Our Thoughts on Industry Fees
The finance industry has done a fantastic job of making sure people have a hard time understanding how much they are paying in fees. That should change.
Cryptic, expensive, and inappropriate fee structures have been institutionalized in this industry for decades. With the survival of many firms reliant on them, candid criticism is tough to find. Many advisors will tout the benefits of low-cost investments but very few are willing to ask disruptive questions about the impact the cost of their own services has on client returns. We encourage anybody seeking advice from a financial professional to fully understand the costs involved and question whether or not those costs are appropriate for the type of service being provided.
As discussed below, the simple logic and basic math supportive of flat fees for advisory services is hard to argue with. We believe adopting this more sensible fee structure advances our goals as a business and we unabashedly promote it as a big part of our value proposition. Simply put, it is better for our clients and is better for Ariadne.
The importance of fees within the investment industry is vastly understated. Cost is a fundamental component in determining the value of any service. It should be fair, transparent and reflective of the service being provided. In our view, traditional methods of advisor compensation are deeply flawed and conforming to similar standards would not align with the values of our firm.
Two pricing models dominate the investment landscape today; sales-based pricing and asset-based pricing. Working with sales-based advisors comes with obvious conflicts of interest. It is tough to know whether you’re getting objective advice when the advisor is earning a commission by selling you something. Alternatively, fee-only advisors are only paid by their clients. Although this better aligns the financial objectives of both parties, the asset-based compensation structure that has been widely adopted by fee-only advisors is still far from fair. In an assets under management (AUM) fee arrangement, a client pays an annual retainer fee based on a percentage of their total assets being managed by the advisor.
Despite its popularity, only in the absence of reason could we reconcile the belief that the cost of doing business with a financial professional should be arbitrarily determined by the size of an investment portfolio. Though lacking in sensibility, with limited alternatives or visible criticism, the AUM model has been allowed to proliferate, masquerading as a “small price to pay” for the services rendered. In most circumstances, it certainly is not.
Flat Fees – A Sensible Alternative
While we are supportive of the entrepreneurial spirit and the right to earn a good living, there comes a point where excess should be questioned. Most advisors charge clients 1-2% of their assets each year. That sounds small but is paying an advisor $20,000 a year to manage a $2 million retirement account reasonable? Is the advisor really doing $20,000 worth of work? Furthermore, does it make sense that an advisor may charge a client with $2 million portfolio twice as much as a client with a $1 million portfolio for the same exact service? We believe the answer to these questions is no.
Varying fees based on the size of a portfolio does not seem very sensible and we believe our clients deserve something more appropriate. In the spirit of fairness, flat fees, not asset based fees, are a logical choice. Our flat fees cover our costs and is reasonable compensation for the services provided. Although our fees may be lower than most providers, the quality of service is not compromised. We do not limit client interactions and are always available to our clients.
Admittedly, we cannot predict with certainty how markets will impact client portfolio returns. We can, however, without hesitation, illustrate the savings realized by paying sensible, flat fees rather than traditional AUM fees. Unsurprisingly, billing clients more sensible fees allows them to reap potentially enormous financial benefits.
Consider two investors with identical $1 million portfolios growing at a steady 7%. Annually, one investor pays a $4,500 flat fee, the other pays a 1% AUM fee. For the purposes of this illustration, we will assume the flat fee increases with inflation by 2% each year. Over the course of 20 years, the flat fee investor will save $281,000 in fees resulting in a 22% increase in investment returns. In total, the savings realized by paying flat fees instead of AUM fees is near $500,000! The numbers are impossible to ignore. The type of fee you pay has a huge impact on your returns.