Friday, May 9, 2014

When 1% Is Really 20%: Assets ‘Under’ Management’s Misleading Personal Financial Planning Compensation

When 1% Is Really 20%:
Assets ‘Under’ Management’s Misleading Personal Financial Planning Compensation

If all you know is a hammer, everything will look like a nail

            The predominant method of fee only and fee based personal financial planning is assets under management (AUM). And coincidentally, the asset under management percentage just so happens to have gravitate to 1% of the total assets managed.
Just coincidentally.

            1% of assets under management?
This metric is wrong – while accurate it is purposefully misleading to indicate ‘a small amount,’ while if the 1% was applied to the rate of return - the percentage would be much larger (assuming a positive rate of return and possibly worse much, worse if applied to a negative rate of return when the risk adjusted rate of negative return was greater than the market loss).
            And that 1% asset under management compensation as a percentage of the rate of return will be probably be an even greater as the increasing demographic of an aging population takes net more and more out of the market which,  compounded by declining birth rates, makes for a greater probability of declining rates of return in the financial markets in the future.

            AUM compensation is not only a conflict of interest between planner and client (I win maybe you win; I win you lose) but it is inherently in conflict with the essence of personal financial planning – aligning personal financial resources to achieve life goals, values and payoffs.
            Arguments to the contrary by Trojan horse asset managers in personal financial planning clothing, are akin to Dracula guarding the bloodbank.

            Assets under Management (AUM) compensation is not only a ruse – it is contrary to the mission of personal financial planning as stated above. And the assets under management compensation causes the personal financial planner necessarily to perform relative external indexes (to Dow Jones, S&P) for more, more, more – instead of relative to the client’s best interests and goals. Furthermore, assets under management compensation functionally and constructively incentivizes the so called financial planner (really a masquerade for being an asset manager in personal financial planner clothing) to focus on comparative rate of return (S&P etc)--- not goals. And to reiterate, personal financial planning is about managing goals not managing assets. Managing assets is merely a tactic to achieve the goals and desired payoffs.

Do not place a stumbling block before the blind
Leviticus 19:14

For example, if the rate of return in the portfolio is 5% and the planner receives 1% on the assets under management, the client is paying 20% of the rate of return. This revelation is not disclosed in the planner’s investment advisory ADV required by the Securities and Exchange Commission under conflicts of interest or risks. Furthermore, if the client’s portfolio declines 5 – the planner still gets his or her 1% - increasing the decline in the portfolio to up to 6% of 16% of the decline.
You win – I win; you lose – I still win?

            Now planners will argue that if the planner doesn’t add value to the client (regardless of compensation method) the client will leave anyway. However, rarely does a planner disclose  that financial planning practices are overwhelming sold on the basis of AUM (AU= gold M= more for me?) on a discounted cash flow basis – like an annuity etc.).
            But if the masquerading asset manager in personal financial planning clothing was managing goals instead of relative rate of return (more, more, more comparatively), then comparison to indexes would be irrelevant. The planner might actually seek to return less than the market though with significantly less risk because the goal has been met or  on target and preservation of capital from risks would be primary. Thus,  Dow might be up 15% but all that was necessary for the goal was 8% - why not lower risk to insulate the goal?
            Why not?
            Assets under Management compensation is reduced.
            Assets under Management is in a conflict of interest with the achieving of goals – fueled by the planner selling more, more, more rather than meeting goals, goals, goals.

            Why sacrifice what is needed for what is not needed?
            The answer is More the allure of More absolutely and relatively for the client – the allure of More by AUM for the asset manager in personal financial planner clothing.

            This AUM compensation has led many a AUM compensated planner to suggest larger mortgages so the client would have More in the market – for a higher rate of return. This is financial leverage rather than the peace of mind of having the house paid off – not being beholden – having FUability because of AUM and the allure of More. In this example, using a higher mortgage on a house is like a Hedge Fund using leverage – which magnifies returns on the upside but also on the downside as the 2007 meltdown proved. Is this AUM inspired leveraging aligning personal resources to achieve life goals and values?

An ass-et manager is an ass-et manager is an ass-et manager

            In a broader context, if the question is ‘what is ENOUGH’ rather than ‘more, more, more’ – AUM would be irrelevant. Managing goals rather than comparison with the Dow Jones – goes further to relieving  financial anxiety, putting money in its place – so then clients can elevate – connect – transcend to their significance – their what next – their purpose.
            AUM is inherently a contraindication to the aforementioned – blasphemy to the mission of personal financial planning – an imposter – a personal financial planning pretender – when in reality it is just a false fa├žade for asset management.

            Solutions to the misleading AUM?

1.      If the so called planner wants to be an asset manager, so be it. But stop calling oneself a personal financial planners and term yourself what you are: an asset management – first foremost – fully transparent.
2.      Also, it suggested that in the SEC ADV form and add new chart (which must be disclosed at the initial prospect meeting) showing the effect of the asset under management percentage as a percentage of rate of return of loss. (There is precedent – mutual fund’s disclose their management costs in year dollars already in their prospectuses). Thus, instead of the crutsy misleading minimization FOOL Disclosure of merely 1% AUM, the client can see the FULL Disclosure maximums of AUM over time.  (That surely will get the potential client’s attention and move the planner, in response, to other forms of fee only compensation –or give up the ruse).
3.      Reduction of AUM and or clawbacks if the there are losses. AUM would be restored once there are new profits.(Now that would be accountability). Thus, you lose – I lose. There is an exception: if there are  losses were, and on a risk adjusted basis, the planner’s performance was such that less was lost than the indexes, the planner, the planner should receive his AUM percentage with no adjustment relative to new profits. Thus, the paradigm of AUM changes to, you lose less – I am still rewarded – because the client has to gain less on the upside to get back to where he or she was previously.
AUM and Clients’ Culpability

There is no parasite (the AUM asset manager in personal financial planner clothing) without a host (the client). And the hosts are the clients whose lips say the want to achieve certain goals but their actions, telephone calls, and complaints say, “More, More, More….” (which is never satisfactory ‘we should have bought more, we shouldn’t have bought as much…)
Without getting in the questions of human nature, fear and greed, etc. still,  an AUM charat as percentage of rate of return chart needs to be disclosed for full and timely fashion. Then let’s see if AUM (assuming no price coordination by planning trade tax exempt associations) can stand on its own which would  uncover the real essence of AUM – holey asset management rather than  personal financial planning in holy cloth.