Net worth is the number you get when you add up all the things you own (bank accounts, investments, property) and you subtract all the things you owe (student loans, credit cards, mortgage). This is your net worth or your personal balance sheet. I like the term personal balance sheet, in lieu of net worth, a bit more because a) it makes more sense to call it that and b) your “worth” shouldn’t really be tied to anything financial. I love you just the way you are!
There’s a better alternative to AUM and it’s pricing based on income and net worth. Here are the 7 reasons why I charge my fees this way:
Reduces Conflict of Interest
When you look to hire a financial planner, working with someone you can trust is often paramount and this boils down to conflicts of interest. I assert that the fee-based model is the purest model in which you can receive advice. There aren’t any product sales. There is better transparency. But just because you’re working with a fee-based Planner doesn’t mean there aren’t conflicts. Most fee-based Planner follow the typical AUM model where the planner is compensated based on the amount of assets they manage on your behalf. So, when you win that $60 million lottomax drawing or have an old defined pension to rollover, it is in the planner’s best interest to manage all of those funds because the more they manage, the more they get paid.
However, what if you’re really interested in buying real estate (you could get something fairly decent for $60 Million, I think) or you need to pay off that pesky credit card debt or student loan debt? These alternatives are NOT in the best interest of the planner because they’d manage less, and thus their pay would be less. This, boys and girls, is a conflict of interest. In contrast, the income and net worth model captures all the things. So, if you want to use that money for any of the aforementioned items, it matters not. You get the same unadulterated advice because it’s all captured on your balance sheet. See? Less conflict of interest Aligns Interests
Not only does the income and net worth model reduce conflicts of interests, it actually aligns your interests. Let me break it down by asking two simple questions:
1) Do you want to make more money? Check.
2) Do you want to have more assets (what you own) than you have liabilities (what you owe)? Check.
That’s what I want for you too! A quick note here: so much about financial planning is about cutting expenses, but shouldn’t it also be about growing the top line (cash inflows) and exploring opportunities to make additional income? Or maybe it’s about ensuring you’re being paid what you’re worth. A planner can assist you in those salary negotiations, especially if they understand the market and the niche.
Best Aligned to Comprehensive Financial Planning
To me, the AUM model is antiquated because it prices based on one aspect of your financial plan. Essentially, there are six components of a financial plan. They are:
– Fundamentals (Budgeting/Cash Flow, Debt Management, Emergency Fund)
– Insurance
– Investments
– Tax
– Retirement
– Estate
Charging based on one aspect is convenient because a) that’s the way we’ve always done it (since we began to leave the commission world) and b) fees are taken directly from an investment account and does not necessarily disrupt client cash flow. The fact is that although investment management often dominates the dialogue of what a financial planner does, it’s just one piece of the puzzle. As an example, I could be managing your $300,000 portfolio and making you a killer 10% return (hypothetically!), but if you are $40,000 in credit card debt at a 16% APR, am I really helping your cause?
Additionally, the market is going to go up, down, sideways or in circles. You WILL have down years with your investment portfolio (don’t worry if you don’t have a portfolio per se…we’ll get you there!). However, that same year you could have killed it in the budget department or knocked out a sizeable portion of your debt or finally purchased the life insurance policy you needed to secure your family’s future. The income and net worth calculation accounts for everything and does a better job capturing and aligning with the tenants of sound comprehensive financial planning.
Measures Your Progress, Value of the Financial Planner
Financial planners will often use your personal balance sheet as a way to assess your financial situation early in a relationship. This assessment should continue year after year because it is the best metric to show progress. One side effect of charging based on net worth is it keeps your net worth front and center, year after year with ongoing planning. It’s not your investment returns or any other number. This is important because a financial planner worth their salt is ultimately helping you increase this key metric by advising you (free of conflict) on the best course of action with your financial goals and dreams in mind.
Tailored to You & Accounts for Complexity
With the income and net worth model, your fee won’t be the same as everyone else’s and that’s okay…you’re a unique snowflake. Not everyone pays the same amount of taxes either. Your bill from CRA should be somewhat proportional to your income (unless you’re running for Prime Minister). But just as your fee won’t be the same, neither will your financial plan (see: unique snowflake). Think about it.
Someone who makes far more income will probably have a more complex financial plan than those that do not. The income and net worth pricing model is tailored to you and accounts for complexity in most cases. Just like someone’s financial plan isn’t a one-size-fits-all kind of thing, neither should the fee associated with that plan.
Proportional to Your Income
Barring extreme circumstance (like low income and high net worth, for instance), the fee based on the income and net worth formula is proportional to what the client makes. Financial planning guru and XY Planning Network co-founder, Michael Kitces, recently penned an article about how a financial planner’s compensation should land somewhere between 1-2% of your annual income. This happens by accident in other models, but it’s a function of the income and net worth model! Math!
Grow Steadily With You
Many of you have negative net worth or negative wealth. That’s okay. My job is to help you figure out the optimal method to move your personal balance sheet from the red to the black, and by doing so, my fee gradually increases. Conversely, under the AUM model, assets an advisor manages typically spikes whenever the client gives more to the planner to manage. This typically occurs when you leave your job and rollover old retirement assets. As an example, say your planner is managing $50,000 for you. You leave your job and decide to rollover your old pension, which has a balance of $150,000. Theoretically, your planner is now making 3x what they were previously, so it’s very spiky and inconsistent over time. Fees tied to income and net worth are smoother and often grow steadily with your income and balance sheet.
Wrap It Up With A Bow
Being a fee-only planner and pricing based on income and net worth is not without its detractors. Some say being fee-only forces the advisor to leave money on the table with regard to earning commissions on products like life insurance and annuities. And pricing based on income and net worth may incentivize the hiding of assets from the advisor. I contend that behavior deters from those seeking comprehensive financial planning (which is the majority of people I work with) because hidden assets will not paint the situation in its entirety and we know those six components of financial planning are interconnected! Still, if those assets are hidden from the advisor, then they’re not advising the client on them anyway (because they don’t know they exist!), so they shouldn’t be compensated. Also, clients that are deceptive probably aren’t a good fit to begin with. I recently read an article about employers not trusting employees to work from home. In essence, if the employer doesn’t trust the employee, why did they hire them in the first place? The same holds true for a client-planner relationship. It comes back to trust and it’s a two-way street. For me, becoming a fee-only financial planner and charging fees based on income and net worth allows me to give you the best advice I possibly can. Plus, it just makes the most sense
Thanks for reading!
The Practical Planner
https://practicalplanner.ca
If you have any questions, please feel free to reach out to us. We are here to help you with all your financial and tax needs.
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