What Is an AUM Fee and How Is It Calculated?
Unpack the AUM fee model, a key way financial advisors are compensated for managing client assets. Grasp its principles and alternative payment methods.
An Assets Under Management (AUM) fee is a common method financial professionals use to charge clients for their services. This fee structure is based on the total value of investments a financial advisor or firm manages. It represents a percentage of the assets under their care, aligning the advisor’s compensation with the growth or decline of the client’s portfolio. The AUM fee model is prevalent for those providing ongoing investment management and comprehensive financial planning.
Defining Assets Under Management
Assets Under Management (AUM) refers to the total market value of financial assets a financial institution or advisor oversees for clients. This typically includes investment portfolios composed of marketable securities such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Cash or cash equivalents held within managed accounts are also generally included in the AUM calculation.
Certain assets are typically excluded from AUM calculations, even if they are part of a client’s overall wealth. These often involve illiquid assets like real estate, personal property, or businesses not held within managed investment accounts. Retirement accounts not under the advisor’s direct discretionary management may also be excluded. The value of these managed assets is determined using their market value, which can fluctuate daily.
AUM is often assessed at regular intervals, such as daily, monthly, or quarterly. Some firms might calculate fees based on the average daily balance of the assets over the billing period, while others might use the balance at the end of the quarter. The total AUM for an advisory firm represents the aggregate market value of all assets managed across all its clients.
Calculating the AUM Fee
The AUM fee is calculated as a percentage of the total assets under management, typically applied annually. This percentage can range from 0.5% to 2% per year, though 1% is a common average for portfolios under $1 million. For instance, a 1% AUM fee on a $500,000 portfolio results in an annual fee of $5,000.
AUM fee structures often involve tiered or breakpoint pricing, where the percentage charged decreases as the amount of AUM increases. For example, an advisor might charge 1% on the first $1 million of assets, then 0.75% on assets between $1 million and $5 million, and 0.5% on assets exceeding $5 million. This structure means clients with larger portfolios often pay a lower percentage rate on their overall managed assets.
Fees are generally charged or deducted from client accounts on a recurring basis, most commonly quarterly. This quarterly deduction represents one-fourth of the annual AUM fee. For a $100,000 portfolio with a 1% annual fee, the client would pay $250 every three months. Financial professionals are expected to clearly outline their fee structure.
Services Covered by the AUM Fee Model
The AUM fee model typically encompasses a comprehensive suite of financial services provided by the advisor. A primary component is investment management, which includes constructing diversified portfolios tailored to client goals, ongoing monitoring of investments, and periodic rebalancing to maintain target asset allocations. Advisors also handle the execution of trades and provide performance reporting.
Beyond investment management, many AUM fee arrangements integrate broader financial planning services. This can include guidance on retirement planning, college savings strategies, and basic estate planning. Advisors may also offer budgeting advice and cash flow analysis as part of their comprehensive service.
Client communication and ongoing consultation are also integral parts of the AUM fee model. Clients typically have access to their advisor for questions, reviews of their financial situation, and discussions about life changes that may impact their financial plan. While the core offerings are consistent, the exact scope of services included can vary between different advisory firms and individual client agreements.
Other Financial Advisor Compensation Models
Beyond the Assets Under Management (AUM) fee, financial advisors utilize several other compensation models. One such model is the hourly fee, where clients pay for the advisor’s time at a set hourly rate. This structure is often used for specific, project-based advice or consultations, such as reviewing a financial plan or providing guidance on a particular financial decision.
Another compensation approach is the flat fee model, where a fixed amount is charged for a defined service or project. This could involve a one-time fee for developing a comprehensive financial plan. Some advisors also use flat annual or monthly fees for ongoing advice, regardless of the client’s asset levels.
Commission-based fees represent a different structure, where advisors earn compensation from the sale of specific financial products. These commissions are typically paid by the product provider, such as an investment company or insurance firm, when a client purchases products like mutual funds, annuities, or insurance policies. The amount of commission can vary based on the product and the transaction size.
Some financial advisory firms also employ hybrid models, combining elements of the AUM fee with other structures. For example, an advisor might charge a lower AUM fee in conjunction with a separate flat fee for comprehensive financial planning services.