FA Center: Make sure the fee you pay an investment adviser fits your portfolio needs

Rather than choose between an AUM or retainer model, many advisers offer both. Charging high-net-worth clients 1% of assets under management, for example, proved a win-win during the historic bull market from March 2009 to March 2020. Meanwhile, offering a flat fee to those of modest means enabled advisers to attract younger professionals and others who might otherwise go without a financial planner.

“With AUM, when clients prosper, we prosper,” said Dave Alison, a certified financial planner in Palo Alto, Calif. “It has the adviser on the same side of the table as the client.” But Alison acknowledges that market downturns disrupt everyone’s equilibrium. Clients require more handholding as advisers rush to adjust to steep revenue declines. “Luckily, bad times are often short term,” he said.

Most of Alison’s business is AUM-based, although some clients pay an hourly fee on a per-project basis. He sees pros and cons with both arrangements. “A lot of our business is fixed expenses such as staffing and overhead, but [with AUM] you’re building a business on variable income,” he said. “So you’ll feel the pinch more” as markets sink.

But he notes that flat-fee work is less predictable. Filling an investor’s one-time need doesn’t necessarily lead to an ongoing relationship. “When I do hourly work, it’s typically transactional in nature,” Alison said. “That kind of work is less sticky.”

Keeping clients poses a challenge regardless of how an adviser is compensated. For those paying a slice of assets under management, bear markets can cause them to balk at fees. They may tell their wealth manager, “If I’m making money, I’m happy to pay you. If I’m losing money, do I still have to pay you?”

Under the retainer model, advisers typically charge between $2,000 and $10,000 a year depending on a client’s assets and the complexity of their financial life. They can reassure clients that they’re saving money by paying an annual subscription versus the AUM setup.

Say an individual with $700,000 in assets comes to an independent adviser who charges a $5,000 annual retainer. That same person would pay $7,000 if they agreed to pay 1% under an AUM arrangement. Saving $2,000 a year might persuade the client to stay with their flat-fee adviser.

Indeed, for advisers who deliver comprehensive financial planning, part of the challenge of charging a flat retainer is communicating the range of services they provide. Clients may not realize that their adviser offers everything from career coaching to tax planning to help negotiating home and car purchases.

It’s easy to quit an adviser who charges a flat monthly or quarterly fee, like a Netflix streaming media subscription: You just cancel and move on.

“With the Netflix model, a client can end it in a heartbeat,” said Jason McGarraugh, a Houston-based certified financial planner. “You’ve really got to justify the service you’re providing to clients.” McGarraugh says that about 60% of his revenue is AUM-based; the rest comes from retainers, often from his clients’ adult children who sign on for $1,500 a year.

Salim Boutagy focuses on the AUM model. A certified financial planner in Westport, Conn., Boutagy says volatile market environments allow him to prove his worth to clients. “With the AUM model, you can tie the fee directly to a specific service: portfolio management,” Boutagy said. Steering clients through a downturn — and safeguarding their assets from lasting harm — can solidify the relationship.

“If you charge a retainer, it’s almost like a gym membership,” Boutagy said. “You might lose more clients unless you constantly demonstrate value. With AUM, you’re always demonstrating value because there’s always a portfolio to manage.”

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