For the better part of three decades, the model of charging clients an annual fee based on assets under management (AUM) has provided a powerful foundation for the emergence of the RIA profession. During that period, the RIA model has overtaken wirehouses, banks and other formats as the favorite of investors, as evidenced by its blistering growth.

There’s no doubt that the strong bull market in two of the last three decades has fueled much of the expansion. In any given year when equities rise more than 10%, advisors enjoy automatic increases in their revenues.

Clients like the model for its simplicity, and advisors enjoy the steady, predictable revenue stream. In fairness to advisors, their fees have come down as their businesses have grown. TD Ameritrade Institutional CEO Tom Nally says the weighted average fee charged by RIAs at the big custodian is now
74 basis points, not that much more than at robo-advisors.

Given that robo-advisors and discount brokerages have embraced it, the AUM model won’t die an easy death. It is unlikely to die at all.

But a number of developments are likely to challenge the model’s universal popularity. First, millennials who never saw the whopping commissions charged by full-service wirehouses in the 1970s and 1980s aren’t falling in love with AUM fees the way baby boomers did.

In fact, some next-generation clients are seeing conflicts in the AUM model that previous generations did not. As Gail Graham writes on page 49, when an advisor tells a successful millennial to take out a big mortgage with a high monthly payment, the prospect sees it as an attempt to grab more AUM.

Then there’s the issue of older clients living off portfolio withdrawals. Many are likely to demand more services as their assets shrink. If a client’s assets fall beneath a given threshold, will the firm raise fees on the remaining AUM? If the client is taxing the firm’s staff, it might appear fair, but who really wants to treat a client of 30 years that way?

Even though RIAs’ profit margins have declined in recent years, the shortcomings of the AUM model may not become apparent unless there is a sustained downturn in equities. The clients’ problem is that they are likely to perceive an advisor’s value in terms of asset management, an increasingly commoditized business.         

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