Why AUM Fees Are Destroying Your Wealth.
Research strongly suggests that good financial planning services can carry significant benefits for high net worth investors. The question for the wealthy investor should be this – what is the appropriate wealth management fee and structure that is fair, reasonable, and ensures you are receiving quality advice?
A lot of work goes into building, refining, and executing a good financial plan. A good financial planner is marked by years of schooling and specialized training. Good planners typically have an MBA, JD, and/or a CFP. They have an in-depth understanding of a myriad of wealth planning topics, such as investment management, trust and estate planning, intergenerational wealth transfer, social security strategies, tax minimization techniques, and a host of others topics. They should serve as fiduciaries in all circumstances and for all types of accounts, and they should be current on political and regulatory policies that could impact you as a client.
Which is to say that it is a premium service for which you might expect to pay a premium fee. Unfortunately, in some instances the fees charged by a financial advisor or financial planner may actually be causing more harm than good. This is because almost all advisors charge their clients an assets under management fee, in which they subtract a significant portion of the client’s investment portfolio every year. These fees may seem small at first – typically presented as a percentage or “basis points” – but when viewed on a dollar basis the numbers for high net worth investors can be shocking.
This fee structure causes fees to grow exponentially as your wealth increases. For example, assume you have $3,000,000 invested with a traditional Wall Street financial advisor and you pay an advisory fee of .88% (the industry average for a $3,000,000 portfolio). That is $26,400 per year out of your pocket (or, more likely, your investment portfolio).
Fast forward a few years. The markets have cooperated and now your portfolio has grown to $4,000,000. Suddenly your .88% advisory fee is taking $35,200 out of your pocket each year. This continues over and over and over again.
We believe this is absurd. And over an extended time period these fees have an incredibly deleterious effect on your wealth and the size of your investment portfolio. The graphic below shows how significant AUM fees can grow over time.
Annual AUM Fees for a $3,000,000 Portfolio Growing at 6.5% Annually for 30 Years
How Should You Pay for Financial Planning and Investment Management Services?
Stop buying your advisor a new BMW every year!
A refresher: “Assets Under Management” (AUM) fees are the typical fee structure within the financial services industry. Under this model, investors pay a percentage of their portfolio to their advisor on an annual basis. At first glance this may seem reasonable. But here’s the unvarnished truth, gleaned by years of experience: AUM fees have no relationship to the amount of work your advisor is doing, or the value your advisor is providing.
In reality, these AUM wealth management fees look a lot like a wealth tax – you pay more simply because you have more. There are very few industries that can lay claim to the dubious distinction of having a similar business model to the IRS.
For many high net worth investors, their largest discretionary expense is the fee they pay their financial advisor. Under the traditional AUM fee model, for most high net worth investors, this expense will grow every year, for the rest of their lives, with no corresponding increase to the quality of the financial advice they receive.
Despite claims to the contrary, the amount of time, effort, and resources that a competent advisor must bring to bear on a client is nearly identical whether a client has a $1,000,000 or $5,000,000 portfolio. It is not an exaggeration to claim that – from the advisor’s standpoint – the only difference between these two clients is the number on their account statements. Consider the following:
- FINANCIAL PLANNING: Both of these clients require financial plans of similar complexity. They both have specific financial goals they wish to accomplish, specific cash flows they expect to realize, and a discrete amount of investable assets with which to work with.
- INVESTMENT MANAGEMENT: There is no discernable difference between them when it comes to investment management. Both portfolios should be rebalanced appropriately in order to remain true to their target allocation and benchmark. This allocation should have been derived via the financial planning process, and not via a more arbitrary method such as the “your age in fixed income” portfolio construction technique.
- SERVICE AND ATTENTION: Both clients deserve excellent service from a dedicated advisor, regular check-ins, ongoing financial planning support, and access to the principals of the advisory firm.
- FIDUCIARY: Both clients deserve an advisor who serves as a fiduciary in all circumstances, and for all account types. Their advisors should be required to act in the clients’ best interest under a legal standard that has real teeth.
Inherent Conflicts of Interest
Another issue with the AUM fee structure is it introduces an incentive for advisors (even fiduciary advisors) to provide advice and counsel that is not in the best interest of the client. There are inherent conflicts of interest embedded in the AUM fee structure and pricing model employed by most in the wealth management industry. Consider the following hypothetical situation:
A 63 year-old client of a Registered Investment Advisor (RIA) expects to live to age 86, but is unsure about when to file for social security. The client is currently paying a 1% (100 basis points) AUM fee on a $1,750,000 investment portfolio (equivalent to $17,500 per year). After crunching the numbers and analyzing the myriad of ways this individual could claim social security, the client’s investment advisor determines the optimal strategy is for the client to wait to claim social security benefits until age 70. This would result in a significantly higher social security benefit, as every year the client defers social security the annual benefit increases by nearly 8%.
However, the client has no other sources of income and would have to live off of the investment portfolio in the ensuing years until reaching age 70. Notice the dilemma for the financial planning or investment advisory firm – if the client begins drawing on the investment portfolio to pay for living expenses, the client will generate less revenue for the firm. The client would be better off deferring social security until age 70, but the financial planner or investment manager would be better off if the client began taking social security at age 63. This way, the client can avoid drawing from the investment portfolio upon which the AUM fee is being assessed.
We are not suggesting this is common. Most financial planners, particularly ones who have earned the prestigious CFP designation, are good, honest, upstanding professionals who do what’s right by clients in every situation, even when it would lead to less revenue for themselves. However, as we’ve seen in the recent past, not everyone in the financial advisory industry has clients’ best interests at heart. Why present another misaligned incentive that encourages advisors to act against their clients’ best interests? AUM advisory fees do not solve this problem. Flat fees do.
An Alternative to AUM Advisory Fees
We believe there is a better way. Wedmont charges a flat annual fee of $10,000 regardless of the size of your investment portfolio. The different between our approach and AUM fees can literally be millions of dollars.
Growth of $3,000,000
Wedmont vs Traditional AUM Advisor
As Einstein allegedly said, “compound interest is the 8th wonder of the world. He who understands it, earns it. He who doesn’t, pays it.” The compounding effects of AUM fees are terrific for your financial advisor and terrible for you.
If you are currently working with a financial advisor, take the time to calculate the amount of fees you are paying this year. These fees are often hard to find and your advisor may avoid answering the question directly. The best method is to locate the section of your account statements that lists the debits and credits in your account over a specific period of time. If you have an especially hard time finding your fees it should raise a red flag.
There is nothing wrong with paying for a valuable service – we all do it every day. But AUM fees are capricious and arbitrary. You and your wealth deserve better.
How is Wedmont so much cheaper than other firms?
The fact is that traditional Wall Street firms are inefficient. They pay inflated salaries to advisors who are primarily salespeople and utilize technology platforms that are expensive to maintain. Many are tied to the trappings of “old-school” brokerage houses (expensive office spaces, company cars, art collections, and expense accounts). All of these expenses are eventually passed on to clients.
Wedmont allocates resources where it matters – employing the most qualified advisors in the industry, licensing best-in-class investment and financial planning technology, and focusing on the Wedmont client experience.
How does the flat fee work?
Our fee is paid quarterly in arrears. One fee covers an entire household (both spouses and minor children), and there are no limits on the number of accounts or the size of the portfolio. In rare cases we reserve the right to charge different entities (for example, a family foundation) a separate fee.