Executive Summary
In recent years, as more and more planners have shifted their businesses to an AUM model, it has become increasingly popular for the media, when quoting planners, to note the firm's AUM. In response, a backlash has also begun to emerge, as many planners justly point out that the magnitude of the firm's AUM does not necessarily correlate with the quality of the firm's financial planning advice or how "good" the planner really is, and consequently suggest that the media stop quoting AUM statistics in articles. Yet while I agree with the criticism - AUM is not likely a very effective measure of how good a planner's advice might be - I still think it's highly relevant. Not because I'm trying to understand the quality of the planner's financial advice, but because it provides immediate insight into the nature of their financial planning practice and the relevance of the challenges the planner may face.
The inspiration for today's blog post comes from an article I read last week on RIABiz entitled "Next-gen advisor breaks the standard RIA mold to grow with her young clientele -- many with $100,000 or less of assets" regarding a 30-year-old planner who, as the title indicates, is building a financial planning practice with younger clients that don't have a lot of assets. Given the ongoing efforts of the profession to create financial planning firms that serve a wider swath of middle America, I was intrigued. At least, until I got into the details of the article, and saw that the firm runs $6 million of AUM.
The point here is not that Blair Hodgson, the subject of the article, isn't trying to build something interesting with her practice targeting higher income young professionals who don't necessarily meet the minimums of other planning firms. The point is that at $6 million of AUM, and a practice that by Hodgson's own admission is just managing to keep her head above water with a combination of asset management fees, hourly fees, and some ongoing retainers, it's not entirely clear yet whether she will really "break the standard RIA mold" or ultimately find that to grow her practice to a more economically viable level, she has to adopt a more "traditional" AUM model with different minimums and a different target clientele.
By contrast, imagine reading an article about a firm that was "breaking the standard RIA mold" and was running $600 million of client assets, many with $100,000 or less of assets. That would imply a firm with upwards of 6,000 clients, which means even at 150 clients per planner, the firm would have a whopping 40 financial planners (not to mention the staff infrastructure required to support them) working in an integrated business to deliver financial planning to the middle market. Now that kind of firm would really appear to be a rarity, and one that truly has "broken" the mold and successfully grown and scaled a business with a less-than-traditional target clientele. There could be some powerful lessons, from how the firm manages to serve clients profitably with a relatively modest revenue per planner (at least compared to more "traditional" firms), to how it provides an infrastructure to the planners that doesn't destroy the firm's economic viability, to how it manages to market itself to get 6,000 middle market clients in the first place!
Of course, I realize that not all firms operate on an AUM basis, and/or the AUM billing doesn't necessarily represent all of the firm's revenues. Hodgson's own practice apparently includes a component of hourly and retainer fees that wouldn't be represented by the $6M AUM figure alone. Other practices may include various forms of commissions or trails that also bring revenue to the firm, not conveyed by knowing the firm's AUM alone.
Nonetheless, I still find it relevant to ask firms about their AUM, and I still like to read what a firm's AUM is anytime the media writes about a practice management issue. It's the single best and easiest statistic that instantaneously conveys information about the firm's approximate revenues. If I also know approximately how many clients the firm has, and its number of staff, I can immediately understand most of the firm's key metrics, from average revenue per client, to average clients per advisor, to average revenue per staff, to an estimate of gross and net profit margins.
In turn, I can begin to more fully understand what the firm's service model may really be, and understand how it delivers its services in the context of its practice metrics. A firm that says it provides extensive planning services to its clients with $200 million of AUM and a staff of 22 probably has little to no profit margin at all, and while its planning quality may be rich due to its extensive staff support, its economic viability as a business is at serious risk in the next bear market and its service model isn't sustainable. On the other hand, a firm that says it provides extensive financial planning services at $200 million AUM with a staff of 4 has radically different metrics; either they must serve clients with a very high average net worth (allowing them to reach $200M with relatively few clients to serve), or they have too many clients per staff member to possibly be delivering the depth of planning services they claim, and while the business may be sustainable (given the profits of $200M of AUM and only 4 staff members), it questionable whether it is delivering on its financial planning promise.
In the end, what all this means is that while AUM doesn't directly speak to the quality of a particular financial planner and the quality of his/her advice or expertise (in fact, I see no reason to cite an AUM statistic at all when someone is discussing a technical planning issue), it does speak volumes about the nature of the planning practice itself, especially when followed up with the two additional key metrics, number of staff and number of clients. Those details, in turn, help to clarify the scalability and efficiency of the practice, and whether it's capable of even delivering quality financial planning in a sustainable manner. Which is especially relevant if we're trying to understand a firm that is doing something unique and noteworthy in the media and might be "breaking the mold", or might just be trying to do so with a yet uncertain future (although I certainly wish Blair the best of luck!). Plus, I suppose asking about AUM has the added bonus that it's just a bit more socially acceptable than asking "how much profit did your firm make last year?"
