Monday, August 6, 2012

AUM Part III AUM Inherently MORE, MORE, MORE MOREon Personal Financial Planning

Assets under Management (AUM) ‘Fee Only Planning Compensation’ Conflicts: Part III
AUM Inherently MORE, MORE, MORE MOREon Personal Financial Planning

More, better, now has a habit of becoming less worse later
Alas quoting myself

            Sacrificing what we need for what we don’t need isn’t personal financial planning but the pursuit of ‘more for more’s sake’ which is ‘the ideology of the cancer cell’ according to writer Edward Abbey. The usual motivation for more (at the expense of enough) is comparative valuation of worthiness by ‘net worth.’ The result all too often: more, better, now  becomes less worse later.
            Assets under Management (AUM) reinforces this self destructive behavioral pattern of relative comparison to others, to indexes (Dow Jones, S&P) rather than measuring progress or lack thereof relative to each individual personal financial goal.
            In the D. H Lawrence’s story, ‘The Rocking Horse Winner,’ the family of little boy Paul is living way beyond its means. Paul mysteriously discovers by rocking faster and faster – the names of winning races horses come to him. Of course, the spendthrift family parlays these tips into its bankroll. (Rock ‘n Bankroll?) However, to get more, and more, and more winning names – Paul has to rock the Rocking Horse faster and faster – until Paul dies of exhaustion.
            ‘More, more, more –what are we all more-ticians’ – e.e. cummings.
            More, more, more - Assets under Management.
            AUM pays off on the ‘more’ assets under management not ‘enough’ assets to meet the goals with the least risk. The more assets under management – the more AUM pays. Inherent in this compensation is often taking ‘more’ risk than necessary for the goal. And more risk – more leverage (i.e. keeping a larger mortgage so as to have more available assets in the market) cuts both ways – especially on the downside.
            AUM is inherently The Rocking Horse Winner approach which too often causes a lot of whinnying, the Dow Jones becomes the Downer Jones, and Mr. & Ms. Planner lose clients especially in down markets.

            A test of AUM’s focus: In down markets do clients ask:
·         How did I do relative to the Dow, S&P etc OR
·         Do I still have ENOUGH?
Odds are the former not the latter.

Therefore, is AUM the most or least consistent compensation method relative to  the mission of personal financial planning: aligning clients personal resources (financial or otherwise) to support their life goals and values or really primarily a Trojan Horse for Assets under Management gathering?

They swayed about upon a rocking horse, And thought it Pegasus.
-John Keats, 'Sleep and Poetry

Assets under Management (AUM) ‘Fee Only Planning Compensation’ Conflicts: Part II

Assets under Management (AUM) ‘Fee Only Planning Compensation’ Conflicts: Part II

(Jim so) Assets under Management (AUM) compensation is like federal tax withholding – less painful than writing a check every quarter. You don’t feel it as it’s ‘taken out.’
A former client reacting AUM Part I

…but with less probability of refund

            I didn’t realize that the phrase assets under management was a synonym for fee anesthesia, & from planner having to justify the value of his services less often than a monthly check written by a client on a monthly retainer.
            I recall in the early 90’s many a commission (transaction compensated) and fee and commission  ‘financial’ planners asking me, ‘how do I transition to fee only planning with my existing client base?’
            I had two answers that I would suggest – tell the client

  1. In one year, I shall go to fee only compensation. You are more than welcome to continue the same compensation method for a year – or change now, but in a year my practice will be compensated fee only. It’s your choice.  OR
  2. I’ve been screwing you all these years, and I’ve finally decided to go legit.

No one took me up on option #2 to the best of my knowledge which would have been refreshing.

            Nearly all of these planners who made the transition choose to be compensated on a basis of assets under management. Some have tried to have it both ways (BI-Financial Planners?) – AUM for assets manage plus an charging an additional small flat fee for the planning. The fee plus AUM reinforces the point of AUM compensated personal financial planning as a Trojan horse for being asset managers camouflaged as a personal financial planners.
We do what’s inspected rather than expected and focus on what is compensated.

