Whenever I speak with a new prospect, I’m always curious whether or not they have a concrete understanding of how fees and revenue are derived within my industry. Quite often I end up finding out that clients had no idea how much they actually paid their former advisor, or are even paying currently. Transparency has been increasing but there is still such a long way to go when it comes to consumers having an advocate so they can understand the ins and outs of revenue generation in the asset management landscape. For those reading this post that are unfamiliar with a general breakdown of how advisors are paid (as well as how much), please take a look at this link below. I will be summarizing the details afterwards and focusing largely on why I feel capped flat fees are the most advantageous for those seeking wealth management services.
Okay, so there are really three primary ways advisors get paid as you’ve seen. Those methods are through the use of commission based products and are transactionally based…by charging a percentage of AUM (assets under management)…or by charging some type of flat fee, whether it be retainer based, transactional, or hourly. You will get a different opinion from a variety of advisors when you ask them what is best for a client, but this is my take…and you’ll either agree with me or you won’t. Let’s take a look at a commission based model.
This model to me epitomizes a lack of transparency and is flush with conflicts of interest. It’s very difficult to have the utmost confidence in someone that has products they are selling, especially when one particular product generates a higher commission than the other. Even if someone does right by you, there will always be that voice in the back of your mind questioning whether or not it was absolutely in your best interest. By its very nature, this model is contradictory to upholding a fiduciary standard.
On that note, let’s break down what a fiduciary standard really means. The following is how the CFP Board has broken down what upholding a fiduciary duty means within their Code of Ethics and Standards of Conduct.
“At all times when providing Financial Advice to a Client, a CFP® professional must act as a fiduciary, and therefore, act in the best interests of the Client. The following duties must be fulfilled:
- Duty of Loyalty. A CFP® professional must:
- Place the interests of the Client above the interests of the CFP® professional and the CFP® Professional’s Firm;
- Avoid Conflicts of Interest, or fully disclose Material Conflicts of Interest to the Client, obtain the Client’s informed consent, and properly manage the conflict; and
- Act without regard to the financial or other interests of the CFP® professional, the CFP® Professional’s Firm, or any individual or entity other than the Client, which means that a CFP® professional acting under a Conflict of Interest continues to have a duty to act in the best interests of the Client and place the Client’s interests above the CFP® professional’s.
- Duty of Care. A CFP® professional must act with the care, skill, prudence, and diligence that a prudent professional would exercise in light of the Client’s goals, risk tolerance, objectives, and financial and personal circumstances.
- Duty to Follow Client Instructions. A CFP® professional must comply with all objectives, policies, restrictions, and other terms of the Engagement and all reasonable and lawful directions of the Client.”
This fiduciary standard is well known by advisors in the independent world, and it’s often echoed how a transactional and commission based model simply cannot live up to this standard. Given this fact there has been a lot of attention given to regulators and who should be allowed to call themselves fiduciaries. A majority of the advisors complaining about the commission model are utilizing a percentage of assets under management model. To their credit I do believe that this model is far better in that it is based in having an ongoing relationship with the client. There are far fewer conflicts of interest present within it as well. There are however still conflicts that I felt myself, while working at a larger wirehouse firm in Merrill Lynch. Let’s talk about these.
When charging a client utilizing a percentage of AUM model, the easiest conflict identified is that of the necessity to maintain as many assets as possible under direct management. This can present a conflict when an advisor is tasked with assisting someone who is looking to purchase a new home or perhaps an investment property. These types of purchases can require substantial down payments, depleting the assets being managed by the advisor. Maybe this client shouldn’t be getting involved with the purchase of an investment property, but what if they have a skill set that could bode well for venturing into this alternative investment. Can we be absolutely certain that the advisor recommending they avoid such an investment has their best interests in mind?
What about when accumulating as many assets as possible is top of mind for an advisor? One major source of asset transfers in this day and age is an employer retirement plan rollover. This could be a 401k or a 403b plan. Something rarely talked about from what I’ve seen is how this can end up limiting a client’s ability to take advantage of back door Roth contributions. Once you’ve rolled assets out of an ERISA based plan you’ve now created basis within a personal IRA for a client (assuming these are pre-tax dollars). This can greatly impact the tax efficiency and wonderful tactic of performing non-deductible Traditional IRA contributions before eventually converting them into a Roth. It’s something I struggled with often when operating under a percentage of AUM model.
Applying this in reverse, there are also strategies where you can potentially roll personal retirement assets back into an employer based plan. This can be highly beneficial for someone that is working well into their 70s. It affords these clients the opportunity to continue delaying RMDs when the income isn’t yet necessary, thus lowering their taxes. Especially in a world where more and more people are working part-time in retirement, this can be a wonderful strategy to employ. If an advisor is dependent upon having these assets under their direct management however, there is an apparent conflict of interest.
One final conflict I wanted to point out under this model is the constant desire to move farther and farther upstream, ultimately servicing the highest net worth client possible. It is inevitable that an advisor under this model will provide a higher level of service to someone paying them $40,000 – $50,000 annually, than the client paying them $5,000. As a quick aside, the fact that clients are paying those larger sums to advisors I think is simply inappropriate in our current investment landscape. Our firm believes in investing in a largely passive manner, while focusing on planning to create tax advantages for our clients. Data proves over and over again that low cost passive management inevitably beats out active management on a longer time horizon. For more on this feel free to read up by clicking here.
This tendency to move upstream and land as many higher net worth clientele as possible inevitably creates a long tail when it comes to revenue generation for an advisor. One where a select number of clients are paying a lion’s share of the advisors production. But the work being performed however isn’t all that much different between the smaller and larger client. Time spent with a household that has ~$500,000 in assets is relatively similar to that of a household with $5,000,000. There may be a few additional complexities between the two households, but it certainly isn’t enough to warrant paying 7-10x in fees. Morgan Housel elaborates in this article regarding the “craziness of asset based fees”.
These thoughts are one of the most compelling reasons as to why I started my own firm, hoping to provide a structure that made more ethical sense. So where does that leave us?
Flat fee-only wealth management is something of an outlier in the industry, and capped flat fees even more so. Very seldom will you find an advisor that charges capped flat fees while providing comprehensive wealth management services. When combining both portfolio management & financial planning offerings, there tends to be an inclination for advisors to charge using a model that is based on a client’s ability to pay, rather than on the level of service they are actually providing. But are we really acting as fiduciaries at that point? Perhaps we should not only look to reduce expenses for clients within their investment vehicles…but within our own fees as well. Isn’t that placing the clients interests above that of the professional and the professionals firm?
Yes…we as advisors have to make a healthy living and should be compensated in a fair and equitable manner, but can we justifiably charge someone 7-10x when the outlay in time is far less than said multiples? Perhaps 2-3x as a maximum is more appropriate and in line with holding one’s self out as a fiduciary. On top of this, technology and automation continue to reduce expenses for business owners in this industry, and I am of the opinion that these savings should inevitably be passed onto the consumer.
This all leads to my current structure where I capped my annual flat fee at $10,000. This cap applies to households with a liquid net worth in excess of $2MM. Could there be a situation where a higher fee is appropriate because there is a significant amount of complexities, or perhaps a household surpasses the estate tax exemption limits, absolutely. Generally speaking this is not the case however and thus I think the most fiduciary thing to do is to cap these fees and be more transparent about what exactly it is we do as advisors.
