Indy's Charging % of AUM

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Apr 26, 2008 7:40 pm

This is way to early for me to be considering, but it's something I'm curious about.  For an Indy FA who wishes to charge his/her clients based on a percentage of AUM, what are the advantages and disadvantages?  Without knowing a lot about it, it seems like a great setup for both the FA and the clients (as long as the FA is making the client money). 

 
If an Indy FA with a $100mm book was to charge his/her clients 1% of their AUM, they would be bringing in $1,000,000 per year.  On top of that percentage, does the FA provide services like estate planning for an extra fee?  Also, does the FA still make money on things like insurance sales?  Just curious how that whole setup works.

Thanks!
 
 
Apr 27, 2008 2:17 pm
 iceco1d, I know that you wrote what appears to be a non-controversial post that is designed to help Old Spice.   I actually disagree with much of what you are saying.
 
"In a fee-only practice, it also elminates any product-based or trading-based conflict of interest."
 
 
Fee-only greatly increases product-based conflicts of interest.  I agree with you in terms of trading based conflicts. 
 
"Also, to charge fees, you are held to a higher standard (fiduciary vs suitability) than you are when you are commission based."
 
You are correct from an academic sense, but I'm not sure that this really makes any real world legal difference.   It also makes no difference for an honest advisor/broker. 
 
The advantage for the client could be considered that they can "pay as they go" and have the comfort of knowing their advisor has no conflict of interest.
 
A fee-only advisor has huge conflicts.
 
 "Insurance biz is still commission driven, although I'm sure that will adapt in the future as securities and insurance biz continues to converage."
 
Why are you so sure of this?  To the best of my knowledge, there is no such thing as fee only DI or fee-only LTCi.   Fee-only term and UL products aren't competetive and I don't know if there are any fee-only WL products.    Judging from the term and UL products, fee-only is a more expensive way to distribute insurance products.
  
Apr 27, 2008 4:52 pm

Let me preface my post by saying that I have no problem with somebody operating their business as "fee-only".  I also happen to have clients who engage me on a fee-only basis.

 
"Not being a smart ass at all...how does fee-only increase product-based conflicts of interest?  I would see the greatest conflict being "more assets with me = bigger payday for me" (when charging AUM fees)."
 
Ex.  Husband dies and leaves 70 year old clueless widow.  She has $1,000,000.  All of it is sitting in the bank.  She has two goals.  1) Live comfortably for the rest of her life.  2) Leave as much money behind as possible for for her children.   We don't know any other facts, so obviously we don't know what she should do.  Let me quickly list some possibilities off of the top of my head in no particular order of things that might be appropriate depending on the complete set of facts.
 
1) Put the money in a fee-based investment account.
2) Put the money in a commission based investment account.
3) Buy a SPIA.
4) Buy LTCi.
5) Buy life insurance on herself.
6) Take out a reverse mortgage.
7) Buy a SPIA to fund the purchase of LTCi.
8) Buy a SPIA to fund the purchase of life insurance.
9) Buy a VA and use living benefits.
 
If this old lady decides to use Jeremy as her fee-only planner,  He will earn his money from AUM fees.  She trusts him and will do anything that he tells her to do.   Jeremy only makes money if she goes with option 1.  Any money directed to any other choice forces Jeremy to take a direct income hit.
 
If this old lady decides to use IceCo1d as her advisor,  he is fee-based and is willing to earn fees and/or commissions based upon what is best for the client.   All 9 choices are available as options for the old lady.   IceCo1d makes a decent buck regardless of what he advises the old lady to do.  In fact, his advice, long term, will make very little difference to his wallet.
 
For which advisor is objectivity easier?  Even if the fee-only advisor is just as objective, isn't it more of a pain in the butt for the client since they have to go elsewhere to deal with implementation for any non-AUM recommendations?
 
As for fee-only insurance products, they may be coming, but as long as insurance is something that is sold and not bought, I don't see it happening.   Of course, I've been wrong about plenty of things in the past and I'll continue to be wrong in the future.
 
 
 
 
Apr 27, 2008 11:14 pm

Interesting point Anon, I never thought of it that way.  Fee only may actually have more conflicts of interest than fee based.  A light bulb just went on.  Any fee only advisors out there want to try and argue the point?

