Free Lunch Seminar - Lamborghini Aventador "Included"
This free lunch is being eaten every day... by investment advisors and brokers.
In my first post in this series, The Tyranny of High Fees, I examined the confiscatory nature of high advisory fees. In short, a one-percent incremental fee will reduce an investor’s terminal asset value by about one-third over thirty years.For ultra-high net worth (“UHNW”) investors, this could amount to hundreds of millions of dollars. Minimizing fees should be part of every investor's financial planning.
Achieving the Free Lunch
Finance theory tells us there is no free lunch on Wall Street. While generally true, there is a free lunch available to almost all UHNW investors: lowering fees. Currently, this free lunch is being eaten every day… by investment advisors and brokers.Lowering fees generates what can be thought of as risk-free return. It amounts to a “deposit” of the savings into the investor’s account every year. This is why investors should be laser-focused on fees and keeping them low.
The Solution: Fee Decomposition
Asset management and wealth management fees should always be decomposed and charged separately.UHNW investors should never pay for asset management and wealth management services through one combined AUM fee. Combining asset management fees and wealth management fees into one AUM fee is another form of Wall Street opacity. It creates an artificial information asymmetry that works to the advisor’s advantage.When brokers and investment advisors try to justify high asset management fees, they inevitably point to the wealth management services (i.e. financial planning and other advice) paid for by the AUM fee. While it is true that many brokers and advisors provide those additional services, clients are almost certainly being overcharged for them just like they are for asset management services.If clients don't know the breakdown of the fees, they can't evaluate or compare them to others. This can only be to the client’s disadvantage. In a fee negotiation, the broker will have a heads-I-win, tails-you-lose setup where the provision of one service is used to justify the high fees of the other. (That is, the asset management fees are high because we are providing wealth management, or, conversely, the wealth management fees are high because we are providing asset management.)
Inflating Wealth Management Fees at the Portfolio Growth Rate
Another part of negative fee compounding is that paying for wealth management services through an AUM fee means those costs will grow at the same rate as the assets grow, even though they are unrelated to the assets.For example, a $10 million AUM account invested 50/50 (stocks/bonds) might have an expected portfolio growth rate of five percent. If the costs of wealth management services are embedded in the AUM fee, they will also grow at five percent per year, over time. This is true even if the client’s situation doesn’t change or require any additional wealth management work. (Which is true for most clients over time.)While the one-fee-for-all-services might be more simple than separate fees, it is abusive. By inflating the wealth management fee at the portfolio growth rate, it is likely to grow at twice the rate of typical goods and services. Of course, if a client’s assets are more heavily skewed towards equities, the wealth management fees will inflate at an even higher rate (possibly three or four times the standard inflation rate).
Wealth Management Services
Wealth management fees should be priced based on the amount of work required and the complexity of the client's situation. Anything else will be unfair to the client (most likely) or the advisor (in the case where the client has a very complex situation and a relatively small amount of assets).Furthermore, while many clients will need a comprehensive initial analysis and plan that could cost between $20 and $50,000, they don’t need a comprehensive financial plan each year and shouldn’t be charged for one. Once the initial plan has been implemented, the wealth management fees should drop significantly. This is simply due to the fact that those services shift to a maintenance regime of monitoring, benchmarking, reporting, and annually updating the plan.These services require much less work than creating a bespoke analysis and plan from a cold start.Table 1: Five-Year Savings from Fee Decomposition
In this example, by using fee decomposition a client could get the same services and buy themselves a Lamborghini Aventador S Coupe with their $445,000 in savings. (Available in Manhattan here.)The truth is that most advisors and brokers cannot justify their asset management or wealth management fees, a topic I will examine in my next post in this series.
Bantam Financial Planning Services
Bantam offers completely personalized, professionally designed and bound Family Strategy Books, which go miles beyond what is commonly referred to as "financial planning".
 I am using this for illustrative purposes only. I am not conducting free lunch seminars nor including Lamborghini Aventadors as a handout.