It is time for asset under management compensation planners to fess up and NAPFA to make a full disclosure note with biographies of its members of how they are compensated: hourly, flat fee, retainer, fee and commission, assets under management etc.

The above said, regardless of compensation method, the real question is doing an audit of the progress, you the client, is making towards or maintaining his personal financial goals (which is in both editions of my book Enough: A Handbook for Your Personal Financial Planning – out of print but probably you can get it for 99cents on the web).r entries on this blog).  The Personal Financial Planning Audit should be done upon engaging the planner (to establish a baseline), quarterly at a minimum the first year of the plan engagement, and at least annually thereafter to monitor progress.
Set up a chart: with goals down the left hand side. For example:

  1. Providing adequate income upon total disability
  2. Providing adequate income upon partial disability
  3. Minimizing capital depletion due to illness
  4. Minimizing capital depletion due to nursing home/home health care
  5. Providing for the kids education
  6. Providing for 100% of income from passive sources (retirement)
  7. Providing for 50% of income from passive sources (slow down) for some period prior to retirement)
  8. Minimizing liability: unintended creditors, personal guarantees etc
  9. Becoming independent of your independent business
  10. Providing adequate income for your spouse upon your passing
  11. Aligning your life goals with your personal resources
  12. Healing personal financial anxiety putting money in its place to transcend to significance
  13. Knowing what ENOUGH is
  14. Knowing what ENOUGH is versus MORE
  15. Etc etc.

Horizontally, have a scale from 1-10 (1 being lowest, 10 being highest) and grade where you are at now (if about to engage a planner). If you already have engaged a planner, think back and grade where you were before planning and do a first ranking (baseline and date it as of the beginning of the planning engagement). Next do the ranking again (separate sheet of paper and date it). The questions then become for comparison REGARDLESS OF COMPENSATION METHOD - has there been progress advance/ maintenance towards satisfying your goals or has there been retreat and or failure? (You might also note if retreat – has there been a concurrent increase of good lunches the planner has taken you to – to message your bottom and bottom line on goals?)

Comprehensive personal financial life planners manager goals; asset managers manage assets (and are typically compensated by YOUR ASSets under Management.
And that is a Salient fact.

Friday, August 3, 2012

Assets under Management (AUM) ‘Fee Only Planning Compensation’ Conflicts - Part I

Assets under Management (AUM) ‘Fee Only Planning Compensation’ Conflicts - Part I

(low saliency pricing ((disclosure-jds))…. can be positive for (the personal financial planner’s businesses by) making it more comfortable and less of a slap (seeing what they are paying each month/quarter?-jds) in the face for the consumers who purchase the business’ bona fide goods and services’
From A Financial Planner’s Blog

            So less reminder –frequency -of what the client pays – is a good thing for the client, less ‘salient’?

I still await the definition of saliency from the writer.
            But the synonyms for salient are: most important, relevant, significant, leading.
            And so ‘low saliency’ (low importance) in personal financial planning compensation is:

·         Rationalization and justification for low or no transparency of compensation (fool) disclosure
·         Disguised protectionism (anti trust activity at the least – violation of trust at worst) for personal financial planners’ compensation
·         And or paternalism at its worst

The question for this entry is the inherent problems with assets under management (AUM) compensation method of fee only personal financial planners. The bigger question is: is this method of personal financial planner compensation (consciously or unconsciously) conducive and consistent with the practice of integrative comprehensive personal financial planning or really just an asset gathering marketing by asset managers in personal financial planner clothing?

Behavior is a function of its consequences – we continue to do what we are rewarded for and avoid, extinguish the behavior that have negative consequences or lack of reward.

