A Fairer Way To Pay Your Financial Planner
Most people I talk to don’t know exactly how, or how much, they pay their financial planner. This is a real problem for these folks and one that the financial industry has been benefitting from for years.
Most planners charge their clients based on the amount of money they manage for them. This is called Asset Under Management (AUM) pricing, and I’m going to use this post to explain why I believe the AUM model is the wrong way to pay your financial planner. An alternative that’s better for clients does exist and quality planners are increasing ditching the AUM model to adopt this more common sense approach. I’m talking about paying your financial planner a fixed annual fee that is set according to your net worth. I’ll explain why, but first, a refresher on net worth.
WHAT IS YOUR NET WORTH?
Net Worth = Your Assets minus Your Debts
Add up your investment accounts, retirement accounts, real estate holdings, savings/checking…etc., then subtract any remaining student loans, mortgage(s), credit card debts…etc. and the resulting figure is your net worth.
This is important because my two objectives as a planner are:
1. Help clients clarify and establish their goals. Then, create an easy to implement a game plan to address any concerns and work towards those goals.
2. Grow the client’s net worth as effectively as possible for their appropriate level of risk.
The first objective can be tough to quantify. The second is easy to measure and it’s the first thing my clients see when they log into their client portal.
Here are 5 reasons why I believe setting a client’s financial planning fee according to his or her net worth is a better and fairer approach than the outdated and expensive AUM model.
1. IT BETTER ALIGNS OUR INTERESTS
How you pay your financial planner is hugely important. As you’ll see on my Fee Schedule, my fee is based on a percentage of your net worth that ranges from 0.7% – 0.2%. Tying my fee to your net worth means that the only way for me to earn more is for your net worth to go up (make you wealthier).
Mountain River Financial is a Fee-Only financial planning firm that operates under the Fiduciary standard. I do not sell any products. I do not receive commissions and I do not receive referral fees. You can rest assured we’re always on the same side of the table because I only earn more when your net worth increases and I will earn less if your net worth goes down.
2. IT REDUCES CONFLICTS OF INTEREST
When you pay your financial planner based on AUM, a conflict of interest arises between you and him. It’s in his best interest to manage as much of your money as possible so he can earn a higher fee. It’s in your best interest to achieve your goals and maximize your net worth. These two interests aren’t always in sync, which is why a conflict exists. These conflicts can be big. A few examples help illustrate this point:
Let’s say your planner charges 1% of AUM and he manages $500,000 for you. He would make roughly $5,000 per year. Suppose though, you wanted to use $300,000 of that money to pay down your mortgage or buy a vacation home. This might be great for you, but your planner’s fee would drop by $3,000 per year. Not so great for him. That’s a conflict of interest because using that money to meet your goals would require his fee to drop by 60%.
If he advised you not to pay down the mortgage, or not to buy the vacation home, you have to question if he is giving that advice because it’s right for you, or whether it is related to his wanting to retain that additional $3,000 a year from managing the full $500,000. With a fixed annual fee, there is no conflict. Regardless of how you used the $300,000, your net worth wouldn’t materially change and as such, the advisory fee wouldn’t be affected.
Or, say you have $100,000 invested with your planner charging 1% of AUM, or $1,000. Let’s also assume you’re also about to retire with $1,000,000 in your 401k. Nice work! Now, you can either leave your $1,000,000 in the 401k plan or you could roll it into an IRA and have your planner manage it. If you roll it into the IRA, your planner would then manage $1,100,000 and his fee would increase from $1,000 a year to $11,000 a year! That’s a big jump.
But, what if the 401k’s investment choices were top-notch and the plan had very low fees because of its large size? Your interests would likely be best served by leaving the money in the 401k to take advantage of those low fees and excellent investments and not pay an additional $10,000 per year to your planner. Your planner’s interests, on the other hand, would unquestionably be best served by having you roll that money into an IRA that he could manage and charge on.
