Seeking Value

There was a genie that had fallen on hard times. Instead of giving away wishes, he decided to sell them as a way of earning some income and getting back on his feet. He could grant practically any wish (provided it did no harm to others) with a snap of his fingers. He charged what he believed were fair prices, depending on the value of the wish.

One day a woman approaches and she really wants to live longer. Her life is great, she’s healthy, and she wants to enjoy it as long as possible. The genie explains that he can extend her life for a cost of $5,000 per year. If she wants an additional five years, she can pay $25,000, he will snap his fingers, and voila. For ten years, $50,000, a snap of the fingers, and it’s done.

The woman thinks about it. “But it’s the same amount of work for you regardless of how many years I get… I want to pay one flat price whether I choose five or ten years.”

Does her reasoning seem absurd to you? It does to me. She is focusing on the amount of work done by the genie, rather than on the value of his service. The amount of work being done is largely irrelevant – a service with greater value can and should cost more.

This is why we charge our clients a percentage of the assets we manage. Is it twice as much work to manage $1,000,000 compared to $500,000? Probably not. Is the value to the client twice as great? Absolutely. By allocating investments efficiently, strategically rebalancing and harvesting losses, and preventing mistakes in volatile markets, we are adding value to every dollar we manage.

Because we often include financial planning services in our investment fee, there is an important secondary reason to charge more for larger accounts – they are frequently (though not always) accompanied by more complex planning issues. The more planning issues we can help with, the greater the value for the client.

Recently, there has been much writing and discussion critical of this fee model and in favor of a flat fee, independent of assets managed. I think there are merits to this model as an alternative in certain situations, and that generally speaking, the more flexible a planner can be with their fee structure, the better it is for everyone. But the key reason for charging a percentage is often ignored in these conversations – that each dollar well-managed adds value for the client.