Pros and Cons of Asset Management Fees

A transition is underway within investment firms. Increasingly, the people you hire to manage your money don’t refer to themselves as brokers or stockbrokers. Instead, they’re now financial advisers, financial planners, or financial consultants.

The titles may not be important, but the method of compensation can be crucial. Traditionally, brokers were paid by commissions. When you bought or sold stocks or certain mutual funds, you paid money to the broker. That’s still true for some investment professionals.

However, many financial advisers are reducing or eliminating commission income in favor of fees; therefore, the money you pay these advisers does not depend on the trading you do. Various types of fees may apply, but an “assets under management (AUM)” approach is probably the most common. With AUM, you pay a fee to the adviser that’s based on a percentage of your portfolio value.

Advisers who favor the AUM method contrast it with the traditional way of paying commissions on trades. Some brokers have been charged with “churning” clients’ accounts—trading heavily to boost their income, even if there was no good reason to do so. With AUM, churning isn’t an issue.

There are, however, possible drawbacks to paying AUM to an adviser. For instance, the amounts involved may not be inconsequential. AUM fees can add up fast with larger portfolios. Will you be getting value from those extra fees with a truly personalized investment plan? Will your adviser help your reduce the tax impact on your investment activity? Will he or she advise you on which investments go inside your 401(k) plan and which go into taxable accounts? Ultimately, it’s up to you to decide if the investment advice you’re receiving, perhaps supplemented by other financial planning, is worth the money you pay every year.

Other options

Besides AUM, what alternatives do you have for investment management? You can do it yourself, if you have the time and inclination, by choosing no-load mutual funds and perhaps paying discount brokerage commissions for selected securities transactions. Another possibility is to work with an adviser who still charges commissions, if the total of those commissions is less than an AUM fee.

Some financial advisers work on a retainer basis for clients who have significant net worth but relatively little in the way of liquid assets to manage. The retainer typically is based on the adviser’s estimate of the time necessary for financial planning. The retainer might be high for a new client, reflecting considerable planning, but then drop in subsequent years until an event such as a business sale requires more effort again.

Hourly fees and flat fees for an upfront financial plan also may be among possible modes of compensation for financial advice. Some advisers will offer a combination of compensation arrangements to suit a client’s needs. For investors, the key is to get complete disclosure of an adviser’s compensation method and periodically confirm that you’re getting value for the amount you pay.

This article carries no official authority, and its contents should not be acted upon without professional advice. For more information about this topic, please contact our office.

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