Why Bob Veres Is Wrong on Flat Fees

First, this isn't the conflict that most anti-AUM fee advocates cite. More common are paying off client mortgages, holding non-portfolio cash reserves, and/or gifting to relatives or charities. All are valid concerns. AUM fees aren't conflict free; no business model is. But the good news is that these are clearly transparent conflicts to the clients, and therefore are easily managed. Advisors should have consistently applied guidelines for how they arrive at their advice in each situation, clearly disclose their conflict and let the clients make their final decision.

But the other side to the conflict-of-interest coin is the "identity of interest" with the clients that AUM fees create: When client portfolios increase in value, the advisors make more money, too. As I client, I prefer that arrangement, rather than a flat fee that pays the advisor the same no matter how my portfolio performs.

3. Revenue Mismatch
Veres writes: "The AUM model creates a dangerous countercyclical mismatch between revenues and workload at your firm. In most other businesses, if you run into a downturn, your firm will consequently have less business to do. You weather the storm by laying off workers or cutting capacity."

Having been an employee of six financial/publishing firms over the years, I can safely say this isn't really how those businesses work, either. With that said, the cycle nature of markets is certainly a challenge for independent advisors. Yet as many industry consultants will attest, many of the problems are self inflicted.

Inexplicably (as with financial publishers), many advisors run their firms as if bull markets will never end. Then they are "shocked" when client portfolios take an inevitable hit. However, the smart firms circle the wagons after extended bull runs, and weather the storms virtually pain free. Once again, the identity of interest with the clients should not be understated: when portfolios go down, advisors make less. I haven't seen a poll on this, but I can't help but think that this isn't not a bad thing in the eyes of most clients.

4. Where's Your Value?
To illustrate how "getting paid based on assets leads people to misunderstand where the great majority of [an advisor's] value lies, Bob tells a story about an advisor who explained his AUM fee structure to a wealthy prospect.

The prospect responded by saying: "If I let you manage my $6 million portfolio, you'll charge a percentage of the assets and also provide financial planning services, right? Suppose I give you just $1 million? Would you still give me financial planning advice?" 

Back in 1987, a prominent financial planner called it "the dirty little secret of financial planning." That is, few financial planners actually get paid for doing financial planning. For the past 40 years, planners have lamented this fact, and the current flat fee movement is just more of the same. Financial planning may be what people need, but more money is what they want—and what they will pay for.

Financial planning is a tool that strengthens an advisor/client relationship by increasing the client's peace of mind.

The current AUM fee model is gaining momentum with advisors in every area of retail finance services—brokerage, insurance, banking, accounting, etc.—for a reason. 

There's nothing wrong with trying to improve on an old model, but in our zeal to make things better, we need to remember why we went to the old model in the first place, so we don't end up repeating history and making things worse.