Apr 28, 2008 7:40 am

By the way, I think that the greatest conflict has nothing to do with mode of compensation.    Reps who are struggling to pay their bills will have the most conflicts.  Reps who are financially secure will have the least conflicts.

Apr 28, 2008 8:28 am

Anonymous -



Please explain how a fee-only advisor has huge conflicts of interest.



Thanks.



C



Apr 28, 2008 8:57 am

Captain,

 
Do you realize that I'm talking about a fee-only advisor that charges AUM fees?   Fee-only advisors who don't charge AUM fees also have conflicts, but I wouldn't call them "huge".
Apr 28, 2008 10:45 am

That's an interesting point that I've never considered.  It seems like every structure could have significant conflicts of interest in one way or another.  I guess it really comes down to a FA looking out for the best interest of his/her clients and not his/her own best interest.  That being said, what's the most profitable fee setup for a FA going Indy?

Apr 28, 2008 1:57 pm

All fee setups can be profitable.  You'll have to decide what works best for you.  Personally, I like having the ability to treat each client as an individual and tailor the business arrangement to that particular client.  That being said, I only go with a fee-only arrangement if the client insists on it.

Apr 28, 2008 4:44 pm
anonymous:

Captain,



Do you realize that I'm talking about a fee-only advisor that charges AUM fees?





Yes, I understand that you are only talking about fee-only advisors.



You said:



"Fee-only greatly increases product-based conflicts of interest."



What are the conflicts of interest that you are talking about?



C

Apr 28, 2008 5:26 pm

Cap, reading anon's post from page one, his point is that a fee-only advisor will probably not recommend a commission-based product if all he/she can offer is an asset-based charge, since it is a direct hit to the pocketbook.  Thus, if a commission-based product is in the client's best interest, a fee-only advisor who charges asset-based fees will have a difficult choice due to that conflict.  I suppose a very altruistic advisor could recommend a course of action that results of a loss of income, but in reality, many of them don't.

 
Now if the fee-only advisor makes either a flat fee for a recommendation that can be taken anywhere, or an asset-based fee for managing the investments of a client, then the conflict can be mitigated, if not resolved.
Apr 28, 2008 5:51 pm

I guess I have a tough time thinking of many products that can't be offered through a fee-only practice.



If the comment was based on the idea that a fee-only practice is limited in terms of product offerings, that just doesn't make sense. The fact of the matter is this - we can be paid to counsel the client on virtually any financial or investment matter.



What products are offered in a commission-based structure that aren't also available through a fee-only advisor?



C

Apr 28, 2008 7:27 pm

"I guess I have a tough time thinking of many products that can't be offered through a fee-only practice."


Captain, finding a product isn't good enough.  You have to be able to find the best product or at least one that is competetive.  Additionally, if finding this product negatively effects your compensation, it adds to conflicts of interest. 
 
Let's play a little game.  I will name the product needed and you tell me how the client will purchase it through a fee-only advisor and how the fee-only advisor will get compensated and how compensating the advisor and paying for the product is an advantage to the client.
 
Term life insurance?
Guaranteed Universal Life insurance?
Whole Life insurance?
Long Term Care Insurance?
Disability Income insurance?
Single Premium Immediate Annuity?
Variable annuity with living benefit guarantees?
 
"If the comment was based on the idea that a fee-only practice is limited in terms of product offerings, that just doesn't make sense. The fact of the matter is this - we can be paid to counsel the client on virtually any financial or investment matter."
 
You are correct, but you are missing 4 very important points.
1) Someone who is fee-based can also do this.
2) The money that will be made "to counsel the client" is miniscule compared to the AUM fees.
3) Any advice that the fee-only advisor gives other than, "Put all of your money in this AUM account," will (often drastically) diminish the advisors income."
4) If the advice is something other than "Put all of your money in this AUM account", the client ends up paying both commissions and the advisors fees.
 
 
 
Let's assume that both you (the fee-only planner) and me (the fee-based planner) charge a planning fee with a $2000 minimum.  We also both charge 1% AUM.   A 70 year old male client comes to both of us with just one goal.  "I want to spend as much money as possible, but never run out of money"  He has $1,000,000 and has a great long term care policy. 
 
Can we agree that a SPIA might be part of the answer for this guy? 
 
