Many, or perhaps most, of us financial advisors make our living by billing clients a percentage of "Assets Under Management." We supervise their portfolios, but we also provide a host of valuable noninvestment financial planning services for which we charge ... well, nothing! That's the "AUM Business Model." As several observers have noted lately, our businesses enjoyed a free ride on the long bull market in stocks and bonds. But now that stocks have actually lost money for the last ten years, clients are beginning to question the AUM value proposition. Surveys say 70% are looking for a new advisor.
How's the AUM model working for your clients? For your business? If your answer is, "Not so well," then it seems you have three possible responses:
1) Empathize with your clients and hope the market gets back to "normal" before they quit.
2) Chuck the AUM model and start getting paid for the planning work you're really good at.
3) Provide a more effective investment service.
The Good Old Days
Good personal financial advisors are well trained and experienced in goal setting, cash-flow modeling, estate planning and a spectrum of needed and even appreciated professional services for which the public has never learned to write a check. Paying a 1% retainer in return for double-digit portfolio returns seemed perfectly reasonable to folks, so we built our modern advisory profession on AUM fees. We religiously honed our planning and client communications skills, and most of us took care of the investments with some version of modern portfolio theory (MPT), style-box diversification and rebalancing.
If you established your business in the '80s or '90s, this was a perfect business model. I mean, Perfect! You provided much-needed services and your fees were paid automatically from client brokerage accounts, so you had zero collection problems. The value of stocks and bonds chugged steadily higher most of the time, validating your investment acumen. When markets were regrouping, as they did in '87, '90, '98 and the great swoon of 2000-'02, your main job was to reassure your clients that markets are efficient, America is great and it is foolish to mess with the strategic asset allocation you have prudently designed for them. And sure enough, every market decline was temporary, your calm professional assurances proved prescient, and client loyalty soared along with referrals. What's not to love?
Reality Sets In
Enter the Great Credit Crunch of 2008. "Not to worry," right? "Declines happen ... keep the faith ... all will be well." OK, this decline is a bit deeper than the others, and it's been going on for quite a while. As a matter of fact, oh my gosh, the S&P 500 has lost 40% in the last ten years! Clients are getting a little testy, your revenues are actually down and referrals have dried up.
Are you starting to feel a little uneasy about the "stay the course" assurances that worked for so long? Should you be? Is the buy-and-hold, strategic-allocation-with-regular-rebalancing style of managing investments (the one service that you actually got paid to provide) really good for all seasons? Or is MPT and its efficient market hypothesis overly simplistic and maybe even dangerous to your increasingly restless clients and to your business?
I've noticed with interest that a high percentage of articles and conference presentations intended to help advisors through this troubling period are focused on being empathetic and having more frequent contact with our clients. "It's all about the relationship," they tell us. Focus on the relationship, on showing that you care!
Well, excuuuuse me! If your 64-year-old executive client has lost 30% of his life's savings under your supervision, and his head is on the corporate downsizing chopping block at work, is another birthday card going to cheer him up, make him happy with your advice? Does he want to pay you to say, "Just work three years longer, Bob," or "We need to help you plan a no-frills retirement, Diane?" Is there some reason that you believe they are not among the 70% of clients that the surveys show are ready to switch advisors?
Of course, it's really important to care. We all value our relationships with our clients; that's one of the great things about the advisory profession. But our clients hired us to do a job. In our AUM business model, the only thing they actually pay us for is managing their investments so they can reach their goals. How are we doing with that? I mean, objectively, how are we really doing?
MPT Teaches That We Are Helpless
Whether it is original MPT or a myopic interpretation of it, business schools and professional certification programs have promulgated the notion that an investor is pretty much at the mercy of the markets. All known information is in the prices, the theory goes. The best thing to do, they teach, is to diversify across all the so-called asset classes (to allegedly dampen volatility) and be happy with the resulting returns. As a result, most advisors have based retirement projections on about a 7% average expected return; we figured about a 10% return on equities, so the 60% of the assets in stocks contributes 6% to the portfolio return. We'll get another 2% from the remaining 40% of the portfolio that's invested in bonds and cash at 5%, minus our fee, and everyone is happy.