I listened to a popular financial advice podcast a few years ago and the guest was the CEO of a very prominent advisory firm. The discussion had turned to the choice between asset-based fees and flat/fixed fees and the relative merits of each arrangement. The guest mentioned that his firm had attempted to use flat fees in the past, but ended up switching back to an asset-based fee. Why did they switch? Well, the guest said something very interesting, “Honestly, percentages are the casino chips of our industry.” What the heck does that mean? Well, the advisor went on the explain that it’s easier to talk to clients about fees in percentage terms rather than in dollar terms. That’s a very important distinction that I think hurts a lot of clients in the long run.
Let’s begin by looking at casino chips. It’s widely known that casinos require players to use chips when gambling for a variety of reasons (e.g. security, ease of tallying, error reduction). But the main benefit of casino chips is that they create an abstraction effect between the player and their money, which can make it psychologically easier to continue gambling. For instance, if a player were betting with actual currency, the financial losses would seem more “real” and might deter the player from continuing to gamble. The casino chips help to get around this. Chips allow the player to lessen the cognitive pain associated with financial losses, even though in reality, the financial loss is exactly the same. As a result, the casino can generate more revenue from the player as they stay at the table longer (or run out of money).
Now transfer this thinking to advisory fees. If you have a $2,000,000 portfolio, an asset-based advisor might say… “Well, your annual fee is 1% of assets under management” and leave it at that. The advisor wants you to be comforted by the idea that your paying “only” 1%. However, when you receive that fee invoice, you will see the actual math, and the fee amount in real dollar terms. So in this case, you might see something like $2,000,000 x 1% = $20,000. I don’t know about you, but to me “1%” sure sounds a lot better than “$20,000”. And that’s exactly why advisors like to quote fees in percentage terms!
Let’s ignore the fact that justifying advisory fees by comparing them to casino chip seems ill-advised and is not exactly a step forward for the financial services industry. If I’m being charitable, the most generous takeaway is that the “benevolent” advisor wants to spare the “vulnerable” client the psychological discomfort of paying fees. A more likely explanation… the advisor is using the “casino chip” effect to take advantage of the client’s natural cognitive bias and leverage a higher fee. Not a great look. In fact, you could even argue that the advisor is weaponizing cognitive bias against the client. Not a great look either.
I don’t personally agree with asset-based fees, but if an advisor wants to use them, that’s ok! An asset-based fee CAN be appropriate in certain circumstances. But any advisor using asset-based fees should be willing to always communicate that fee in real dollars and cents (as we do here). There’s no need to hide behind a psychological curtain like a financial Wizard of Oz.
