Why Do Most Advisors Still Base Their Fees on How Much Money You Have?
Recently, a publication targeted toward financial advisors published an article wondering if advisor fees based on assets under management (AUM) would soon be extinct. In just two sentences, this quote halfway through the article sums up precisely why the AUM model has survived for this long:
“It’s so popular because it’s easy, and advisors don’t have to communicate how much money that is; they just say, ‘We charge 1%.’ It doesn’t sound like a lot of money, but it is.”
Precisely. We live in a world where stores get our attention by advertising boldfaced discounts: 20% off! 30% off! 40% off?! Holy cow, they’re practically giving the store away! In that context, it’s easy to see how being charged “just” 1% sounds like a relative bargain.
In Fire Your Financial Advisor, Golden Reserve founder Greg Aler points out how silly this fee model would be for any other service:
“No one asks how much you paid for your car before they do your oil change. Or what you paid for your house before shoveling your driveway. Or your salary before quoting a knee surgery. Some lawyers may take a percentage, it’s true– but only if they win, which assures some service-based value alignment. There is no such alignment regarding the value between the consumer and the financial industry. Slapping every account from $50,000 to $10 million with the same fee… is either mind-blowingly lazy or mind-blowingly greedy or both.”
Retail financial advisors are quick to argue that the AUM fee model incentivizes performance that is mutually beneficial; when you make money, they’ll make money, too. In reality, it’s not such a win-win. There are clear conflicts of interest that don’t work in your favor. Consider this:
- Retirement-optimized investments won’t make your advisor the most money.
That’s because they tend to be low-cost and low-risk, which has less upside for your advisor. Simply put it’s not to their benefit to steer you away from high-risk, high-fee investments.
- Retirees are drawing down their accounts, not building them up.
You’re using the money you saved to live the Retirement you planned, (and hopefully taking distributions according to a tax strategy that will lower your overall tax burden). However, this reduces your total assets under management, thereby reducing what your advisor earns.
- AUM means your advisor makes money even if they did nothing at all.
Though your advisor might like you to think they can beat the market, they have no such superpowers. The market will continue its usual bull and bear cycles and your advisor will still collect a paycheck, even if they don’t touch your account all year.
It’s clear why the AUM model persists: for your advisor, it’s too good to quit. But for savvy retirees who know that 1% fee isn’t the bargain it seems, quitting is easy. Get a Retirement planner who works on a transparent flat fee, and let the AUM model go the way of the dinosaurs.