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Why Paying Assets Under Management Fees is Like Getting a Car Loan From A Used Car Dealer

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What sort of payments can you afford?

“Why is it that anyone driving slower than you is an idiot, and anyone going faster than you is a maniac?”
–George Carlin

People hate buying cars from dealerships. The stereotypes abound. The white-shoed salesperson. The slimy process where he has to go “check with his manager” to see “what we can do for you.” The paperwork. The additional fees that get tacked on in the end. The enormous price tag that goes with buying most cars. It’s no wonder that most people would rather experience brain surgery without an anesthetic than go through buying a car.

There is one way which car dealers work to make the buying process appear easier. Instead of making you write a big honking check for whatever the car is worth, which makes Monkey Brain scream in his cage, they reframe it in terms of small amounts – “only” $400 a month. They don’t even, usually, tell you the interest rate. They just want you to think in terms of a small payment compared to the potentially large payment that you could make if you paid in cash up front. They also divert your eyes away from the total amount of money that you’ll pay over the life of the loan, which is significantly higher than what you’d pay right now if you just wrote a check.

If they’re smart, they go even one step further. They have the payment auto-drafted out of your bank account when the payment is due rather than making you actually go through the pain of having to write a check. As Dan Ariely explains in his book Predictably Irrational, it’s not necessarily the amount of the payment which causes pain, but, rather, the payment itself.

Thus, when you’re at the car dealership, signing up for that loan, Monkey Brain thinks that he’s avoiding pain now by not having you write a check to pay for the car in cash. Instead, he’s signing Future You up for dozens of additional psychic knife wounds each time you have to make that payment. But, if the money is automagically drafted out of your account, you don’t have to write the check, and you don’t have to activate those pain centers in your limbic system. Monkey Brain gets to have his cake (“VROOM!”) and eat it too!

It’s not until later when you do a little accounting and wonder “if I made all of this money, where did it go?” that you start to realize that you were had. You could have written the check up front and not paid the car dealership or the bank all of that interest. You would have more money now and could buy MORE bananas! Bad Monkey Brain!

When you look for financial planning advice, it’s easy to fall into the same money pit that Monkey Brain falls into at the car dealership. You go to your strip mall financial advisory firm with branches nationwide and you walk in looking for some advice on what to do with your money so that you have a better chance at retiring when you want without having to eat cat food when you stop working.

The advisor beams with glee. He explains to you that he can invest your money for you and that his great “skill” will help you out against all of the vicissitudes of that mean, nasty, old Mr. Market. Just hand him the keys to your accounts, or, better yet, let him move it over to his brokerage, and he’ll take care of it for you. Plus, even better, you don’t even have to pay money up front! All he’ll do is remove 1-2% of your total net worth every year at the end of the year so that you don’t have to be bothered with writing a check.

This is called an assets under management (AUM) model of financial planning, and it will slowly rob you blind. The problem with this model, from you, the investor’s perspective is that you never have to write the checks. You avoid the pain. Monkey Brain can participate in willful blindness about what this is doing to your nest egg because you don’t light up pain centers in your brain by having to write a check to your “investment advisor.”

Let’s compare how that model looks against an hourly model (mine). If you use me, you’re probably going to have to lay out about $2,000 up front. Monkey Brain is going to scream and scream and scream about how many bananas that could buy, and he’s going to send images of the 183” flat screen TV or the closet full of Jimmy Choo shoes flashing through your mind’s eye.

At the end of our work together, barring an unexpected major turn of events in your life (“Really? The lottery numbers were 1-2-3-4-5-6?!? AND Bill Gates was actually my illegitimate uncle and left all of his money to me?!?”), you’ll be done. You’ll be educated, set, and have a plan tailored to your specific life circumstances, and you’ll know what to invest in and WHY to invest in it (hint: no front-loaded mutual funds).

If you go to the strip mall financial planner with offices nationwide staffed by the fresh-out-of-college with no real world experience wide-eyed salesperson “investment advisor,” you’re going to pay, on average, 1% of your invested assets every year.

Let’s assume, for the sake of a simple set of mathematical assumptions, that you have $250,000 worth of investable assets and you’re contributing $10,000 a year to that amount through age 65. You’re 35 and will live another 50 years. At age 66, you’ll start withdrawing $75,000 and increase it 3% each year for inflation. The market returns 5% every year (remember, this is a simple example; the real market doesn’t work this way AT ALL).

How much are you going to pay the strip mall financial planning firm with the AUM model to, in all probability, underperform the market?

