The Flat-Fee, Fee-Only Advantage – Part 3: Aligning Fee to Value Provided
This is Part 3 of a three-part series on how Fee-Only financial advisors get paid. In this series, I have highlighted the advantages that the Flat-Fee compensation model has over the AUM model. In Part 1, I addressed conflicts of interest and in Part 2, I reviewed how pricing compares over time.
As strong as those arguments are for Flat Fee over AUM, the topic of this post makes, in my opinion, an even stronger argument for working with a Flat-Fee advisor. Here it is in a nutshell: The AUM method does a poor job of aligning the value of the service to the value of the advisor’s fee. As I explain below, the value of the service is, to a large extent, independent of the value of the portfolio. Yet AUM advisors insist on charging fees on portfolio size and:
on something they have little control over
on a poor indicator of the amount of work to be done
in a way that discriminates against many of the families that need the most help.
These issues are largely avoided under the Flat-Fee compensation model. Let’s look at each of these points more carefully.
Little Control Over Portfolio Size
The first issue is that AUM advisors are charging fees on something (portfolio size) that they have very little control over. Your portfolio size is a result of your savings rate (or lack thereof), market returns and other occasional contributions (e.g., inheritances, bonuses, stock compensation). Financial advisors generally have little to no control over any of these things.
Take the savings rate. As a financial planner, I might recommend that you contribute 15% of your income to your portfolio based on your goals. But you decide to save 25% instead because you’re a go-getter and want to grow your portfolio even faster. Why should my compensation be higher because you deemed it prudent to save a little more? Conversely, why should I be dinged because of your expensive luxury shoe habit that doesn’t allow you to save as much? My advice was objective, factual and based on best industry practices, so it stands to reason that the value of the advice is the same, whether you decide to follow it or not.
It’s the same issue with market returns. As much as we would like to get the credit in good market-performance years but none of the blame in bad years, financial advisors do not provide portfolio returns. Financial markets provide returns. I had no control over the S&P 500’s 27% gain in 2021 nor its 20% loss in 2022. That’s not my job. My job is to recommend and implement an appropriate asset allocation and to keep you from doing something foolish like chasing market performance or selling at market bottoms. Here, again, is a clear example that the advice we provide is objective and based on our education and experience. Therefore, the value of advice should be consistent, regardless of how the market performs.
Yet, I heard stories from AUM advisors in 2019, 2020, and 2021 about how giddy they were that they were generating much more revenue due to fabulous market returns (the S&P 500 returns were 29%, 17%, and 27%, respectively, in those years). And then I heard sob stories in 2022 because their compensation dropped significantly after a brutal year in the markets. Yet none of the market performance was under their control. To me, this makes no sense. The value of the advice was the same in each of those years, so it stands to reason that a flat fee is a better method to price the service.
This same logic applies to circumstances that can grow the portfolio significantly like inheritances and bonuses. I think you can easily see how crazy it is to charge on something that we have no control over. Why, then, do AUM advisors think it’s rational to link their compensation to these things? It’s like your doctor charging you based on your weight or your mechanic on your car’s mileage.
Further, the investment management method that most advisors use nowadays (passive, diversified, low-cost and tax-efficient) is largely a set-it-and-forget-it approach that is better aligned to flat fees. Whether your portfolio is $100,000 or $1,000,000, we’re essentially entering the same keystrokes to allocate or rebalance your portfolio because we use percentages. A 30% allocation to US stocks to a large portfolio does not cost us more time or money to type into a computer than the same allocation to a small portfolio.
Now, if you’re paying your advisor to “beat the market,” then an AUM fee might be appropriate. But most good financial planners are not playing that game (and I caution you to not play it either) because they know it’s a game that almost nobody wins. Instead, they’re (hopefully) providing comprehensive financial planning and giving you advice on things that we actually do have control over like tax and estate planning. Which leads to our second issue: portfolio size is a poor indicator of the work to be done for a client.
Portfolio Size Is a Poor Indicator of Work To Be Done
I can tell you from firsthand experience that some of our clients with very large portfolios have less planning time needs than clients with little or no portfolios. That’s because the large-portfolio client already pulled the right levers and is in cruise control, benefiting from their prior hard work. There’s planning to be done, for sure, and it has large dollar consequences because of the extra zeros in their portfolio. But the planning is not at the same intensity as someone who is scrambling to get started building a portfolio. The small-portfolio client has to create a cash flow statement, prioritize debt repayment, tackle student loans, set up retirement accounts, fund a home purchase, set up their estate documents, adjust their insurance, review employer benefits, etc. Sometimes the amount of work isn’t even close between small- and large-portfolio families. But that is not what AUM advisors want you to believe, and their fees demonstrate that.
