The ridiculous nature of asset-based fees

I was recently speaking with a friend in the business about a prospective client who was referred to him.  He was excited to work with this couple whom he knew to be great individuals and good friends of an existing client.  In addition, this couple had a investable net worth of over $10 million.  Now, most financial advisors working on a percentage-of-assets model (i.e. a typical 1% fee) would salivate at an opportunity to bill this couple roughly $100,000 per year to provide investment advice.

My friend, however, felt that this figure was wildly unreasonable, given the amount of time, energy and expertise he expected to spend with these clients on an annual basis.  He felt that a more reasonable annual fee would be a small fraction of the $100,000 (or 1%) charge that this couple would be quoted by much of his competition.  The maddening part is: my friend felt compelled to possibly charge beyond what he felt was reasonable in an effort to be in the same ballpark as other advisors and to not be brushed off as “discount” or a lesser option.

The business of investment advice is a strange one.  The leading model of advisor fees results in high net worth investors paying high fees simply based on their ability to pay, and not related to the services they receive.  An investor with $5,000,000 who meets with his advisor once a year will pay ten times as much as a demanding investor with $500,000 who sees an advisor every quarter.

Recently, an article was published on the New York Times’ website about an investment advisory firm that makes a strong effort to be transparent with clients and prospects regarding all levels of fees. That said, this asset-based fee firm told a hypothetical client with a $10,000,000 portfolio that the firm’s fees for portfolio management would be $76,250 per year (and growing as the portfolio grows).  I don’t know about you, but for $76,250 a year I would expect a team of J.D.s, CPAs, CFP®s and CFAs to handle all of my legal and financial affairs. I want someone paying my bills, filling out my kid’s financial aid applications, negotiating my homeowner’s insurance rates and the negotiating to drive down the price of my vacation home. I’d certainly expect more than monthly statements and a one-to-four-times-a-year portfolio review common at most investment firms.

Let’s imagine that instead of shopping for a financial advisor, my friend’s prospective client was interviewing estate planning attorneys. This couple has no children and plans to spend the bulk of their assets during their lifetime, leaving the balance to a few selected charities. They are not interested in tax-saving strategies that may involve charitable gifts during their lifetime, and their charitable intents at the end of life leave them with no estate tax liability.

Now imagine an estate planning attorney quoting this couple $25,000 for a $4,000 estate plan simply because they have the means to pay.  No one could justify this fee!  And yet this exact scenario plays out every day in the advisory business.

Let’s also suggest that this couple is looking for a CPA to help with annual tax planning.  They have no business interests or W-2 income, and most of their taxable income comes from Social Security and a 1099 from their investment portfolio. Can you imagine a CPA quoting them $5,000 for tax prep because they have a $5,000,000 net worth? No!  The CPA will estimate the fee based on the actual work that is expected to be done.

Sadly, my industry is a far cry from such reasonable pricing terms, and it seems unlikely that the nature of asset-based fees will change any time soon.  Investors interviewing and evaluating investment and financial planning professionals should absolutely question the value of asset-based fees and calculate these fees as an average hourly rate. Your advisory firm should comfortably answer a question such as “How much time do you expect to spend working with me and my portfolio on an annual basis?” If not, they may be more interested in the revenue your portfolio generates than having an honest conversation about the value a financial professional brings to a relationship.

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  • f5

    This post makes me feel glad that I work for a young, growing firm that would charge 1/3 of that fee for a $10m client and does not bill on AUM.

    The fact that the industry still wants to charge based on AUM, and at such levels, allows for a competitive advantage.

    • Paolo Mezza

      Working in a Multi-Family Office charging a fee based on AuM (but increasing less than linearly as a function of AuM) I find your approach intriguing: there’s no doubt that a client with less money can require more work than another with more. On the other hand, given that surely a large part of your work is done in common for all of your clients, a similar criticism could be adressed to your fee structure: if you charge X$ for each client when you have 100 clients, it’s not fair that you charge the same amount when you’ll have 500 clients, according to your argument, THEY should benefit from the economies of scale generated so you should lower X substantially… ;-)
      So in the end I guess no system is perfect, if I were a client I’d say that yours sounds more appealing but if I had above a certain level of wealth it would make sense to hire a “team of J.D.s, CPAs, CFP®s and CFAs to handle all of my legal and financial affairs”…

      • James Osborne, CFP®

        You’re right, no system is perfect. My pricing structure is designed around how many clients I know I can personally handle and deliver a high level of service. I know how much time, on average, I spend on each client, where my margins are and what my capacity is. This is how I arrived at my $4,500 annual fee. At this time I have zero intention of every trying to manage 200 clients, let alone 500 clients. I won’t write it off, but it is not in the picture now. In any case, bringing on more clients than I can personally manage means bringing on another professional advisor, limiting the potential economies of scale at that point.
        For most of my clients, I am happy to be a part of the team of professionals that manage their financial and legal affairs, even if we are not all under one roof.
        Thanks for your thoughts and best of luck!

