5 Influencing Factors of AUM Fees

Financial advisors often charge clients based on a percentage of their assets under management (AUM), especially for investment and wealth management services. While these fees may vary based on details such as the firm’s services, the relationship between the professional and client, and the type of management, the range of 1% to 2% AUM is commonly noted as the standard. But why is this the case?

Below, we break down the five factors that influence the AUM fees financial advisors charge clients for portfolio management:

1. Portfolio Size

The size of a client’s portfolio is a core foundation for the AUM fee structures advisors use. Firms and professionals commonly place payment percentages on a sliding scale. For instance, a high-net-worth client with over $1 million under management may see a lower rate than another with around $100,000 in assets. This approach motivates clients to grow their portfolios at a specific firm.

“Many advisors/firms have a tiered structure where fees decrease at certain asset thresholds, since the relative cost of managing additional assets diminishes beyond a certain point,” says Melissa Murphy Pavone, CFP^®, CDFA^®, financial advisor and founder of Mindful Financial Partners. “These tiered rates allow advisors to offer more value to high-net-worth clients, who may need more complex and specialized services.”

At first glance, this tiered structure based on portfolio size may seem backward. If clients with larger portfolios often have nuanced needs and allocations, why wouldn’t clients with fewer assets pay less? According to Nancy D. Butler, CFP^®, CDFA^®, CLTC^®, CSA, owner of Above All Else, Success in Life and Business, one reason is that firms “typically have a system in place for how they manage portfolios” and therefore “have no more work to manage larger portfolios than they do smaller portfolios.” She adds, “Since it takes about the same number of hours, they need to charge more for smaller accounts to compensate them for their time and can afford to charge less for larger AUM accounts.”

Basing AUM structures largely off portfolio size both incentivizes people to stay with an advisor over time, but also ensures that the time spent planning and building a client’s account is proportional to the amount of work needed. In general, larger portfolios will be in a maintenance and monitoring mode whereas new clients with fewer assets will require more effort for an expert or organization, justifying a higher annual rate.

2. A Financial Advisor’s Experience and Credentials

While portfolio size is the clearest and most direct detail making up an AUM fee, the experience and credentials of a financial advisor or those at a firm are another important factor. Professionals who have spent more years in the industry will often be more attractive to prospective clients, as they’ve likely been able to work with a diverse array of clients and experience the ups and downs of portfolio management. The advisor will often recognize this and reflect it in their rates.

Similarly, many individual advisors will have spent immense time and money earning high-quality designations and credentials to gain and showcase their knowledge. Professional titles from high-quality organizations, such as the CFP Board and CFA Institute, require one to complete rigorous educational programs, collect substantial on-the-job experience, and uphold strong ethical standards. When an advisor has earned reputable marks, they can signal a commitment to their practice and ethics to their clients. These experts will be in high demand and, therefore, may be worth a premium.

The experience and professional certifications experts carry can impact AUM fees, but it’s not always without some regulation. That is, they’re not always able to charge sky-high prices based on who they are, especially when employed at larger firms. “Many broker-dealers have fee guidelines for their advisors that include years of experience, designations, financial education, and more,” says Butler. “The guideline provides the lowest and highest fee the advisor can charge.”

However, as Jon Ekoniak, managing partner at Bordeaux Wealth Advisors, notes, higher fees don’t always guarantee more experience or better credentials. Clients should do their research to understand an advisor’s background and qualifications. “The client needs to beware that they are not overpaying for someone who is less experienced and less credentialed” and “should ask about one’s credentials and certifications,” he emphasizes.

3. Time and Number of Clients

The amount of time a professional must spend working on a portfolio is another contributor to AUM fees. If an advisor must spend significant time upfront consulting with clients, researching, planning, and helping construct an asset allocation, that will be an understood portion of the fees.

However, time is finite, and some firms will spend less working directly with clients, which could lead to lower fees if they can’t provide the same customized experience other firms offer. “The biggest factor in determining how much time an advisor can spend with their client is by the firm’s client-to-employee ratio. Those with higher ratios may not even have the capacity to provide personalized or customized service,” observes Ekoniak. “From 15-1 to 30-1, the service is likely to be lightly personalized (perhaps using model portfolios, but a personalized financial plan). For those firms where there are more than 30 clients per employee, the offerings are going to be more generic and appeal to the mass market.”

Regardless of the ratio of clients to employees and customization, it’s not uncommon for firms to standardize AUM fees at around 1% for portfolio management. Ekoniak points out that this is because it “offers a reasonable fee for firms to make money yet still provide value well over and above the cost of the service.” Depending on the firm and its offerings, a 1% AUM fee may include tailored portfolio management, but may also bundle other services such as financial planning, estate planning, or tax management. It may also cover transaction costs and brokerage fees within the account.

4. Portfolio Management Style

AUM fees can also shift due to the management style of a client’s account. Some clients may opt into a discretionary relationship where a financial advisor can make trades on their behalf without approval. Others, however, may decide to adopt a non-discretionary arrangement, where the client makes the final decisions and signs off on all trades.

A financial advisor holds significant control over a client’s portfolio under a discretionary arrangement. The expert will actively oversee properly allocating assets according to a client’s risk tolerance, time horizon, and goals, and doesn’t usually need to get approval before doing so. On the other hand, in a non-discretionary arrangement, the client retains most of the control and responsibility of managing their investments. Although they can still help with trading after a client gives permission, the professional is less of an active manager and more of a passive advisor and resource.

The impact on fees may be surprising, however. While it may seem like it would be costly for a discretionary manager to devote time and expertise to handling an account, Ekoniak highlights that it’s the other way around: “Non-discretionary management is actually more expensive to deliver because it is more time consuming to obtain the investment approval for every investment that is being recommended.” Conversely, robo-advisors, which typically use discretionary management approaches, can be some of the most cost-effective in the business, with annual fee percentages below the industry standard of 1%.

5. A Firm’s Resources

Finally, a firm’s resources may impact the AUM fees clients face. In one sense, a firm may be more apt to charge higher prices when it’s proud of its resources and staff. For example, organizations, including both robo-advisors and traditional advisors, may use their cutting-edge technology to substantiate higher prices. Similarly, they may also do so because their experts carry high-quality certifications and experience, as we mentioned earlier.

Firms in the investment management subset of the financial advice industry may also charge higher AUM fees because of the overhead they may face. For example, this may include things like:

• Advisory experts and administrative employees.
• Technology, including computers, phones, and various software.
• Office space.
• Advertising costs.

The exact influence of operating expenses on fees can be hard to quantify. However, one may reasonably assume that a company with higher business costs could increase rates. “The more efficient a firm operates its business, the lower its costs are likely to be. Whether this gets passed on to the client or not is up to the firm,” says Ekoniak. “Technology is not cheap but it can certainly make a firm more efficient in the long run.”

While advanced infrastructure and resources can be a selling point for a financial advisory firm, even with the potential for increased prices, Ekoniak points out that this can impact the experience on the side of the client for some services. “The more one relies on efficiency and scalability, the less customized or personalized the service is likely to be,” he says. “There are some items (such as financial reporting) that are good to be completely automated whereas there are other areas (building an estate plan to fit one’s wealth transfer plans) that are much better to be personalized.” In some cases, smaller organizations with fewer experts and resources may be able to offer more personalized services at lower fees than larger ones.