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.’

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