Are AUM fees heading toward extinction?

Across the financial planning industry, the multidecade transition away from commissions and toward asset-based fees has made such fees a staple of wealth management that’s commonly promoted as putting the advisor on the same side of the table as the client.

The case for charging fees pegged to the size of a client’s portfolio has always been easy to make for advisors who are eager to truck out the mathematical reality that asset-based fees rise and fall with the portfolio balance, suggesting the advisor is motivated to increase the size of the portfolio.

“Asset-based fees keep the objectives aligned between client and advisor; clients make more money, the advisor makes more money,” said Thomas Balcom, founder of 1650 Wealth Management.

To most clients and advisors, the asset-based fee model has been too good to pass up, which is why more than 90% of registered investment advisors charge asset-based fees, according to the latest InvestmentNews Benchmarking Study.

The report shows that among RIAs managing at least $100 million and registered with the Securities and Exchange Commission, 98.7% charge fees based on assets, which can range from 40 basis points to more than 1% depending on account size, relationship and services. While very few advisory firms publish their fees in plain view on their websites and there’s a lot of discounting, the most popular starting point for asset-based advice has been 1% ever since the early 1990s.

“While it appears that there is a race to zero, clients are not flinching at paying fees for perceived and actual value,” Balcom said. “If you are creating a simple ETF portfolio and charging 100 basis points, clients may balk. However, if you are creating a more bespoke portfolio that contains investments that are not readily available to the public, clients will see the value of paying investment management fees.”

Even as the advice industry appears staunchly committed to asset-based fees, there’s a lot more going on beneath the surface, as RIAs embrace multiple fee models to attract and retain clients.

According to the InvestmentNews report, 77% of SEC-registered RIAs offer fixed fees, 62% offer hourly fees and 4% charge commissions.

“The economics of the advice industry still revolve around AUM fees, but it’s pretty striking that three-quarters of firms are employing fixed fees in addition to AUM fees,” said Devin McGinley, director of research at InvestmentNews.

ALTERNATIVE FEE MODELS

Having seen asset-based fees barely budge one way or the other off the popularly stated 1% bogey, McGinley isn’t convinced the migration into alternative fee models is much more than a ploy to “bring new clients in the door.”

“I don’t see big changes down the road when it comes to fees,” he said, citing as an example of the fee-based momentum the fact that the 25 largest broker-dealer firms have been generating a majority of revenue from asset-based fees instead of commissions since 2020.

But while certain corners of the legacy brokerage industry migrate toward asset-based fees and large swaths of the RIA space continue to embrace asset-based fees like a religion, some folks anticipate a shifting landscape that could drive major change in the way advisors charge clients.

“As advisors look to expand offerings to a younger investor base, we’re seeing different fee models,” said Anand Sekhar, vice president of practice management consulting at Fidelity Investments.

“Advisors focused on the needs of those younger investors are creating fees that are appropriate for the work,” Sekhar said. “Similar to the legal and accounting professions, fees are being aligned so the value for services is commensurate with the value the advisors are providing.”

Matthew Matrisian, senior vice president and chief channel officer at AssetMark, believes the macro trends will continue to show a migration to asset-based fees because the shift from commissions is still underway. But he said the next fee transition was already happening.

“If I had to put my money on a fee model, it would be more leveraged toward the flat fee,” he said. “The flat-fee model, and potentially some subscription-fee models, is what the next generation of investors are used to. They use the subscription model for everything.”

FEE DIVERSITY

Angie Herbers, managing partner at the practice management consulting firm Herbers & Co., said diversity of advisory fees was coming quickly, and advisors should be preparing their practices.

“We’re already seeing more firms charging flat, retainer and hourly fees,” she said.

Herbers believes the more creative advisory fee models are driven by “lower close ratios,” which means advisors are finding it more difficult to get prospective clients to sign on the dotted line.

“Going into Covid, the long bull market drove a lot of growth of net new and current assets,” she said. “But during the most recent bear market, consumers just paused. They weren’t moving assets [to new advisors] like in the past, they weren’t saving as in the past; some were working less. That slowed down growth at advisory firms.”

RIA close ratios for prospective clients, which for years had hovered comfortably in the 70% range, have dropped over the past couple of years to around 33%, Herbers said. This has become a wake-up call for firms scrambling to bring in new business.

“In the recent bull market, consumers started shopping for advisors again, but they aren’t actually shopping on price, they’re shopping on trust,” she said. “The fee model of the future will be based on the value advisors bring to the table rather than the value clients bring with their assets.”

‘OVERALL COMPLEXITY’

In that regard, Carolyn McClanahan, director of financial planning at Life Planning Partners, is ahead of the curve.

“We charge a flat fee based on the overall complexity, and that includes asset management,” she said.

When McClanahan came into the business in 2004, she charged an asset-based fee “because that’s what everybody did.

“I quickly realized the wealthier clients were subsidizing the less wealthy clients,” she said. “I was doing in-depth planning for everybody, and AUM fees didn’t cut it.”

In 2006, McClanahan developed a formula for charging a flat fee, which she did by “starting backwards and figuring out what I needed to be profitable and run a business.

“I didn’t want to charge hourly because clients hear the clock ticking, and I wanted to do comprehensive financial planning,” she said. “When I started charging flat fees, my minimum was $2,500 a year. Then I got so busy and had to make a business decision about helping everyone.” The minimum has been bumped up twice and now stands at $10,000, and it can be adjusted if complexity changes.

“It’s a little bit squishy; I tack on $1,000 pretty much for every complexity,” McClanahan said. “A big thing is how organized somebody is. I will take fees off for a super-organized person.”

