Flat Fee vs Percentage-Based Fees

The appropriate pricing model is an important business decision for providers and clients. While many debates exist about flat and percentage-based fees, the two have advantages and disadvantages. Flat fees assure clients’ predictability and cost certainty and facilitate budgeting without unexpected costs. On the other hand, percentage-based fees will change depending on the project’s scope. The interests of both parties are then aligned to share the increase in the value of services rendered.

This article will differentiate the two models in the AUM context, providing their benefits and ideal scenarios to help you decide which model best suits your business goals and client preferences.

Flat Fees in AUM

Flat fees in AUM are charged based on a client’s assets, irrespective of the portfolio value. It has a predictable pricing model with cost certainty offered to clients and is, therefore, more amenable for clients to budget and plan investments. This could work particularly well for larger portfolio sizes because, when assets grow, the clients do not pay for increased assets in their fee structure. 

Flat fees simplify discussions and negotiations, making the relationship between the client and their financial advisor more transparent. Clients will set long-term goals unaffected by constantly changing costs affecting their strategies, maximising overall satisfaction and trust in the advisory service.

Advantages of Flat Fees in AUM

• Predictability: The flat fee informs the clients about their costs, thus helping them to budget and plan for the service.
• Cost predictability: The customer knows how much money he or she will spend on asset management services, regardless of the portfolio’s value.
• Simplified billing: Flat fees simplify billing and reduce administrative burdens and costs.
• Transparency: Level fees are transparent, as clients can easily calculate the price they pay for asset management services.

Limitations of Flat Fees in AUM

• Limited scalability: Flat fees can be inappropriate for large or complicated portfolios since the cost does not reflect the actual value of managed assets.
• Not aligned: flat fees will not align the interests of an asset manager with the client as he has no motivation to expand his portfolio.
• Poor compensation: the flat fee is not adequate for asset managers, especially those managing complex and high-value portfolios.

Percentage-Based Fees in AUM

AUM percentage-based fees charge a fee based on a percentage of the portfolio’s value. This form of pricing aligns with the interests of asset managers, and client managers are incentivised to grow the portfolio.

This fee structure also benefits the clients since they do not have to incur any upfront costs and can invest more capital immediately. This model has lower fees on a rising market because the fee varies with how the portfolio will perform. Plus, this model has a higher transparency, providing an easier comprehension of what the clients will pay for. Managers thus build trust in their clients and encourage teamwork by providing long-term growth. In conclusion, this approach works towards a well-balanced interconnection that allows for sustained results for both ends.

Advantages of Percentage-Based Fees in AUM

• Aligned interest: Percentage-based fees align the interests of the asset managers with those of clients, as managers would be incentivised to grow the portfolio.
• Scalability: Percentage-based fees will also suit large or complex portfolios well because they provide the actual value of assets managed.
• Incentivisation: Percentage-based fees incentivise asset managers to be good and grow their portfolios.
• Flexibility: A percentage-based fee can be utilised flexibly while pricing, with an asset manager adjusting their fee according to the value of a portfolio.

Restrictions of Percentage-Based Fees in AUM

• Uncertainty: Percentage fees tend to confuse a client who, at some unknown point, will discover the costs involved.
• Conflict of interest: Percentage fees create potential conflict of interest among asset managers to take up as much risk for portfolio growth
• Complexity: The model is usually more complex than the fee amount charged for every transaction by asset managers, even to unfamiliar clients.

The choice between flat and percentage-based fees in AUM depends on several factors, including the client’s investment goals, risk tolerance, and portfolio size.

When to Use Flat Fees

1. Predictable portfolios: Flat fees are appropriate for predictable portfolios with a stable value.

2. Small portfolios: Flat fees are appropriate for small portfolios where the management fee would be relatively small.

3. Client preference: Flat fees may be preferred by clients who value predictability and cost certainty.

When to Use Percentage-Based Fees

1. Large or complicated portfolios: percentage-based fees for large or complex portfolios, given that the fee for management relates to the assets being managed

2. Growth-oriented portfolios: per cent fees are applied on growth-oriented portfolios whose asset managers are directly obligated to deliver for their bonus payments.

3. Aligned Interest: Percentage-based fees align the interests of asset managers and clients, as the former would be incentivised to grow the portfolio.

Also, Read – How to Evaluate a Funds Risk Return Profile

On a parting note…

Such unique circumstances between the client and the portfolio will essentially be the deciding factors for choosing whether to use the flat fee structure or the percentage-based fee for asset management. Flat fees help predictability for budget planning as they are known and straightforward for stable or small portfolios where a client focuses on cost certainty. Conversely, percentage-based fees align the interests of asset managers and clients, especially in larger or more complex portfolios where growth potential is paramount.

Finally, knowledge of the pros and cons of each model helps the clients and service providers to make decisions based on their financial needs and desires. If proper investment nature, risk tolerance, and long-term goals are considered, both parties can select the appropriate pricing model for a successful and transparent partnership.

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Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.