What happens to the fee-only advisors total compensation if he advises the client to buy a SPIA? 
What happens to the fee-based advisor's total compensation if he advises the client to buy a SPIA?
Who has a much greater financial stake in the specific decision that the client makes?
 
 
Apr 28, 2008 7:34 pm

Just so I can keep up, what's SPIA stand for?


Thanks!
Apr 28, 2008 8:34 pm

Single Premium Immediate Annuity. Used for immediate guaranteed income from a lump-sum.

Apr 28, 2008 8:44 pm

Thanks!

Apr 28, 2008 10:28 pm

Anon -



… and so far your point is….



#1 - That a fee-only advisor doesn’t make money if the client invests elsewhere?

#2 - That a fee-only advisor doesn’t have the ability to offer insurance services?

#3 - That a fee-only advisor doesn’t have the ability to offer annuity products?



Fee-only advisors are considered fiduciaries. This means that the SEC requires us to put the interests of our clients before our own personal financial interests. If there is something out there that the client needs, a.) we’ll find the solution, or b.) we’ll advise them that they should go elsewhere. If they aren’t a good fit, we’ll let them know. It’s happened before, and it will happen again. Fee-only advisors aren't as willing to please EVERYone, and we don't need to. We own the firm, the practice, and prefer to be a bit more picky than our BD-tied fee-based brethren. Again, if we don't have the solution, we'll let the client know.



Fee-only wealth management practices routinely offer insurance services. I’m lost why you think this isn’t possible.



Fidelity, Schwab, Vanguard. Three low-cost SPIA and VA providers that don’t excessively charge the client the 3 to 4% annually in order to maintain the convoluted, complex and overly-ridiculous annuity products that fee-based and commission-based advisors use to augment their income.



Again, I’m still wondering where the conflict of interest exists.



All you’ve mentioned is that the fee-only guy would cram a client into an AUM product regardless of the situation. Not true. Other products exist, and all that’s been mentioned so far is that the fee-only guy has no annuity options for consideration. Not true… not true.



As for your ’70-year-old’ hypothetical client… I’d tell them that we can give them an annuity if they need it. But, I don’t think he needs it. I’d then ask him to call his fee-based buddy, and get a proposal. I’d then ask him to let our group analyze the proposal, and I’d tell him that his fee-based buddy would be collecting a $70,000 commission. That, in most situations, would end the discussion, period, with the BD-based, fee-based sales person.



C

Apr 28, 2008 10:51 pm

Don't we ALL (no matter if you are commission, fee-based, fee-only) lose when the client invests elsewhere? Who's to say that selling yourself and your product is a conflict of interest?



If selling yourself is that 'huge conflict of interest' you are referring to, you really need to provide something with more substance. That's a weak argument.



My take? The fee-based guys need to come up with gimmicks, tricks, and anything possible to make the client THINK they have the proper product or service, regardless of whether or not the salesperson is qualified to render advice concerning the purchase of the product. Once you tie a commission to the purchase of an investment, AND have an advisor that can 1.) receive commissions and trails on funds and 2.) provide commission-based annuity options, it's all up to the advisor whether or not to be ethical.



I'm shocked at the number of 'product of the day' portfolios, annuities, and managed accounts that I've seen from the BD-affiliated advisors. It's not pretty, and to a large extent, it's been highly skewed due to the high commissions offered through their product offerings.



I can certainly say, without much doubt, that the fee-based advisor is highly conflicted.... conflicted enough to wonder what it would be LIKE to go full RIA, but can't quite break away from the commissions. They want to... but just can do it.



I'm not terribly surprised that you have to insist that clients actually need those types of products. Sales people that think there is a need, generally are acting on the self-fulfilling prophecy that they've manufactured in their office.... i.e. 'My client NEEDS this annuity'... c'mon... really? Or, is it that you NEED the sale.......



C

Apr 28, 2008 11:56 pm

Captain,

 
I'm not sure why, but I will take the time to address your points. 
 
#1 - That a fee-only advisor doesn’t make money if the client invests elsewhere?
 
More to the point, the fee-only advisor only makes money if the client goes with a fee-solution.  All other solutions negatively impact the advisor.
 
#2 - That a fee-only advisor doesn’t have the ability to offer insurance services?
 