Reflecting on her early days of charging fees based on client assets, she recognizes the appeal.

“It’s so popular because it’s easy, and advisors don’t have to communicate how much money that is; they just say, ‘We charge 1%,’” she said. “It doesn’t sound like a lot of money, but it is.”

‘MIXED MESSAGE’

McClanahan, a longtime critic of asset-based fees, joins other critics in arguing that charging based on assets diminishes the value of financial planning and places too much emphasis on a part of the business that is often described as commoditized.

“People way overcharge for investment management but undercharge for planning,” she said. “Asset-based fees kind of give a mixed message that investments are the answer and it’s a part of the financial plan.”

While proponents of asset-based fees often claim the model reduces potential conflicts of interest because the client and advisor are aligned in their commitment to investment performance, the pitfalls in that argument are many. Among the challenges are whether to charge on cash, advising a client on whether to take money out of an investment account for a large expenditure and allocating to investment strategies that are out of sync with an investor’s profile.

“Every fee model has a potential conflict,” McClanahan said. “The potential conflict we have is you could be paying us this fee and we’re not doing the work, but we get around that by spelling out our planning schedule for our clients. They get reports throughout the year, so they know the value they’re getting.”

Calculating the value of the services provided is something advisors lean on often when justifying their fees, regardless of the fee model.

“A fee is only questioned when the value is in question,” said Patrick Dougherty, president and chief executive at Dougherty Wealth Management. “I charge the upfront fee for the initial plan, then an AUM fee as well as an ongoing planning fee, because planning is continuous and ongoing, and the most important thing I do for the client.”

As far as the direction of asset-based fees, Dougherty believes there’s more sizzle than steak.

“There’s been a lot of talk for the last 20 years about fees going from an asset-based model to an hourly and/or retainer model,” he said. “It’s mostly been wishful thinking by the big journalists and newsletter types trying to will their predictions to come to fruition. The reality of those of us in the trenches is that clients like the AUM fee model because it removes the conflict of interest and gives the advisor incentive.”

DIFFERENT MODELS FOR YOUNGER ADVISORS

However, Dougherty does see the potential of different fee models for advisors just breaking into the business.

“The younger planners are trying the hourly or retainer model because it is easier for the client to buy into,” he said. “For the advisor who has the ability to communicate their value to the client, the AUM model is easily understood by the client. I like it because it weeds out the prospect who doesn’t like paying for advice.”

Bob Veres, publisher of the Inside Information newsletter, understands the inertia behind asset-based fees, but he doesn’t believe the fee model is where the industry is heading.

“I think AUM fees are not the future; it’s basically commission in drag,”  Veres said, suggesting that asset-based fees make it more difficult for advisors to distinguish themselves as financial planners.

“When people talk about their fees, I ask them what data they have about how much time they’re spending on different clients and activities, and do they know what their time is worth,” he said. “To me, all this discussion revolves around a lack of data. Charging by AUM is really a lazy way to set your fees. It’s time to get less lazy.”

On the topic of introducing different fee models for younger clients, or clients who may not have a lot of assets to manage but still need financial planning help, Veres said that was the future in more ways than one.

“Down market means younger clients, so moving down market basically means moving toward the future,” he said.

Another reality that’s keeping so much of the industry wedded to asset-based fees is the fact that advisory fees stand virtually alone in resisting the fee compression that has hit every other stop in the financial services supply chain.

TIGHTER MARGINS

To that point, many advisors will often retort that they have had to increase services to keep up, thus effectively cutting into their profits.

But Veres believes tighter margins are something advisors of the near future will have to learn to live with.

“It’s inevitable that the revenues compared to the service provided are going to go down,” he said. “Advisors will make less money. It could be there will be more competition and they will have to provide more services. But right now AUM is a big disconnect, and I don’t think the next generation of consumers will stand for that disconnect. The more consumer awareness we get, the more we move away from commissions to fees and from AUM to other revenue models.”

That’s exactly the kind of outlook Anders Jones has been banking on since he co-founded Facet in 2016 as a subscription-based advisory platform for people with less than $500,000.

For between $2,000 and $6,000 a year, depending on complexity, Facet offers comprehensive financial planning services that can include investment management. So far, the platform has attracted 13,000 households, 80% of which had never worked with a financial advisor.

SUBSCRIPTION MODEL

Jones believes the subscription model that isn’t connected to client assets will be the secret to success for venture-backed Facet.

“Step back outside of financial services and you see a trend of transaction-based businesses going to subscription,” he said, citing examples such as Netflix and Dollar Shave Club.

“You need to look at the value the advisor is actually providing,” Jones added. “If you have $1 million and an advisor says he adds value primarily by beating the market, run in the other direction, because the average advisor is not going to beat the market. The real value a planner adds is the plan.”

Perhaps the most unique aspect of the push away from asset-based fees is the opportunity to serve a market previously viewed as unappealing to the financial services industry.

“Our aspiration is to go more and more down-market, because 76% of U.S. households don’t have access to affordable and unconflicted financial advice,” Jones said. “From that perspective, I think there’s still a lot of fee model options. My crazy prediction is that 10 years from now, half the industry will be charging a subscription model.”

Industry consultant Herbers sees a similar evolution in the advisory space as RIAs saturate the wealthiest end of the market.

“What I do know is high-net-worth individuals without financial advisors are few and far between at this juncture, and the only way advisors can be profitable with smaller clients is with diversity of fees,” she said. “With asset-based fees, there’s more incentive to go after the largest accounts, but more diverse fee models expand access to financial advice. You can serve low-net-worth people with under $100,000 very well with different fee models.”