AUM Fees: Things To Consider

The AUM, or assets under management, fee model has grown more popular over the years. The investor (you) pays a financial advisor a percentage of their portfolio in order to manage the investments in the market. The financial advisor will buy/sell certain stocks, bonds, ETFs, mutual funds, etc. in an effort to beat the market. The percentage charged can vary, but in general it hovers around 1%.

In addition to managing the funds, many advisors/institutions with this model will offer ongoing financial advice in accordance with your goals. This model is still considered “fee-only.” A financial advisor with the fiduciary status can offer the AUM model and still be considered a fee-only fiduciary. This is not to be confused with fee-based or commission-based financial advisors.

Disclaimer: I am not a CPA, CFP, CFA, or certified financial representative in any fashion. This post is intended for informative and entertainment purposes only. Your investment decisions are your own.

Financial advisors are paid by the size of the portfolio managed.

Let’s say you decide to pay an AUM fee to a financial advisor for your brokerage account only. You sit down with them, feel comfortable with everything, and let them manage $25k at a 1% fee. Hell, $250 bucks a year for a financial advisor sounds extremely reasonable right? How is this guy in business?

Originally you keep with your original plan, putting in about $500 per month. In your next meeting with the financial advisor, you mention that retiring early might sound nice. He shows you, with the hard numbers, a well laid out plan to get your 401K funds into a Roth account for him to manage. Not only that, but my minimizing 401K contributions, and maximizing brokerage contributions, you have the potential to retire for good in 5 years! Sounds awesome right!?!

Unfortunately, in this completely made-up case, you would be hit with a tax burden like no other if not done strategically. Also, instead of this guy managing a small $25k, you are now paying him fees for a $1 million portfolio (or $10,000 per year 😬). The financial advisor in this case is incentivized to manage more of your investments sooner than later. Even if this guy is technically a fiduciary, you did mention that early retirement sounded nice, right?

An hourly or project-based advisor is going to be paid the same regardless of the process, so they might be more inclined to advise the optimal route. They might help you come up with a plan to help mitigate the tax burden that involve smaller Roth conversions annually for the next 5 years, resulting in you calling it quits in the same amount of time. It’s in their best interest to keep your best interests at heart (in many cases) so that you’ll see them again in the future.

It’s hard to keep up with the market.

In the past we have discussed how almost 90% of fund managers fail to beat the market. This isn’t because it’s impossible to beat the market. It might be because that person has a boss who is directing them to follow certain benchmarks. It might be because the financial advisor feels they may lose you as a customer due to the volatility of certain stock choices. It may be because you had instructed them on certain allocations, and they are just following orders. Who knows?!?

At the end of the day, there are really only a few big-name fund managers that consistently beat the market over the course of decades. Does the name Warren Buffett come to mind? It should! He’s widely known as one of the greatest stock pickers of all time! I’m not telling you to go invest with Berkshire Hathaway right now, but I am telling you that finding a financial advisor that consistently beats the market for long-term investors is like catching lightning in a bottle.

As your investments grow, so do your fees.

This is one that many people in my life don’t seem to grasp. Of course, right now your $25K investment is being charged $250 a year. Down the road, when looking at retirement you may have $2 million invested and want a professional to manage it. The annual fees on this with a 1% would be $20,000 a year! 😶 Not only that, but they were collecting a 1% fee the entire way up to $2 million!

To further illustrate this point, let’s take someone who starts at $25k and invests $1k per month for 40 years. We discussed above how difficult it is to find a financial advisor who beats the market. In this case, our guy is matching the market but has a 1% AUM fee. If we are utilizing a total stock market index fund, conservative assumption on return would be 7%.

The below examples are screen shots from calculator.net.

Holy crap!!! So just by consistently investing in the market, compound interest starts to take over, and this portfolio almost hits $3 million! Now that is a comfortable retirement!

Now let’s say we got one of the really good financial advisors who keep up with the market. They are charging a 1% AUM fee along the way, so we’ll make all the same assumptions. This time, unfortunately, we’ll utilize a 6% return to account for the AUM fees.

Holy cow! 😬😶🙈

So, by utilizing a better than average financial advisor charging a 1% AUM fee, we are looking at our investments being $685,771.49 lower than what they could be!

If we want to utilize the 4% Rule in retirement, this would be the difference of paying yourself $86,964.26 annually or $114,395.12 annually. And that’s only if you fire your financial advisor when you retire! Heaven forbid they keep sucking from that golden nest egg you built for yourself during retirement! 😬

Other problems with AUM fees.

The actual payment of an AUM fee isn’t something you get billed for, in most cases it’s taken directly from your investment account. Many times this is done quarterly which minimizes the impact of your total net worth at any particular time; thus, the fees will sometimes fly under the radar.

Depending on the financial advisor you are working with, there may be other fees that fly under the radar as well. Certain fee-based advisors will charge the AUM fee, as well as an advisory fee every time you want to have a meeting. Talk about kicking a dog while he’s down, huh?

