You've probably heard the saying, "The best offense is a good defense." But you probably haven't heard this adage applied to compensation models. In the current market, advisors need strong defenses to hold their ground. The right compensation model can fortify these defenses.

It shouldn't come as a surprise that many advisors, particularly those with fee-based practices, are working harder than they have in previous years and for considerably lower compensation. While some advisors blame their shrinking revenue on the volatility of the stock and bond markets—or even on potholes in the road of modern portfolio theory—others are fueling a groundswell of concern regarding the shortcomings of price structures based solely on asset-management fees.

Think about it: How can a one-size-fits-all approach to pricing provide adequate compensation for the ongoing, diverse work that you do to guide clients through complex issues? After all, the financial planning workload, typically more burdensome than the investment management load, usually isn't disclosed or even addressed in investment advisory agreements that clients sign. Yet many clients may believe that they are engaging you for all of these services.

It has long been accepted that well-diversified portfolios can provide protection against bear markets, but how does this concept apply to an advisor's business? How can advisors position their service offerings and structure their compensation to withstand a prolonged bear market when their only charge is percentage of AUM?

First, this doesn't make sense because the amount under management is not an indicator of how much time or effort you spend on a client's planning issues. Secondly, it results in inadequate compensation. Down markets exacerbate this.

A New Model

So changes in this compensation model may be in order. Making such changes can be difficult, but in the long run, they might help you weather market storms and other periods when clients draw down their assets. To put things in a different perspective, think about whether your business can continue to serve all of your clients when those who present less demanding, less complicated planning issues are paying the brunt of the cost.

In addressing your compensation model, the best way to start is by constructing a menu of the planning services that you intend to offer and then assigning a cost to each. This approach:

• Creates a document that clients can refer to. Having a piece of paper for clients to keep on file is highly desirable in an industry in which fee transparency is becoming an increasing concern.
• Highlights the specific tasks you perform and/or services you offer. When you use a catch-all AUM fee, many of your services aren't apparent to clients.
• Ends the all-you-can-eat buffet. Knowing that each task or service has a cost makes clients more judicious in making requests.
• Positions you to sign and work with new clients. Those seeking more comprehensive financial services might be attracted to the range of expertise that your pricing menu reflects.

Making It Work

Some have disparagingly characterized separate AUM and planning fees as reminiscent of auto mechanics' separate charges for parts and labor. But as investment management becomes increasingly commoditized—and investment advisory income suffers from the bear market—charging a separate fee for planning can help your business grow.

This model involves creating a price list that includes fees for the planning services that you offer or plan to offer, along with your AUM fees, all on the same sheet of paper. Services that you may want to consider charging separately for include planning for education, income tax, retirement, estates, deferred compensation, stock options, wealth transfer, charitable giving and health care.

There are three basic steps to determining a ballpark figure for planning services:

• Estimate the number of hours that you or a member of your staff will spend on each project. This is tricky, but the more accurate you can be, the easier it will be to budget for projects. This estimate should represent all the time spent by each staff person who works on a project.
• Determine what your time is worth by the hour. The easiest way to do this is to use your previous year's gross production numbers. It's easy to get gridlocked on this number because there are so many variables that can affect it. Keep it simple, and be prepared to review this figure annually or at least every few years.
• Assign each project on your menu a score based on its complexity. This factor can be based, in part, on whether you're working on these projects yourself or having a staff member handle them. The infrastructure complexity cost can be more scalable each year as your staff becomes more experienced in responding to these requests.