the fact that the advice is usually less than ideal makes it the most expensive option once you take the opportunity cost of the bad advice into account.
That does not mean you cannot purchase financial products such as insurance or a mortgage from a commissioned agent such as an independent insurance agent. However, when you go to do so, you need to recognize that the agent is incentivized to sell you as expensive of a policy as possible. So it might be wise, if you need advice, to determine the type, amount, term, and features of your insurance policy with a fee-only advisor PRIOR to going to the agent to purchase the policy. The agent is often the most knowledgeable person about the ins and outs of policies, of course, and can help you determine which policy to buy and help shop you around to the various companies so you end up with the best deal.
But this is not the same as getting good financial advice. Mistaking a commissioned insurance (or mutual fund) salesman for a real financial advisor is a common mistake among white coat investors. Note that these advisors are often called “fee-based” advisors and that this is very different from a “fee-only” advisor. A fee-based advisor charges both fees and commissions, while a fee-only advisor charges only fees.
The Problem with AUM Fees
My second least favorite method of paying for advice is an AUM fee, a percentage of your portfolio paid to the advisor each year. The main issue with AUM fees is that they can grow to a ridiculous sum. For example, if you were paying 1% of a $500K portfolio ($5,000 per year), that's probably a fair price for good financial advice. But when the portfolio grows to $5 Million ($50,000 per year)? I'm sorry, you're being ripped off. Even if you're receiving more value than $50,000 per year, it's still a rip-off because you can get just as good of advice for 1/10th to 1/5th the price.
A more minor issue with an AUM fee is that it is generally just subtracted from the account, usually on a quarterly basis. This method of payment, rather than writing an obvious, large, painful check each year, causes people to be a little less conscious about overpaying for advice. Other criticisms of the AUM model include the fact that an advisor is incentivized to roll money into accounts they control and charge for (such as an ill-advised IRA rollover), to not pay off mortgages or student loans, and to not offer advice or service on employer-provided retirement accounts.
These issues have caused some in the financial blogosphere to avoid recommending advisors who charge AUM fees at all, for example, The Physician on FIRE and The Physician Philosopher. In a recent Saturday WCI Network post, The Physician Philosopher wrote:
With an Assets Under Management (AUM) model where you pay financial advisors a percentage of your assets each year. You never directly cut them a check. It is swept out of your assets unbeknownst to you every quarter. At 1%, which is the industry standard, that is going to cost you a boatload (A boatload = millions of dollars).
For example, at 1%, of your $3 million dollar IRA in retirement, a 1% AUM will cost you $30,000 per year. Compound that on 6% interest for thirty years and you’ll begin to get an idea of how big of a number AUM costs you.
My assistant editor, who often writes the “SEO Blurb” for the posts, came up with this one for the post:
Run for the hills if your advisor is charging an AUM fee. A good financial advisor is a flat fee-only fiduciary without the conflict of interest.
and my social media person, who writes the tweets promoting each new blog post, used that line in a tweet:
Boy did I catch some (completely appropriate) flack for that, since it really doesn't represent my view on AUM-fee charging advisors. Here are some examples:
Why I Take Money From AUM-Charging Advisors
While I think the best ways to pay for advice are an hourly rate for financial planning and a flat annual fee for investment management (although they also have their own conflicts of interest), I certainly do take advertising money from advisors who charge AUM fees and have for years. Over the years I've been blogging, the AUM fee has become (probably deservedly) more and more maligned, so I thought today it was important for me to explain to my readers WHY I have advertisers that charge AUM fees and WHAT they should do about that if they are looking for an advisor or perhaps already have one who charges an AUM fee.
The most important thing is to not throw the baby out with the bath water. First, realize that an AUM fee is a DRAMATIC improvement over a commission-based model. It is a FEE-ONLY model. You are paying a fee (and unless you're really ignorant a fee that is relatively easy to discover and calculate) and you are generally getting minimally-biased advice.
Second, one great thing about an AUM fee is that in most of the important ways, it aligns the advisor's interests with yours. The advisor wants you to have a bigger investment account. You want to have a bigger investment account. She works hard to get you to save more (which most people need to do.) She works hard to get you a solid return, because it further grows the account. These are good things.
Third, keep in mind that many of the “good guys” in the industry and many of your favorite authors either once charged or are currently charging AUM fees. William Bernstein, MD. Rick Ferri. Bill Schultheis. Larry Swedroe. Vanguard. Paul Merriman. Need I go on? Many of the most experienced advisors “grew up” in an era where the bad guys charged commissions and the good guys charged AUM fees. It's harder to find the combination of gray hair and flat fees than you think. Certainly, there is little incentive for those advisors to change their model now that they have a practice full of clients who are apparently fine with that model.