Certain financial advisors/institutions have a minimum threshold before you can invest. The greater the reputation, the higher that amount is. In the above example I used $25k as a quick example, there are quite a few “professionals” that will laugh you out of the room for trying to work with them. On top of that, the ones that are willing to work with you might be less experienced or less productive.

Once working with them, if the advisor decides to invest your money into higher cost mutual funds, the cost of those funds ultimately gets passed down to you. If you didn’t direct them to stay away from certain funds, they have free reign to try things out. Naturally, most advisors would do this because they believe their investment strategy will win overall. But… remember when we talked about how rare that is?

Now at this point… it kind of feels like I’m bashing all financial advisors. 😂 I promise you that’s not the case. The truth of the matter is that most fee-only fiduciaries are not slimy evil pick pockets. The majority of them are looking to guide you along the financial path that best suits your wants and needs. In a lot of cases I dislike the AUM model, but there still are a few reasons it might make sense for a Savvy Solo.

Hands-Off Investing

Investing with an AUM fee is far greater than not investing at all. In the above example, you see that the investor got over $1.6 million in compound interest even with paying AUM fees. If having a professional manage your portfolio is going to motivate you to invest more, than do it!

I know a retired person who has absolutely no idea what her net worth is, and she doesn’t want to know. She pays a fee-only fiduciary an AUM fee to “take care of all that.” She knows that she’ll have more than enough to live the life she wants to live, and that’s enough for her. When she wants to travel the world (which she does quite a bit), or do something out of the norm, she simply calls her financial advisor and they see how they can work it into the plan.

Naturally, for me, this is terrifying. But for some people, the cost of the AUM fee is absolutely worth getting all this financial crap off their plate!

Less Volatility

With any actively managed account, a good financial advisor is going to make money moves when volatility inevitably hits the market. They might re-allocate to more bonds when it looks like the market is about to crash, or re-allocate to more stocks when a boom is on the horizon. Hell, they might have done some research on a particular market sector that’s about to explode and get part of your portfolio in all that greatness.

Usually, with an actively managed account, the lows aren’t as low. Given the recent market volatility, I can understand why some people would opt for a smoother ride. Granted, this means that the highs aren’t going to be as high, but for some this is a trade-off worth taking.

Ongoing Support from a Professional

Above I had given an example of how a meeting with a financial advisor brought up the topic of early retirement. It’s possible that thought never even crossed your mind, and wouldn’t have if not for that meeting. You don’t know what you don’t know, and in some cases it’s best to work with a pro to reach your goals. In the case of a financial advisor that only charges AUM fees, there is no extra charge to sit down with them and come up with a plan.

The vast majority of financial advisors have access to Fintech (financial technology) that we cannot get our hands on without some sort of exorbitant fee. This helps the financial advisor run a million simulations on your current portfolio to get accurate projections on the future. With that info, it’s much easier to come up with a plan (retirement or otherwise) that satisfies the investor.

My retired friend mentioned above didn’t pay anything extra when she planned a trip to South Africa for safari, or when she went on a several week vacation through Europe, or when she made improvements to her house. It was a simple call or sit down meeting with her financial advisor to see if/when those things can be done, and she’s living her dream!

Performance Incentive

With the AUM model, the larger the account the larger the paycheck. This creates incentive for any financial advisor, fiduciary or otherwise, to make your money grow as fast as possible! The more money you make, the more money they make!

Does this mean they are going to put you in highly volatile stocks? Not without your blessing! They would, in general, want to make safer moves with your money as to not scare you off. Some paycheck is better than no paycheck right? Again, that means the highs of the market won’t be as high for you, but maybe it’s worth saving the headache anyway.

AUM Fee Structure

Whatever % you are being charged, it’s a straightforward and simple structure. It’s possible that once you hit a certain threshold (for example, $750k) your AUM fee % will be reduced! This increases motivation to invest more, which works out better for all parties in the long run.

There are a ton of financial products out there with very complicated fee structures. Be very weary of any financial product that involves insurance, any kind of “guaranteed return,” or heaven forbid anything that has the word annuity in it! 😱 With the AUM model, the financial advisor isn’t getting commissions on selling you some crappy product. When you win, they win, and vice versa.

I’m not personally paying any AUM fees right now, nor are they part of the plan for my future. Why? The reasons against them far outweigh any reasons for them, but that’s just for me. The current VTSAX and Chill strategy I’m working will do just fine for me. Once my portfolio hits a certain threshold, and it’s time to see a financial advisor, the plan is to pay hourly or project based.

Even with the recent extreme market volatility, I’m sleeping great at night. The US stock market has always bounced back from every hardship. In fact, after every recession it comes roaring back to all-time highs! If you are the nervous nelly type that is going to sell at the first sign of distress, then maybe paying an AUM fee-only fiduciary is the right option for you.

I have comfort in knowing that whatever turmoil is in the immediate future for the US stock market, extreme growth is sure to follow. Might as well get in now while stocks are on sale, right? 🤪

Stay classy Solos! ✌️