This is huge.  The insurance solutions that can be offered are not in the client's best interest.
 
#3 - That a fee-only advisor doesn’t have the ability to offer annuity products?
 
They can offer some annuity products.  There are none that they can offer if a living benefit guarantee is wanted.  SPIAs that don't pay commissions don't perform better than those that do. 

Fee-only advisors are considered fiduciaries. This means that the SEC requires us to put the interests of our clients before our own personal financial interests.
 
When a fee-based advisor is putting a client into an AUM account, they are also working as a fiduciary.   The reality is that this doesn't mean jack.  Being considered a fiduciary doesn't make someone ethical.  I walk both sides of the fence.  One's ethics and duties to their clients don't change because of their mode of compensation. 
 
If there is something out there that the client needs, a.) we’ll find the solution, or b.) we’ll advise them that they should go elsewhere. If they aren’t a good fit, we’ll let them know.
 
Good for you, but don't lump everyone together.  There are honest fee-only planners and crooks who are fee-only planners.  The point is that with the majority of your clients they need to be sent out for at least part of what they need and doing this hurts your pocketbook, thus there is a greater conflict of interest.
 
It’s happened before, and it will happen again. Fee-only advisors aren't as willing to please EVERYone, and we don't need to.
 
It's this, "our poop doesn't stink" mentality that frustrates me with fee-only planners. 
 
 "We own the firm, the practice, and prefer to be a bit more picky than our BD-tied fee-based brethren. Again, if we don't have the solution, we'll let the client know."
 
What's this crap?  There's nothing about being fee-only that makes someone own the firm.  I own my firm.  I'm not fee-only.   Your pickiness isn't a preference.  Rather is just points to the fact that you'll starve if you try to work with everyday folks.   Maybe your "we" is different than the "we" that I see.  What I see with fee-only aum advisors is that no matter what the problem happens to be, the solution is a fee-solution.  It's no different than someone who only sells insurance.  The solution to everything is insurance. 

Fee-only wealth management practices routinely offer insurance services. I’m lost why you think this isn’t possible.
 
Here's a golden opportunity for you.  You are either going to teach me (and everyone else)something new or you are going to deepen my conviction that most fee-only planners have huge gaps in their insurance knowledge.  In fact, I'd go so far as to say that these gaps are large enough that many fee-only planners don't have the requisite knowledge to fullfil their fiduciary duties.  After all, how can someone do what is best for their client if they don't know when an insurance product makes sense?  Let's go back to my game.  Did you blow off my questions, or as I suspect, don't you have the insurance knowledge to play along.
 

Let's play a little game.  I will name the product needed and you tell me how the client will purchase it through a fee-only advisor and how the fee-only advisor will get compensated and how compensating the advisor and paying for the product is an advantage to the client.
 
Term life insurance?
Guaranteed Universal Life insurance?
Whole Life insurance?
Long Term Care Insurance?
Disability Income insurance?
Single Premium Immediate Annuity?
Variable annuity with living benefit guarantees?
 
Fidelity, Schwab, Vanguard. Three low-cost SPIA and VA providers that don’t excessively charge the client the 3 to 4% annually in order to maintain the convoluted, complex and overly-ridiculous annuity products that fee-based and commission-based advisors use to augment their income.

Why would anyone care about their SPIA being low cost?  As for the overly ridiculous annuity products, maybe you can help me.   I have a very conservative client.  She is not willing to lose any money.  She has $200,000 in an old 401(k) in a stable value fund.  She needs to get 9% to achieve her investment goal of retireing in 10 years.  I was planning on putting 100% of this money into an overly ridiculous VA inside of an IRA.  We are going to invest the money very aggressively.   We have a ten year guarantee of $200,000.  I'm sure that you have all sorts of reasons why this isn't good.  However, do you have any alternatives that will give her a chance of earning 9% while having no chance of losing money?   


Again, I’m still wondering where the conflict of interest exists.
 
Only one solution pays you money and you can't see a conflict?  It's no different than the insurance agent.  I've got no problem with how you do business.  I've got no problem with the insurance agent.   Your equals.  We're all equals.  It's just that anyone who can only make the majority of their money in one fashion is bound to have the most conflicts.