    • James Osborne, CFP®

      Hi – I agree there is a lot of room in the industry for an advantage when it comes to different fee structures. Best of luck.

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  • Kyle Moore

    James, the way I see it is the more AUM a client has, the higher risk for the advisors for various reasons. We all hope to never make a mistake, but a trading error on a $10mm client will have greater implications than a $1mm client. Granted, this doesn’t mean a linear 1% fee on both is fair compensation for this risk, but I’d be interested in your perspective.

    • James Osborne, CFP®

      The liability to investment professionals from larger clients seems to be the last leg to stand on when defending asset-based fees. But I think it is dramatically overstated. First, practically all registered investment advisory firms (self included) carry liability (E&O) insurance. The most common claims to E&O are trading errors (as you mentioned) and liability defense (getting sued). Most policies have a reasonable deductible ($5L – $25K) that you will hit with a claim from a $1M client or a $10M client, and then some possible co-insurance.
      So the actual increase in liability is fairly small. It’s absolutely not a linear relationship. I brought on my largest client to date earlier this year and ran things by my E&O carrier. They actually advised me against increasing my per-claim limit until I hit $500mil in AUM.
      With good controls and liability insurance the risk is fairly small. I imagine you could use this to justify some small AUM charge for large accounts (over and above a retainer fee) but I haven’t felt the need to do so.

      • Kyle Moore

        Thanks for your reply. I’m intrigued by your fee structure. Will you take anyone willing to pay your $4,500 fee? What would you say to a prospect with $200k in investment assets?

        • James Osborne, CFP®


          Most of my clients have portfolios large enough that the retainer fee is less than 1% of their portfolios. I have, at my discretion, discounted the fee for younger/smaller relationships that are otherwise a great fit for me.


    My financial advisor is charging me 2% for a $700,000.00 portfolio which I think is excessive

    • James Osborne, CFP®

      I would generally be inclined to agree, unless you feel you are receiving $14,000 worth of services.

  • Steve Marcum

    James, I appreciate this and other thoughtful posts you’ve made available on your website. I agree, the work of an advisor is going to be relatively constant for a $200k client as it is for a $5M client. I’d be interested in your take, though, of these two questions:

    1) Could you argue that larger clients receive a greater benefit from an advisor, regardless of the fact that it there is little incremental cost to that advisor? Good behavioral coach (staying invested through market ups and downs), tax-efficient investing (buying bonds in retirement accounts and stocks in non-retirement accounts, tax-loss harvesting, tax-efficient distribution strategy), rebalancing, etc is certainly going to make a greater $ difference for a $5M client than a $200k client. So shouldn’t the $5M client be willing to pay more than a $200k client? Furthermore (and this is the really interesting question), should an advisor be justified in charging that client more because–assuming they are doing their job well– the advisor is actually adding more $$ value?

    2) My understanding (which, correct me if I’m wrong here) is that flat-fee planning has been around for a long time. While it does seem to be growing quickly, it’s still very small. If the flat-fee is better for the client and isn’t anything new–why is it such a small portion of the market? There are thousands of competitive advisors–but somehow they (I should say “we” bc I am an advisor–albeit a young one) haven’t cut each other down on pricing. Why do you think that is?

    Really interested in your thoughts here. Thanks!