Even if the workload is similar for all clients, why should some pay more than others? Let’s say you have a $2 million portfolio; your fee is $20,000 per year. I can tell you that it’s very likely that your advisor is giving you the same level of service as someone with a $1 million portfolio that is paying $10,000 per year. That’s because advisors tend to adopt a financial planning process that they apply to all their clients, regardless of portfolio balance. And when it comes to investment management, a larger portfolio usually does not require that much more time or effort. A little more perhaps (mostly due to tax, gift, and estate planning, not portfolio management), but certainly not twice the time and effort. As this study shows, advisors working with clients of all portfolio sizes tend to work roughly 40 hours a week.
It should be obvious, then, that a portfolio’s size is a poor indicator of the work to be done. Flat fees, on the other hand, address the work = fee issue nicely. All Flat-Fee models (hourly, project-based and subscription-based) can be adjusted up or down from a baseline fee to account for more or less work. And that’s exactly what most Flat-Fee advisors do: they adjust their fees to account for the complexity. For example, our fees are higher in the first year because of the heavy lifting that is usually involved in getting the financial plan in place but decrease when we’re able to put many things on cruise control. It really can be that simple.
Discriminating Based on Finances
For me, the biggest issue with the AUM model, and the clearest example of how it doesn’t align with our service offering, is the minimum balance requirement. This prerequisite discriminates (maybe inadvertently, maybe intentionally) against families and individuals that also need financial planning and are more than happy to pay for it. That’s because the AUM model requires you to have assets for your advisor to manage before he or she is even willing to talk to you. And not just any amount of assets, but enough assets (usually $500,000+) so that AUM advisors can earn sufficient income to justify the services they are providing. In other words, $500,000 in investable assets is the threshold you have to cross before you are worthy of their services. What kind of bullshit barometer is that? What backward era are we living in? SMH. The financial industry is so creative when it comes to creating financial products that you don’t really need, yet it can’t (won’t?) solve this issue.
For many families, a “minimum balance” requirement puts much needed financial planning out of reach, even though they are willing and able to pay for advice out of their incomes. Most families don’t have $500,000 sitting around in a brokerage account yearning to be managed. I certainly don’t. Instead, like me, their assets are in things like 401k accounts, 529s, Health Savings Accounts and real estate—none of which can be managed by the advisor.
This is a total shame because when families have many moving financial pieces, it’s crucial that they have a thinking partner that can guide them through the thinking process. Many families have more than enough income to pay for the fee. Why, then, does the AUM advisor require that the fee be paid from their portfolio? What other profession requires that you pay for your services from a specific account? It’s ludicrous. Once again, Flat Fee model to the rescue. Many other Flat Fee advisors that I know believe, like me, that everyone deserves professional financial advice, regardless of portfolio size. I give a huge shout-out to organizations like XY Planning Network and Garrett Planning Network that are at the forefront of change when it comes to breaking the minimum fee requirement.
In this series, I’ve highlighted the many benefits of working with a Flat-Fee advisor over one who charges AUM. Not only does the Flat Fee model reduce conflicts of interest, it also aligns the value of the service (i.e., objective advice) to the value of the fee. And in most cases, the Flat-Fee model will be less expensive to the client in the long run, allowing the client to keep more of their investments.
Although at times in this series I’ve taken a light-hearted approach to prove my point, I feel this issue deserves much more serious attention, especially from you, the client. Many unsuspecting families can’t imagine what goes on in our industry and, therefore, don’t know what questions to ask. Unsurprisingly, financial advisors, with their lucrative lifestyles on the line, are not willing to share it. I’m not saying that advisors don’t deserve to make a good living. I just don’t think they ought to be able to do it without their client fully understanding how they’re getting paid.
I feel so strongly about Flat-Fee pricing for financial planning and investment management that not only have I adopted that Fee-Only model for my pricing, but I'm also working as an advocate to persuade more advisors to move away from the AUM model. Keep an eye on this space and follow us on Instagram, Facebook and Linkedin for more information about my upcoming speaking engagements about why all financial planning should include Flat Fees and not exclude anyone based on portfolio size.
And forward this to your friends and family. Sure, I'd love to be your financial planner. But even if you're considering another advisor, at the very least, I hope everyone understands their payment options. Nowadays it doesn't have to be the way it always has. Flat-Fee, Fee-Only financial planning is the future. And there's no reason you should be paying any more than you have to for financial advice that will help you live the life of your dreams.
Read Part 1 and Part 2 of our Flat-Fee, Fee-Only Advantage series.
Read the entire series.
I provide a free, no pressure15-minute intro call to give you a chance to ask questions about our services, fees or whatever else is on your mind related to your finances, your future and figuring out how to live the life of your dreams right now.