These interests are in direct conflict. Leaving the money in the plan would save you $10,000 per year, but would cost him $10,000 per year in lost fees. There would be no conflict with a fixed fee based on net worth because your net worth would remain constant regardless of whether you left the money in the plan or rolled it into an IRA. As such, the fee would also remain constant.
Or, let’s say your planner charges based on AUM and manages $50,000 for you. Let’s also assume she has done well and your portfolio has averaged a 12% annual return. Is she doing you any favors if you also have $50,000 in credit card debt with a 17% APR? Of course not. It would be a no-brainer to use that $50,000 to pay off the debt, otherwise, your net worth would actually be going down every year even if your 12% return continues.
Additionally, an investment portfolio requires serious risk to generate a 12% return while the credit card debt accumulates interest at 17% APR every day. A conflict exists here because your planner’s fee would drop to $0 if she advised you to do what’s best for you and pay off your debt with the money she was managing.
There wouldn’t be a conflict in this situation with a fixed annual fee set according to net worth. In that instance, both you and your planner would be better served by paying off your credit card debt with that $50,000 because it would prevent your Net Worth from continuing to decrease.
The fixed annual fee eliminates the conflicts that arise in these examples and many others. Individuals want to increase their net worth and advisors want to earn more. With a fixed annual fee tied to net worth the only way for the planner to earn more is to grow the client’s net worth.
3. IT’S MORE TRANSPARENT
A fixed annual fee is completely transparent. We charge your bank account or credit card directly each month so you know exactly how much you pay us. We believe every client should know this and we believe this knowledge facilitates the open and honest relationship required for a successful client/planner relationship. With AUM pricing, how much you pay your planner changes each billing period and finding out how much you pay is often hard to find on your account statements.
Here’s how it works at Mountain River Financial. We collect the information needed to calculate your net worth. We multiply your net worth by the appropriate percentage from our fee schedule to get an annual fee. We then divide by 12 to calculate your monthly fee.
Example: A client with a net worth of $650,000 pays $650,000 * 0.6% = $3,900 per year. $3,900/12 = $325 a month. We recalculate the fee every year based upon a client’s updated net worth.
4. BETTER FIT FOR FINANCIAL PLANNING
Mountain River Financial provides financial planning and wealth management services for clients. Financial Planning covers six main areas:
1. The Basics – Budgeting, Debt Management, and Emergency Savings
2. Investment Planning
3. Insurance Planning
4. Tax Planning
5. Retirement Planning
6. Estate/Legacy Planning
It’s difficult to tackle any one of these areas in isolation since they are all quite interconnected in the real world. That’s why financial planning involves some degree of all of them, even if just a quick review of things in some cases. With six areas of planning, it seems strange to charge a fee based on just one area (Investments), even if it is a very important one. The AUM model has prospered because it is simply too lucrative for most advisors to give up. We want to change that.
5. YOUR FEE IS SPECIFIC TO YOU, PURPOSEFULLY
A personal financial plan is just that, personal. Proper plans are built on more than numbers and spreadsheets, but also on the preferences, goals, and concerns unique to every individual. The plans we create for clients reflect that and are fully tailored for them. Likewise, the fee our clients pay is different for everyone (though all are calculated in the same way). Our Fee Schedule is structured to reflect the increased complexity that comes with increasing levels of net worth.
There is a fairer and better way to pay your financial planner. In my prior role, I spent seven years with an institutional Registered Investment Advisory firm in Connecticut where I consulted with financial planners all around the country. The final five of those years were spent doing in-person consulting in these planner’s offices working on how they could better serve their clients and run their businesses.
How these planners charged clients was a central part of our discussions and after hundreds of these interactions, I can confidently say that the fixed annual fee model is the best and fairest approach for clients to pay their financial planner. A successful financial planner/client relationship requires a strong foundation of trust. I set my annual fee based on client net worth because I believe it is the fairest way and the best model to sustain that strong foundation of trust.
If you’re interested in learning more, please get in touch.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Robert Stromberg, and all rights are reserved. Read the full Disclaimer