You’ll, in this example, die with $1.44 million in the bank. However, you’ll have paid the strip mall financial advisor $436,969.52 for the privilege of playing with your money.

How much does this assets under management fee cost you?

If you weren’t paying the fee and instead paid $2,000 up front one time to get proper financial planning and training so that you didn’t feel like you needed someone else to manage your money for you and earned the same return (statistically likely), you’d die with $1,975,498.29 in the bank.

That’s $533,303.31 more.

So, you’re engaging in a wealth transfer from yourself to your “investment advisor” of $436,969.52 over your lifetime. In exchange for this “service,” which, as a matter of probability, means that you underperformed the market, you wind up over a half a million dollars poorer than you would have otherwise been had you been willing to pay a little up front to fully educate yourself and properly plan to manage your own assets.

A half a million poorer because Monkey Brain didn’t want to write a check up front and preferred to stick his head in the sand and pretend that other payments weren’t occurring.

Furthermore, a recent survey of investment advisors found that 93% of them suffered from “post-traumatic stress disorder” symptoms during the crash of 2008. Why? Because they were trying to “tactically” invest money; yet a study in 2012 showed that investors who try to time the market (another phrase for “tactically” investing money) underperform the market.

Yes, if you’re paying someone else to manage your money, your Monkey Brain is paying their Monkey Brain to play with fire.

This doesn’t even account for the lack of actual financial planning associated with many of these strip mall investment advisors. They just want to take your money and invest it (while taking their fees) without even covering the entire gamut of your financial life. As a result, you don’t change your behaviors, save more, spend intelligently, or have any sort of actual plan. They’re just playing the markets with your money.

If you go to an investment advisor who wants to manage your money and take a percentage of your assets, you’re doing the investment planning equivalent of walking into the used car lot and financing your purchase on a 96 month note. You’re falling for the same psychological tactics used by car salesmen to make paying much, much more money seem like you’re paying less. Except, this time, because you’re financing, you’re doing the equivalent of buying a car with a major oil leak and horrible gas mileage. You might not pay up front for it, but you’ll pay a lot more in the end. There are very few scenarios where it’s more cost effective to use the assets under management type of financial advisor, and in almost every case, you won’t have enough capital to get the attention of one of these advisors.

Do you want to see how this arrangement would affect your situation? I’ve included a worksheet so that you can play around with the numbers to see just how much you’d be impacted. Feel free to use your own assumptions!

Here’s the worksheet!

Has an investment advisor tried to convince you that he could outperform the market? Have you asked him how much you’d wind up paying over your lifetime for him to manage your money? Have you asked him to prove to you in a statistically significant way how he can consistently outperform the market while maintaining the same amount of risk? If you want to talk in financial planning terms, tell him to statistically prove his alpha; if he doesn’t understand that phrase run far away.

Does the thought of potentially losing an enormous sum of money because of hiding fees make you want to throw up? Every time I hear someone tell me a story about a strip mall “financial advisor” who takes people’s money, it makes me sick.

What have your experiences been? Tell us about it in the comments below, and please share this article with your friends!

By Jason Hull, CFP®

11 replies on “Why Paying Assets Under Management Fees is Like Getting a Car Loan From A Used Car Dealer”

I definitely agree with you here. I am not comfortable charging for AUM. I have seen people not being served well by an AUM advisor. Once he got his payday, the advisor neglected the client, probably to spend more time collecting up other clients and their assets.

For some other perspectives, Mike Piper put together a Q & A on different fee models:
http://www.obliviousinvestor.com/asking-the-advisors-how-to-pay-for-investment-advice/
Rick Ferri makes a good case for AUM as long as that is how the client is best served, particularly someone who can’t or doesn’t want to DIY. Rick also tells you upfront that he uses ETFs and index funds to match the market, not to outperform the market.

Mike Kitces has another take on the fee-only retainer model here:
http://www.kitces.com/blog/archives/478-Three-Financial-Planning-Business-Models-To-Effectively-Serve-Gen-X-And-Gen-Y-Clients.html

I, as a young 2ndLt, was once suckered into the notorious commission-based model. Just like you’re saying, the ‘Monkey Brain’ said, ‘Look! It’s free advice! How could that not be great?’ It took about 3 or 4 years to figure out how stupid that was. It took a few more years to find the right advice on how to do it myself.

