Are you a high-net worth individual considering hiring a financial advisor? If so, you are likely familiar with the assets under management (“AUM”) model. This model charges clients a percentage of their assets under management every year, usually ranging from 1% to 2%. While this might sound like a good deal, it comes with some significant drawbacks that could cost you money in the long run. Let’s take a closer look at why this model isn’t your best option.

The AUM Model Incentivizes Risky Investments

One of the most significant problems with the AUM model is that it incentivizes poor performance through risky investments. Since advisors receive more money when their clients’ assets increase, they are less likely to prioritize performance (e.g., suggesting riskier investment options) and focus instead on increasing their AUM—which can be done simply by convincing clients to invest more money.

The AUM Model Is Expensive for Clients

Another issue with the AUM model is that it can be expensive for clients. For example, if an advisor charges 1% of AUM and his or her client has $1 million invested, they will pay $10,000 in fees each year—and if those assets increase to $2 million, then they will be paying double that amount!

See the range of fees under a 1% of AUM model:

Assets Under Management            Advisor Fee (1% AUM)    

            $1,000,000                                         $10,000

            $2,000,000                                         $20,000

            $4,000,000                                         $40,000

            $8,000,000                                         $80,000

          $16,000,000                                       $160,000

High-net worth individuals must continually ask themselves: What value am I receiving from my advisor(s) for the fee I am paying? It’s a sobering thought, but for many advisors under the AUM model, there is no differentiation in service for the $1 million client and the $16 million client described above—but there is a $150,000 swing in revenue to the advisor.

The AUM Model Is Painful in Poor-Performing Markets

The AUM model is also a pain point for high-net worth individuals in a downward-trending economy. For example, if a client has $15 million in assets under management, the advisor is charging $150,000 per year in fees. If the asset value drops in a declining market by 3.3 percent, the client is left with $14.5 million in assets, a $500,000 loss in value, and an advisor fee of approximately $145,000 (i.e., a total loss to the client of $645,000). No financial plan is a 100% guarantee to success, but the AUM model certainly accentuates a client’s financial pain in a poor-performing market.

Flat-Fee Models Are Better for Clients

Flat-fee models charge clients one transparent, flat rate for services regardless of how much money clients have invested or how much clients’ assets increase over time. This ensures that clients only pay for what they need and nothing more—making it an attractive option for high-net worth individuals who are looking for value without sacrificing quality. Additionally, flat-fee models encourage advisors to prioritize performance since they are not incentivized to increase their AUM as much as with the AUM model.

Consider the client with $6 million in assets:

Advisor Fee (1% AUM)            Advisor Fee (Flat Fee)                Difference          

            $60,000                                     $20,000                               $40,000

Again, the client must step back and ask: Am I receiving $40,000 in additional value from the advisor charging 1% of AUM than the advisor charging a flat fee?

The Provident Financial Planning Model

Provident Financial Planning offers a flat-fee structure paired with depth in services. The Provident Financial Planning (“PFP”) model provides transparency and flexibility to clients without sacrificing quality service or advice tailored specifically to clients’ needs. In fact, the PFP model incorporates an in-house CPA, JD, and CFP® team of experts focused on serving clients more holistically than other wealth managers. Provident Financial Planning isn’t simply focused on investments; our team provides comprehensive, one-stop services, ranging from wealth management to tax strategy to tax compliance (i.e., filing tax returns) to estate analysis.

Financial planning is an important part of managing your wealth and achieving your financial goals but finding the right advisor can be difficult. Provident Financial Planning is a faith-based, flat-fee firm focused on serving clients more while charging clients less.

Consider a different approach to your financial future.

Thank you for trusting Provident Financial Planning. This commentary will continue regularly. Please share this article with anyone who may benefit and contact me directly with questions or comments.