So what do you think? Do you find it relevant to understand how a firm is structured when discussing practice management issues? Is AUM a relevant point for the media to cite, at least when discussing a practice management issue? Do you ever ask about AUM when meeting another planner and learning about their business? If you don't think AUM is a good metric to ask about, is there an alternative you think is better?
I believe AUM should not be included. It sends the wrong signal: “only the giant firms are successful firms”. It also ignores firms like mine: when we open the doors in March, AUM will be only one third of revenue. Fees for financial planning, immigration planning, business succession planning, divorce planning, and tax planning and preparation will represent the bulk of our revenue. Stating AUM does not give folks any real insight into our business.
Richard,
While I agree and noted in the post that many firms have other revenue sources, I strongly disagree that citing AUM “signals only giant firms are successful.” I suppose some individuals will make that inference because they personally judge their own success by their AUM, but that’s their personal opinion (and if that’s how they judge success, by definition AUM is their measure).
In reality, some of the worst managed firms I’ve ever seen were “giant” firms. Yet similarly, some of the “best” firms I’ve seen are only “best” because they’ve created a process that is unprofitable, not economically viable, and completely incapable of being replicated. Which means short of being an interesting anecdote, I find what they’re doing to be largely irrelevant, because in reality the firm is closer to a subsidized charitable offering than a business.
The bottom line is that AUM is not a perfect measure to understand someone’s business realities. I need to see the company books to know for sure. But AUM is actually a radically better measure for understanding a firm’s metrics than we give it credit.
And if someone is going to put themselves in the media about a practice management issue, isn’t knowing SOMETHING about whether their business is even viable a relevant question?
I agree that knowing SOMETHING is certainly better than knowing NOTHING….especially when the business is being touted as a game changer due to their model. On that we agree. However, AUM misses something in businesses like ours. Saying we have $50 million in AUM isn’t saying much, but saying we have $50 million in AUM and it only accounts for a third of our total revenue is saying a whole lot about our business and where the emphasis is (planning). Perhaps total revenue or revenue per employee is a better metric?
Michael, I think your post on the relevance of AUM was excellent and right on point. Another way, in addition to AUM, of measuring a firm is through revenue per client. While AUM measures firm size, revenue per client generally measures more of profitability or what type of clients a firm is working with. This statistic may be best in private discussions about a firm, not in the press, but I think a very valuable indicator.
I have always been bothered by the reporting of AUM. As a single planner business, the large AUM figures of larger firms make me feel very tiny indeed. A lot of my work is hourly and I do have a profitable business. Maybe the number of advisors in a firm would be more relevant and/or whether they focus on investment management or planning. I can see that you are inferring the number of advisors from the AUM, but maybe reporting on the actual size of the firm’s employees and the way they charge is more of a direct way to get to that information.
I’ve never understood this, why we care about AUM. Is it supposed to be a tactful way of asking about a firms revenue? A method to brag without seeming crass? I don’t get it, why don’t we just quote revenues? What’s the point?
In practice, I find most firms are not comfortable/willing to share their revenue publicly (for whatever odd reasons). They are much more willing to share AUM, though (which gets us to approximately the same place).
Michael,
I understand many of us are swayed away by the media as far as AUM is concerned. What do i see to have a holistic approach towards business should come from balanced metric approach (i.e. Fees+trial commission+annuity from insurance product if any). Giving equal weights on each of these components would prove worthy. For.e.g. when market turn bearish if a firm is dependent of AUM model surely going to go down dramatically which we have seen. Building AUM would not significantly make any difference as far as financial planning business is concerned.
While I agree that AUM does not provide insight into how well a financial planner’s advice may be, I do believe that it is an important metric to report on.
The reason is that when you look at the sustainability of a firm with $500 million in assets versus $50 million in assets, the firm with $500 million clearly wins. This does not mean that they provide better advice, and it may not even mean that they are more profitable.
However, when a client evaluates a potential firm to work with, having the assurance that the firm will be there for the next 20, 30 or 50 years is important.
Mike you brought up a good point when you discussed hitting a bear market. The firm with $500 million has a number of options that a smaller firm would not to reduce its overhead in this situation to remain profitable.
I absolutely agree with you on this topic. The only caveat I would add is that more firms are generating revenue for financial planning that does not include assets under management. Still, I completely agree that the title of that article was sensationalized at best. While I am certainly not “breaking the mold” (Yet!), I am trying a new and different approach to building a financial planning practice. And for further full disclosure, I began building my practice in January 2011, only 12 months prior to the date the article was published.
Blair,
Indeed, I’ll full grant that this metric will get “fuzzier” for firms that incorporate a lot of non-AUM revenue lines. Ironically, it’s also less effective for “traditional” planning firms that still have a significant base of insurance-related commissions and trails.
Nonetheless, I have to admit it’s still a remarkably good barometer in the majority of situations I encounter. And at least it’s slightly less personal than just saying “So, how much revenue does your firm make and how many employees do you have” as an icebreaker. 🙂
– Michael