The majority of advisors charge clients using an asset under management (AUM) fee schedule. This is simple and well-ingrained in the advisor business model. But it presents a few challenges.
Benefits of AUM Pricing Model
There are a few benefits to the AUM pricing model, both for the investor and for the advisor. One benefit is that the advisor is incentivized to grow the portfolio – since their pay is directly tied to the account value. The advisor absolutely cares, from a purely financial standpoint, what happens to the value of the account. Another benefit may be that investors are used to the AUM pricing model; it isn’t foreign to them. AUM fees are fairly straight forward to calculate. Even if the advisor uses a tiered pricing model, it is easy to provide a simple blended (overall) rate that the client will pay.
The advisor benefits from the AUM model because historically, over time, the stock market increases. Using the Rule of 72, advisors managing an equity-heavy portfolio may see their fee, in dollars, double over a decade. Much more than the rate of inflation. There is no doubt this is good for advisors, not so much for investors.
Challenges of AUM Pricing Model
This brings about a pricing and fairness question – if the advisor is doing roughly the same amount of work, should the advisor’s compensation double just because the stock market went up significantly? After all, the advisor and investors, individually, have no influence over the market as a whole. If there isn’t a significant increase in other services offered (additional planning etc…), is a doubling in dollar fee justified in the service and advice provided by the advisor?
And that brings us to the real question when it comes to fees – value received. Pricing is only an issue in the absence of value. And value is perceptual and subjective. Perhaps the greatest challenge to the AUM pricing model is the investor’s individual perception of advisor value. It is often skewed because of the AUM model. Investor fees are calculated based on the account value, and in most situations come out of the account value. It doesn’t matter what the advisors says, the calculation and payment of fees signal that investors are paying for performance.
Signaling Your Value Through Your Fee Schedule
Most advisors will show investors a tiered AUM schedule, but make no mention of how they value themselves. Perception is influenced by how information is framed. Instead of using a tiered pricing schedule, why not break out the (blended) fee based on how you want to be valued? That could be very effective in combatting the, “I pay you for performance” perception and help investors value the advisor through the correct lens.
If you charge 1.00% AUM, you could break it down to 30bps for one value, 30 bps for another, and 40 bps for another. This is a quantitative way to demonstrate your value. Planning and investment management may be one of the values. Another could be accessibility / bandwidth. And another should be some representation of coaching/advice. No mention of trading, performance etc…
If we want someone to perceive us a certain way, sometimes the best thing to do is explicitly state how we want to be perceived. When it comes to how advisors price themselves, a fee schedule that ties specific values to a fee can do just that.