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. In this post, I’m going to explain why I  believe the AUM model is the wrong way to pay your financial planner. An alternative that’s better for you, the client, does exist, and quality firms, like Mountain River Financial, are increasing ditching the variable-fee AUM model to adopt this more common sense approach to billing for their services. This approach uses a fixed monthly fee (adjusted annually) that is set according to a client’s overall net worth. Keep reading and I’ll lay out 5 reasons why this is a better way, but first, a refresher on net worth.

WHAT’S 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 student loans, mortgage(s), credit card debts…etc. and the resulting figure is your net worth. It represents exactly how “wealthy” you are.

Here are 5 reasons why paying your planner according to your overall net worth is a better and fairer approach than the outdated, opaque, and expensive AUM model.

1. BETTER ALIGNMENT OF INTERESTS

How you pay your financial planner is incredibly important. As you’ll see on the Mountain River fee schedule, our fee is based on a percentage of your net worth that ranges from 0.6% – 0.2%. Tying the fee to your net worth means that the only way for your planner to earn more is for your net worth to go up. It’s that simple.

Mountain River Financial is a Fee-Only financial planning firm that operates under the Fiduciary Standard. We do not sell any products; we do not receive commissions; and we do not receive referral fees. You can rest assured that we’re always on the same side of the table, because the only way for us to do better, is if our clients are also doing better and growing their wealth.

2. IT REDUCES CONFLICTS OF INTEREST

This is huge. When you pay your financial planner based on AUM, a conflict of interest arises between the two of you. It’s in his or her best interest to manage as much of your money as possible so he or she can earn a higher fee. It’s in your best interest to achieve your goals and maximize your net worth. Because these two interests aren’t always in sync, a conflict exists. These conflicts can be significant. A few examples help illustrate:

EXAMPLE #1:

Let’s say your planner charges 1% of AUM, and she manages $500,000 for you. She would make roughly $5,000/year. Suppose though, you wanted to use $300,000 of that money to pay down your mortgage or buy a vacation home. While this might be great for you and totally appropriate, your planner’s fee would drop by $3,000 per year. Not so great for her. That’s a conflict of interest because using that money to meet your goals would require her annual fee to drop by 60%!

If she advised you not to pay down the mortgage, or not to buy the vacation home, you have to wonder if she is giving that advice because it’s right for you, or because she wants to retain that additional $3,000 a year from managing the full $500,000 investment portfolio. 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 impacted by the advice that was given.

EXAMPLE #2:

Say you have $100,000 invested with your planner charging 1% of AUM, or $1,000/year. Let’s also assume you’re about to retire with $1,000,000 in your 401k. Nice work! Now, you can either leave the $1,000,000 in your 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 quite the increase and all because he is managing one additional account.

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 you an additional $10,000/year 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. It would be impossible not to question a recommendation to roll money out of an employer plan when working under the AUM model. 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 not be impacted.

EXAMPLE #3:

Let’s say your planner charges based on AUM and manages $100,000 for you. Let’s also assume she has done pretty well, and your portfolio has averaged a 8% annualized return. But, what if you also have $50,000 in credit card debt with a 17% APR? Your financial planner is absolutely not helping you by advising you to keep your money invested in your account. It would be a no-brainer to use $50,000 from your investment account to pay off the debt, otherwise, your net worth would actually be going down every year even if your 8% investment return continues and her fee would go up! Additionally, an investment portfolio requires material risk to generate a 8% annualized return. The credit card debt accumulates interest at 17% APR every day, guaranteed.

Another big conflict exists here because your planner’s fee would be cut in half (assuming this was the only account she managed) if she advised you to do what’s best for you and pay off your debt using the money she was managing. There wouldn’t be a conflict in this situation with a net worth-based fixed fee. In that instance, both you and your planner would be better served by paying off your credit card debt with that $50,000 because doing so would help grow your net worth.

The fixed fee eliminates the conflicts that arise in these examples and nearly every other!

3. IT’S MORE TRANSPARENT

A fixed annual fee is completely transparent. We charge your bank account 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 partnership. With AUM pricing, the amount you pay your planner changes each billing period, and finding out how much you pay is often difficult 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 $900,000 pays $900,000 * 0.6% = $5,400 per year.  $5,400/12 = $450 a month. We recalculate the fee every year to reflect the 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 is much more than just investing. Proper 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. Good financial planning involves some degree of all of them. Given the integrated nature of these 6 important areas of planning, it’s simply not in the client’s best interest to be paying a fee only based on one area – investments – even though it is an important one. The major problem is that the AUM model is simply too lucrative for most advisors to give up!

5. YOUR FEE IS SPECIFIC TO YOU, PURPOSEFULLY

A personal financial plan is just that, personal. Proper plans are built on not just 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.

In Conclusion:

There is a fairer and better way to pay your financial planner. In my prior role, I spent seven years with an institutional wealth manager 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 planners’ 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 a fixed annual fee that is set according to your net worth is the best and fairest approach for you to pay your 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 am sure it is 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