Charging a percent of “assets under management” is a really great business model for financial advisors. They spend their first few years in the industry building up a “bank of business” by selling their advisory services to consumers. Maybe they find 100 clients who average $500K in assets each. That would be $50M in assets under management. That would kick off $500K/year in advisory fees to the advisor. Pretty sweet gig.

But for the consumer, even though 1% per year sounds low, it gets ugly over time. Interestingly the amounts show in this graphic aren’t what the advisor actually gets paid. For example, over the 40 year period Chelsea’s advisor would “only” collect $280,000 in fees. But from Chelsea’s perspective, that money could otherwise have been invested and growing instead of dissolving to the fee. So her opportunity cost is much more!

The “assets under management” (AUM) model has some other problems as well. First, the main incentive of the advisor is to get and keep those assets under management. They’re only interested in giving financial advice insofar as it prevents you from firing them and taking your assets away. Imagine if you need help with some other dimension of money (estate planning, insurance, budgeting, debt, taxes, etc). Is the person who gets paid based solely on your investments motivated to help you with that? Not really.

Additionally, even the investing side has a weird incentive. AUM managers may be incentivized to be overly conservative. They might see a down market year as a risk to losing a client so they would keep your money invested too conservatively (thus costing you way more down the road).

Anyway, this isn’t a rant against financial advisors. There are so many good ones out there. It’s just the business models that present these weird conflicts of interest. If you’re looking for a financial advisor that charges $150/hour, check out Nectarine.

As always, reminding you to build wealth by following the two PFC rules: 1.) Live below your means and 2.) Invest early and often.

-Jeremy