    • James Osborne, CFP®


      Thanks for your thoughtful questions. To your points:
      1) Yes, there is an argument there. It’s not one I really care for though. Let’s take Vanguard’s study calculation that an advisor might at 3% in returns through tax loss harvesting, asset location, behavioral maintenance and efficient portfolio implementation. How much of that 3% is the advisor entitled to? Why are they entitled to any of it? We could say that the advisor can take 2% and still leave the client better off, but that’s a bit ridiculous in my opinion, and high by industry standards. It’s the job of a fiduciary to deliver that 3% to the client. Whether the client has $500,000 or $5,000,000 is beside the point.
      Ultimately, advisors who charge asset based fees will continue to look for justification to do so, and the behavior gap is an easy way to do that. Personally, it doesn’t sit well with me as an advisor that I’m entitled to a % of someone’s wealth.
      2) I’m not sure I’d agree that flat-fee portfolio management has been around for a long time. Sure, hourly or per-project financial planning has been and continues to be a viable model for many professionals. Personally I was only aware of a handful of firms doing flat-fee (not % fee) portfolio/wealth management, and really only one who had built a very large practice doing so.
      To me, the “why not” comes down to incentives. No established advisor has any incentive to move from % AUM to flat fees – doing so would likely decimate the profit margins of most firms who depend on a small group of very large clients to drive profits. And most advisor start-ups probably don’t give much serious thought to a smaller fee than 1%. 1% is what the industry charges, so they will too. Most investors looking for a professional relationship simply accept that fees are 1% – that is what “everyone” charges, and not very many people are asking questions about it. Go visit 10 large advisory firms in your town and I’d be shocked if fee schedules vary by more than 10% on any portfolio size. Lastly – the industry has done an excellent job of talking about costs as a % and not in dollar terms, which masks the cost to the client.
      – James

      • Steve Marcum

        Thanks for the quick, and again thoughtful, response. A couple of follow-up thoughts:

        1) I think a flat-fee approach is sensible, transparent, and simple. But I don’t follow your logic on the immorality / inappropriateness of the AUM model. I’m an AUM advisor, so recognize that I’m as biased to the AUM model as you are towards the flat-fee model. But I love discussion on this topic and would value your opinion here. So… if, in fact, an advisor adds 3% a year to a client’s investment returns (a gross generalization, impossible to precisely determine, and something I don’t agree with), then yes, I think any rational client would be willing to pay up to 3% a year to an advisor. Why not? The value was added. SHOULD a client pay 3%? Of course not. Competition drives the price down. Why pay 3% when you can get the same service for 1%. Or maybe even 0.5% if the client has $1M and finds a flat-fee advisor charging $5k. I just don’t see the immorality or inappropriateness (if that’s a word) of the AUM model. Again, the value-add is largely determined by AUM of the client. Why not charge according to AUM? It might be a poor business decision if clients can get the same service for a lower $$ amount elsewhere… but I don’t see how it is inappropriate. And I’d just keep in the mind that no advisor–no matter how they charge (AUM / flat-fee / commission / hourly) –delivers the full 3% to the client. Unless of course the advisor doesn’t charge any fee whatsoever. So I don’t understand what you mean by saying that its the fiduciary’s responsibility to get the client 3%. I think maybe what your saying is that its a fiduciary’s responsibility to charge as little as possible to maximize the client’s return? And if that is the case wouldn’t an hourly fee model be the most appropriate?

        2) Good insight. I share your thoughts here.

        Thanks again for your thoughts and good luck!


        • James Osborne, CFP®

          Ok, so let’s turn the tables. Let’s say that a wealthy couple is working with an estate/tax attorney. With reasonably good planning, the attorney easily saves this couple $1,000,000 in estate and income taxes. Should the attorney get $500,000 for the work?

          When I say it is the fiduciary’s responsibility to deliver the assumed 3%, I mean that regardless of compensation models, that is our job as advisors. So doing it well doesn’t entitle the advisor to part of the return, in my mind. Doing it well is what clients expect when they enter into a professional relationship.

          Ultimately this is a discussion about what is fair and reasonable, which is very subjective. For me it is not about charging as little as possible, but it is about charging what I perceive to be fair value for my services. Maybe I am under-pricing my services. For me, I wasn’t comfortable having clients pay $30-50K a year to meet twice and get quarterly reports and do planning. I’ve never framed it as “value-add” which is also very subjective – our value as planners certainly can’t be limited to a dollar amount. So I chose a structure that I felt best reflected the work I do for clients.
          One last comment – I also did not like the “subsidy effect” that happens with so many advisory firms where a few large clients foot the bill for many smaller (and often unprofitable) relationships that the advisor has. Clients should cover their costs of the relationship, not someone else’s.

          • Steve Marcum

            I wrote a couple of responses to your reply, but then realized that I was mostly re-hashing points I had already made. So I’ll just agree to disagree for the time being :)

            To take a step back, I do completely agree on the principal of charging a fair and reasonable price. And I think that’s the heart of the discussion. We may disagree on how fair and reasonable should be determined (cost vs value). But if nothing else, I believe that greater discussion on and transparency around the fee structure of financial planning should lead to more informed decisions. So thx again for your thoughts, and I wish you and your clients the best of luck.

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