If someone doesn’t want to do DIY, then that’s their decision, but that should be a fully informed decision, including how much that person can be expected to pay over a lifetime. I do like Rick and at least he’s honest about what he’s trying to do. If it’s a trust situation, I understand AUM, but, again, why is it a percentage of assets under management? If I’m mirroring index funds to match the market, I’m not putting in incremental effort to manage $500,000 versus $1 million. It’s all profit. It should be flat fee AUM to cover the effort of management and the requirements that the SEC puts on you for reporting.

You and I were both suckered into that same notorious company, I suspect, who likes to use previous junior military officers and senior non-commissioned officers to spew out a bunch of chart porn and sucker you into paying a 5.9% front load. Holy cow, if I could put that company, along with the strip mall “investment advisors” out of business, I’d have reached a pinnacle in my professional life.

Whether the intentions are good or not, the math simply doesn’t add up. 1% every year whether you make money or not is going to eat your retirement funds! The new normal is about 4-5% annualized. If you are going to give away 1% off it, that just doesn’t make sense.

Good, common sense article!

Hi Sarah–

I’m sorry that you feel offended. Have you actually looked around at the website to understand that “Monkey Brain” is what I term our limbic system due to its driving urges to make us act in the moment and which most closely resembles the brain structures of monkeys? Perhaps if you take a look at a few articles which explain how our limbic system undermines our best efforts, you’ll be able to see past the term, or, better yet, understand its context, and apply the lesson in this article rather than leaving. If not, I’m sorry; unfortunately, I can’t please everyone.

Hey Jason,

Nice article! While I’m in full agreement that the AUM model (even for fee-only advisors) is a rip off, I just don’t think most people will take your financial plan and run with it for the rest of their lives. Sure, there may be a small percentage of your clients that become do-it-yourselfers because of your great education, but the vast majority would like some hand holding and assistance as they walk thru life.

Now, I agree the hand holding should not cost an arm and a leg. That is why I would prefer to see a retainer based model became the default where the client knew they would get 10 hours of service a year for a $4,000/yr retainer (just pulling numbers out of a hat here). If the client needed more or less time, the price could be adjusted yearly to reflect the additional efforts needed to better serve the client.

Now, you could very well serve a client with this model using hourly planning each year, but studies show the high saliency of the fees actually cause the client to not call when they need help (same as you referring to the high upfront fee for a full financial plan)! That is exactly the opposite of what they should do and handcuffs your ability to help them.

And even though portfolio management using low cost index funds is not difficult, it is nice to have a yearly meeting to update the client of any changes or need for changes. Other benefits include rebalancing, tax loss harvesting, adjusting asset allocation based on changes in life circumstances, yearly tax planning, etc. Those are all real services needed for those that do not wish to DIY.

And as Dr Bernstein’s research has shown, maybe the most important aspect to an investment management relationship is the hand holding and barrier between the client selling all his/her assets during the next bear market.

Just some of my thoughts. Didn’t intend for it to turn into a book. Keep up the good work!

Hi Gabe–

Thanks for commenting, and I don’t mind a book! 🙂

I’m not averse to a fixed price retainer approach if that’s what is necessary to change the behavior. Ideally, though, the education during the initial engagement is sufficient enough to remove the need for the Bernstein barrier. The use of a financial planner shouldn’t be a crutch, and we really shouldn’t be money therapists, inviting you to come sit on the couch every time you have a bad dream. If someone uses a retainer arrangement, then the plan should be to wean the person off of the retainer arrangement as soon as possible.

Maybe my bigger, but unarticulated (or not clearly articulated) beef is that planners view their clients in terms of cash flow into the firm. There was a vibrant discussion on a fee only financial planner group in LinkedIn (alas, not an hourly, fee only group) about how it was impossible to build up a financial planning practice on hourly fees only and that the planner should be looking at how to grow the enterprise value of the firm via asset management because of the recurring revenue stream.

I was blown away by that. A planner’s first thought shouldn’t be “how much recurring revenue can I get” but, rather, “what serves my client’s best interests.” I’m not naive about business; I’ve been there, done that, got the successful exit t-shirt. The best way to grow a business, though, is to serve and serve well in a way that benefits both sides.

The perceived high salience of the fees, as you reference, is due to the fact that AUM arrangements aren’t particularly front about the overall costs. Clients don’t understand what should be the much higher salience of the overall costs because of cost deferral. They don’t write a check for it, so it doesn’t hurt. I know that’s a battle against psychology and Monkey Brain that I’m not going to win.