All you’ve mentioned is that the fee-only guy would cram a client into an AUM product regardless of the situation.
 
We all want fee solutions.  It's what pays us the most in the long run.  It's just not what is best for the client in all situations. 
 
Not true. Other products exist, and all that’s been mentioned so far is that the fee-only guy has no annuity options for consideration. Not true… not true.

Are you sure that the only thing that I mentioned is that the fee-only guy has no annuity options?  I think that I mentioned that the fee-only guy has no competetive insurance options.  Feel free to prove me wrong.  Again, however, from your posts, it's pretty appearant that your insurance knowledge is at the beginner's level.  Give me an example of when a fee-only guy can use an insurance product and have this product be in the best interest of the client and not hurt the advisor's income.



As for your ’70-year-old’ hypothetical client… I’d tell them that we can give them an annuity if they need it.
 
Can you get him an annuity or do you have to tell him to go buy one?  Can you get him any annuity or just one from a select few companies?  If the best one pays a commission, do you tell him to use that one?  If so, is it really in his best interest to pay you a fee when a commission product is the best?
 
But, I don’t think he needs it.
 
It's tough to think that someone needs something if his purchase will cost you $10,000 of annual income.  I'm sure that he doesn't "need" it.  However the question isn't whether he needs it.  The question is whether buying a SPIA will help him achieve his goal.  It will guarantee him about $90,000 a year for as long as he lives.  What's your better solution?   The SPIA wouldn't be the complete solution, but it sure makes sense to me that it would be part of a solution.  Give us a better solution.
 
I’d then ask him to call his fee-based buddy, and get a proposal. I’d then ask him to let our group analyze the proposal, and I’d tell him that his fee-based buddy would be collecting a $70,000 commission. That, in most situations, would end the discussion, period, with the BD-based, fee-based sales person.
 
Is it only your fiduciary duty that keeps your ethics in check?  Or is it that, as I suspect, your insurance knowledge is non-existent?  In other words are you intentionally lying about the commission or do you have no idea about the commission of a SPIA?  If you know of any SPIAs that pay 7%, let me know because I'd gladly sell it.   Why should the client care whether the rep made $70,000 or $40,000?  If the client is intelligent, he'll realize that all that matters is that he is being guaranteed $90,000 a year for the rest of his life.  By the way, the commission will be closer to $40,000.  Of course, if he lives a long life, he'll pay substantially more in fees and have a realistic shot of running out of money if he is taking out $90,000 a year.  
 
My major point is simple.  Someone who can charge fees or earn commissions has less conflicts than someone who can only earn commissions or who can only earn fees.
 
The fee-only people are on the same conflict level as the people who are non-registered commission-only insurance sellers.   The fee-only people will take this as an insult while the non-registered commission-only insurance sellers can see this for being a simple statement of fact.  
 
 
Apr 29, 2008 5:23 pm

Having recently gone through my book and changed some of my clients to fee or asset based accounts, I can certainly say that it is a quandry in some respects.  If you are going to charge a fee, then I feel you should be doing something substantive for that fee other than just watching the account occaisonally.  I can see no point in charging for babysitting a portfolio of long term tax free muni bonds.


My solution was to take some of the investment accounts and split them into two. 
 
One part being a commission based account with those assets that would require minimal movement or are basically set for a period in time.  Bonds for example, GNMAs and income type mutual funds that are not as likely to be traded out of the commissioned fund family. 
 
The second portion of the account we would move into fee based and would consist of those assets that we plan to be able to move more frequently (no trading costs to the client, unless they chose the option to pay the ticket charges for a lower AUM fee).  Stocks, ETFs, no load funds so we can invest cross families without worrying about the breakpoint bullcrap that we have to do now, options and other frequently traded instruments.
 
I also do insurance, life, ltc and annuities.  The clients are made aware that I will be receiving a commission, just like any other insurance agent that they would go to, and that the commision that I would receive would be similar to that of any other agent.  They also are informed that they can go to another agent for these products.  Since most of my clients like me  they usually say that they would rather that I do the insurance business so I can get the commission and so that everything is in one place.  I don't see that this is a conflict as long as the client is disclosed and told that they have an option to go elsewhere.
 
For those commission clients who want to have me do financial plans or other planning, I just charge them according to the RIA's suggested schedule of fees for those services.