Yes, there are inherent potential problems with all methods of fee only personal financial planning compensation. In particular:

·         Hourly: a license to be inefficient and often negative reinforcement relative to the client calling the planning (especially before the fact) as the client is concerned about the clock ticking on each and every 5 minute call.
·         Flat retainer: from the planner’s standpoint this can lead to over utilization of his services while for the client, he or she wonders if the price monthly or quarterly is worth it.
·         AUM: Asset under Management Percentage (with the emphasis on ‘under’): As Maslow said, if all you know is a hammer, everything will look like a nail.’ The other areas of personal financial planning process - asset protection (e.g. insurance against capital depletion etc)), asset conservation (e.g estate planning, ever income conservation (e.g tax planning) have a tendency to become second class citizens – orphans overlooked – as asset accumulation (AUM) compensation pays the bills. (Note: assets under management is typically the highest valuation method to maximize the value of the personal financial planning firm upon sale – not that that would have an impact on the choice of compensation method.)
·         Percentage of Income against a Percentage of Net Worth whichever is greater. (Relatively few planners use this method – which probably has some value for high income low net worth individuals – professionals – doctors –athletes).
·         Percentage of Net Worth (not including house and personal property): The positive the planner pays attention to facilitating the closed held business owner becoming financially independent  of his independent business  The negatives: most planners, have little business planning skills (and don’t even have a business plan for themselves) so the planner would be way overpaid without these type of skills.)
·         Bracket fees (both for initial plan) and an ongoing planning (monthly retainer). The positive – clients won’t hesitate to call before the fact and know what their maximum cost will be. Instead of the compensation derived from assets under management and the focus thereof, the planner is managing goals instead of an inherent focus accumulation in the assets under management compensation method. The negatives: first, the planner will have to know his planning process to not be over utilized. Secondly, with the client writing a check monthly or quarterly (rather than just being taken out of the Schwab account ‘painlessly’), the planner has to continue to establish his value – relative to goals being made or maintained (poor baby!)

Ok- it’s obvious, I prefer the bracketed fees method of compensation. And yes, it is my opinion, that assets under management compensation – is but a soft commission and inherently a Trojan horse for gathering assets rather than personal financial planning. And yes, with its inherent focus on assets under management more, more, more becomes accumulation (which may or may not be necessary, managing assets INSTEAD OF managing goals) becomes the aim..
Cases in point (and not isolated) of AUM’s focus shortchanging to the detriment of managing goals?

  • AUM planners overlooking Long Term Care risk (which if incurred would have cannibalized the retirement goal)
  • AUM planners forgetting about replacement value by ordinance on home owners insurance (cost about $30)– which resulted in one homeowner this writer was informed of having to come up with $30,000 even though he had replacement value on his Florida property).
  • Complaint ratios? (closed complaint ratio on homeowner and auto insurers)  “That’s my clients frequency of bortzing about their spouses,” one AUMer said to me. (And the AUM planner wasn’t kidding). Schwartz’s law on insurance: What good is a Mercedes (great financially strong company), that is the shop all the time (high complaint ratio), and if it has no gas (lousy policy)? All three elements are necessary: financial strength, low complaint ratio, excellent policy terms.
  • The worst: AUM planners (SUB PRIME AUMers?) telling clients to maximize their mortgage (instead of paying it down or paying it off which would lower their slow down or retirement goal need) and instead put the money into the market to get higher returns (as well as leveraged higher returns on their home). How did that turn out, Bunkie? (Over and over again from planners I heard this old saw (rationalization)– and each in  case the ‘so called’ planners were compensated on the basis of AUM! .The risky desire for PREMATURE ACCUMULATION RESULTED IN PREMATURE DECUMULATION PRIOR TO DISTRIBUTION or Personal Financial Planner Ejectile Dysfunction.
  •  Despite disability insurer UNUM being downgraded 13 times, AUM planners of my acquaintance didn’t move their client’s disability coverage (even when there was no insurability question) as ‘the insurance guy is on top of the situation.’ (Meaning don’t bother me, I have assets to manage – that’s my job.)
Yes, fee only planners compensated on the other methods could have made the same mistakes. However, especially on the mortgage situation, the other methods did not have the incentive to leverage large mortgages increasing the planner’s asset base of compensation for the planner’s compensation benefit.
Part II will focus on the Bracketed Initial Plan and Flat Fee Retainer as well as judging the planner’s success relative to goals (not assets under management).
So much for ‘saliency.’