An alternative model could be the financial planning equivalent of Legal Shield (“we have financial planners, and we’re not afraid to use them”), but that’s really just another recurring fee model which provides people something they don’t really need. How often do you really need a lawyer or a planner? A handful of times, perhaps, and then you should be done.

Maybe I have too much faith in humanity and in the power of my readers and my clients to beat their Monkey Brains, but in a vast majority of cases, people shouldn’t need hand holding once they go through the planning process. Honestly, having a behaviorally driven market benefits those of us who do not invest behaviorally because it creates opportunities for us to buy things on sale.

Jason-

Glad to hear your thoughts. To some up my answer to your reply, I do think you have too much faith in humanity if you think the majority of the people across the world can take a great financial plan and run with it the rest of their lives. I used to have ideas just like you, but I’ve just found too much irrationality in decision making by everyone I know to think otherwise. I really do hope you prove me wrong, though!

About the LinkedIn discussion, I understand your frustration. But unless a fee only hourly planner is a great marketer or salesman, truth is that he/she has to find some way to get clients in the door or else they won’t be able to keep the lights on. I agree that a fee-only planner has a duty to put the client’s interests first, but any self-employed person is a salesman to some extent. It is a fine line between the need to build a profitable business to feed your family and doing what is best for your clients. I’m sure none of us get that right all the time!

While I’m not saying it would be perfect, something like the following might work out best for both the planner and the clients he/she serves.

Hourly Planning Fee – $150/hour
Flat Fee Plans Depending on Complexity – $1,200 – $3,000
Investment Management w/ Ongoing Financial Planning – $2,000 – $4,000 flat fee per year. Fee could be based on net worth with a minimum and cap.

This way the client could continue with the relationship if they wished to not DIY at a price that would make sense to them assuming they followed your advice and started building wealth. I guess the main difference is that I do see value in an ongoing relationship where you might not. In your ideal world, would investment management disappear as a profession?

If it was just as simple as learning and implementing, clients wouldn’t need our help at all. All of us in “knowledge professions” have basically lost the war to Google. What I mean by that is information is completely free if you have internet access.

I started my career in the tax business. Every business owner I served could get on Google and look up every single answer to his tax questions and use TurboTax to complete the return for $50 or so. But many still valued the professional hand holding as you put it knowing the information was out there for anyone with time. So instead of withholding information from clients and getting them to pay us for that knowledge, now we educate hoping they still decide to use our services knowing the information and strategies we will use could be obtained for free.

Overall, I think we agree on the issues being discussed. I just have less faith in client implementation that you. I enjoy reading your passionate posts!

I think the same applies to investment management. It isn’t that low cost index funds are complex or that dollar cost averaging is difficult to set up or that yearly rebalancing to your target asset allocation takes brains. All those things are true, and the Bogleheads among us will laugh at the mere mortals who still desire to pay for such services. But for whatever reason, people either do not have the discipline to execute the strategy or do not wish to mess with it.

I’ll let others jump in here; I agree that we agree on most things and on your assessment of our differences. The way you’ve structured the client fee arrangements in the first two examples is pretty much what I do. I’m hourly, but I also tell clients how long it will take me and provide a not-to-exceed cap. If I say it’ll take 8 hours and I work 16, I charge 8.

To answer your question about the investment management industry, I think there’s a role, despite my obvious vituperation. I just think that the slice should be much smaller. The two areas that come to mind where investment management is appropriate are for older people who are losing their cognitive abilities and combat veterans with PTSD/TBI who are psychologically incapable of dealing with the risk. I’m sure there are other categories along those lines for which it’s appropriate, but for the vast majority, in my opinion, of people who use investment management services, it’s inappropriate due to the AUM model. I do like your approach: flat fee with financial planning thrown in.

Let’s look at the other end of the spectrum, though. Look at the 84 year old woman who just won the lottery and is going to pay a firm $810,000 for AUM (hat tip to Rob Aeschbach for pointing this out to me). For 810 stacks per year, she’d better have access to attorneys at Skadden and Arps, the Ritz Carlton concierge, a private pilot, and weekly lunches with Warren Buffett as well as getting her money managed. Yes, she would require more work than you and I would or our typical clients, but she does not need $810k worth of services every year.

Hi Jason,
I’m a journalist, working on a story about how financial planners manage to pay their bills when there’s so much pressure on their fees. And I know this thread is a little old, but I find it really beautiful — here you good folks are talking about what’s best for the client, with nary a word about your own profitability! If you see this comment, please give me a shout, OK?

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