Fourth, there is a transition afoot in the field. There are more and more advisors charging flat fees and hourly fees every year. But they're still a minority of fee-only advisors, and 8-9 years ago when I started blogging, finding one of them that actually worked with dozens of doctors AND was interested in advertising was well nigh impossible, especially when their practices filled within a year of advertising with me. So when readers asked for a recommendation, where was I to send them? It took a lot of work to come up with 30 or 40 firms that were fee-only, fiduciaries giving good advice to doctors at a fair price at any level of assets. When The Physician on FIRE made his recommended list, he had the luxury of choosing 10 firms from the 40 I had put together over years–a far easier task.
Fifth, many advisors have some sort of a hybrid model. Once you dive into the details, you'll find that many advisors charge a fee that is “kind of AUMy”. For example, Daniel Wrenne, one of my recommended advisors, has this fee structure:
- 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
Is that a flat-fee? Or is it an AUM fee? I chose to call it a “tiered AUM-based flat-fee” and many of my “AUM Advisors” charge something similar.
Sixth, flat fees can be higher than AUM fees. For example, consider another of my recommended advisors, Fox & Company Wealth Management:
- Financial Checkup – $3,000
- Basic $1,250/quarter + initial setup fee of $1000
- Premium $2,500/quarter + initial setup fee of $1500
- Concierge $3,750/quarter + initial setup fee of $2000
Well, those are technically flat fees, but they're also pretty much all higher than Daniel's fees (although can easily still be in the range I consider to be fair.) So it's not as simple as “AUM is bad and flat fee is good.” Sometimes you actually have to do some 3rd grade math.
Seventh, at low levels of assets, an AUM Fee is usually cheaper than a flat fee. Given that 1/4 of doctors in their 60s are not yet millionaires (including their house), lots of my readers are far better off paying even standard AUM fees than a typical flat fee.
Eighth, in case it isn't obvious, I'm running a for-profit business here. While I try to do some reasonable vetting of my advertisers (none more so than financial advisors), at the end of the day the entire world is caveat emptor. I can only hold your hand so much. I can show you what good advice looks like. I can show you what a fair price is. But if I want to provide you a selection of good firms to choose from, I cannot insist on perfection from any single firm. You want the cheapest advisor you can find? Do what I do and manage your own money. If you like this financial stuff, managing your own money is the best-paid hobby you could have. If you don't like this stuff, managing your own money is the best-paid chore you have available to you.
What To Do About AUM Fees
So, what should you personally do about AUM fees? Should you avoid hiring an advisor who charges them? I don't think so. As mentioned earlier, if you can get good advice from someone charging you nothing but an AUM fee while you have a sub-$500K Portfolio, you are likely coming out ahead of another investor paying a flat fee. That will take most doctors several years or even a decade before anything must be done.
Eventually, I hope your portfolio will grow to such a size that a typical AUM fee will represent an onerous fee. You should do the calculation each year to make sure you know what you are paying. The math is simple- portfolio size multiplied by the AUM fee. If the fee decreases with higher level of assets, be sure you understand exactly how that happens. For example, if the fee on the first $500K is 1% and the next $500K is 0.75% and the fee after that is 0.5% and you have $1 Million, are you paying $7500/year (the usual case) or $5K/year?
As that AUM fee moves into the 5 figure range, it's time for you to make a decision. Are you going to start doing this yourself, change advisors, or negotiate a lower fee? Your negotiation endpoint can be a lower percentage of new assets, a lower percentage of all assets, or perhaps a cap on total annual fees. Most advisors are likely to give you at least a small discount in order to keep your business, but an advisor with a full practice may feel no need to give you a discount at all (they're running for-profit businesses too and they only need to find 50-100 docs willing to pay their fees to have a very nice little business). In that scenario, you'll have to choose the DIY route or move to a true flat fee advisor, or at least another AUM advisor with a cap on their fees.
As you can see once you understand the nuances of the industry, AUM fees are not necessarily bad. The entire fee package must be looked at, compared to the value provided, and compared to the alternatives. It's fine to use an advisor who charges an AUM fee as long as you are getting good advice at a fair price.
What do you think? Should an AUM-charging advisor be avoided on that basis alone? Should a business accept advertising dollars from AUM-charging advisors? Have you had a good or bad experience working with an advisor under this model? Comment below!