Last week brought out the best – and worst – in the fiduciary discussion. Some may call me odd, but I often entertain myself by scouring the mass media for misconstrued interpretations of fiduciary matters.
Given the White House’s singling out of Sheryl Garrett, many in the national media focused on her. I seem to remember reading somewhere (exactly where I can’t recall) a reporter referring to the hourly fee rate as the “fiduciary fee.”
This surprised me because, for all the interviews, writing, and talking I’ve done, I’ve never heard of the term “fiduciary fee,” let alone the deification of hourly fees as the chosen compensation model.
Heck, even Sheryl herself feels there’s a place for asset-based fees (namely, where they’ve always been). You can read her thoughts on this along with those of Michael Kitces and several other practitioners in “The Best Way Plan Sponsors Should Pay Fees for 401k Fiduciary Advice,” FiduciaryNews.com, March 3, 2015).
There’s an undercurrent of asset-based-fees-are-evil prevailing in much of the non-trade media and even at times in the trade press. Just the other day someone Tweeted @FiduciaryNews “Does a plan with $100 million require more work from the RIA than one with $75 million? #FixedFee”
Granted, once you enter the rarified atmosphere of nine-digit plan sizes (that’s more than $100 million), we are starting to see greater use of fixed fees to prevent the inevitably insane large fees generated by a never-ending asset-based fee. Of course, it’s quite possible many would consider that fixed fee to also be insanely large. But at least the fixed fee, unlike asset-based fees, has the benefit of being capped.
But this misses the fallacy of the Tweeters’ question. The question of whether larger plans “require more work” than small plans places the focus of the compensation model on the wrong metric. The “require more work” concept comes from the hourly rate point of view. It implies fees must only equate to units of work expended. But that’s not the only way fees are used.
If we’re talking about general contractors, there’s usually a base fee that is promised if the work is completed within the agreed upon time. Often, though, there are also bonuses for completing the project well ahead of schedule and penalties (i.e., reductions) for failing to complete the project within the timeframe.
In fact, the case can be made where, in the case of the bonus, the contractor will receive a higher fee for doing less work (based solely on the measurement of time) and, in the case of the penalties, the contractor will receive a lower fee for doing more work.
Fees, then, are better employed as a function of incentive-based outcomes rather than equated to mere time-card management.
That’s why I never hire attorneys or accountants who insist on charging by the hour. Why? Because I fear their incentive is to maximize billable hours. That may be in their interest, but it certainly isn’t in mine.
Rather, if I want one of these professionals to perform a limited scope project for me, I ask them to quote a single price.
“But what if it takes more hours than I estimate?” is the customary complaint. To which I immediately reply, “Then your imputed hourly rate will be less. On the other hand, if it takes less time, then your imputed hourly rate will be more. Either way, I pay the same. Only your actions can determine the hourly rate you will earn.”
In the case of asset management fees, the question isn’t whether it takes more time, it’s whether the time spent yields better results.
When hiring a contractor, I would gladly pay them more for a quality project finished early. I’m thinking most people would do the same. If that’s the case, why wouldn’t they want to pay investment advisers more in exchange for asset growth? (And before you can say it, yes, since I don’t believe in market timing, this wouldn’t apply to those relying on index vehicles.)
It is within this spirit that I will now deviate from the normal prose. Here, the intention is to spirit you away from this season’s extraordinarily droll doldrums and think of sunnier days. Fortunately for poet Joyce Kilmer, he died nearly 100 years ago, so he would never have to see this monstrosity.
I think I shall never see
A fee fiduciary
A fiduciary is prest
Against whatever’s for the best
In interests of clients, say
As befits amount they do pay
A fiduciary whose fate
Lies not to charge an hourly rate
Upon plan sponsors it is plain
Who intimately seek to gain
Fees are made by fools like me
An asset bas’d fiduciary