Advisory firms spend more money on compensation than on any other expense, so getting it right just makes good business sense. Your compensation plan should define the behaviors you value the most and reflect what you are willing to pay to attract and retain key talent. I have found some consistent compensation misconceptions across advisory firms.

Myth No. 1: I'm underpaying employees.

Reality: Although advisors are concerned they may be underpaying key talent, most are paying at or above competitive market rates. Advisors need to make sure they are paying a competitive rate that is commensurate with the role, skills and value the employee is contributing to the firm.

Using industry-benchmarking data is an effective way to determine if you are paying competitively, and to establish a salary range and total cash compensation for each position.

When analyzing industry data, remember you are paying employees for the particular jobs they perform, which is the cost of labor or market rate, not reimbursing employees for their cost of living.

Assessing the competitiveness of your firm’s total cash compensation requires looking at the overall context, including how salary and incentives are balanced with each other, how cash compensation is balanced with other plan components, and what the market demand or rate if for the position in question. Your compensation plan should be aligned with your business strategy; reward and reinforce the key contributions to the success of your firm; be affordable and sustainable over time; and be in alignment with what your employees expect to get in exchange for working at the firm.

Myth No. 2: Only salespeople are motivated by money.

Reality: It takes more than money to motivate the members of your team, but do not underestimate the effectiveness of a well-articulated compensation plan. 

You have only a few tools in your compensation kit when it comes to delivering cash compensation to employees: base salary, bonuses, incentives and spot bonuses.

Used properly, these are sufficient to motivate your team. Unfortunately, many firms fail to distinguish properly between them, and, as a result, everything blends into a confusing mess. The biggest complaint I hear from employees is that the compensation plan is not transparent.

Base salary is paid to an employee in exchange for a body of knowledge, skills, abilities and experience used to perform a specific role. This is preferably outlined in a written job description. Without clear goals and objectives, and without well-defined job descriptions, base salaries have become an entitlement.

On the other hand, a bonus or incentive should be awarded for meeting or exceeding stretch goals for the firm or the individual.

The goal here is to leverage employees’ own motivation to improve behaviors and practices that drive the firm’s success.

Finally, spot bonus programs are typically used to recognize and reward exemplary one-time achievement, often with an on-the-spot cash award of $25, $50, $100 or more, or additional paid time off. Your compensation plan needs to work in conjunction with a goal- setting process and consistent feedback that allows your employees to be recognized for their contributions.

Myth No. 3: I need to pay a cost-of-living adjustment every year.

Reality: This practice increases your fixed costs and is not tied to measurable results that have a positive impact on the firm. The two forces that drive pay are the market price, which is what the employee is worth in the market, and the internal value, which is what the employee is worth to your firm.

Increases to base salary are about recognizing changes in market price and/or the increase in the internal value of your employee. Define a base salary range for each position based on its value to your firm and its market value. Revisit the range on a continuing basis and adjust as needed. Move an employee within the range as job size, responsibilities and skill sets change over time.

Myth No. 4: It’s too challenging to create stretch goals for administrative and support staff positions, so I should pay them a discretionary bonus. 

Reality: It is easier to create incentive metrics for client-facing positions, but you can have success with creating goals for staff positions as well. Stay away from paying discretionary bonuses, which are generally paid without regard for measurable criteria. They are less effective in motivating behavior, as they do not define a clear tie between pay and performance. They can also foster an entitlement mentality for employees, no matter what type of year the firm is having financially.

To create incentive metrics, start with the job description for the role and a list of the firm’s key initiatives for the next 12 to 18 months. Then enlist the participation of each employee and engage him or her in the process of creating three or four goals that can be measured in an agreed upon manner. The incentive drivers can be team-performance- based or individual-performance-based, but I recommend no more than five performance metrics to a plan. Suggested incentive metrics for support staff include: client segmentation projects, client events, marketing initiatives, technology or software implementation, client service delivery and skill development, and attaining certifications.

Myth No. 5: Incentive compensation is a one-size-fits-all plan.

Reality: Your firm is composed of a diverse group of people who respond differently to incentives. The purpose of any incentive compensation plan is to motivate your people to achieve the firm’s goals. Tailoring incentive goals to each individual, his or her role and a realistic description of what can be accomplished can be a powerful motivator.

You should understand each team member’s personal drivers. A compensation plan is part of, not a substitute for, ongoing performance management practices in a firm.

Myth No. 6: I will fix my firm culture through my compensation plan.

Reality: Your compensation plan should be built upon a pay philosophy that aligns with the culture and direction of your firm.

For example, if your firm has a culture of being very team-oriented, then one of your guiding compensation principles would be to value or reward team performance more highly than individual performance.

If you want to attract and retain the highest caliber of talent, your compensation plan should be targeted to pay above the median and, in some cases, at the 75th percentile of pay. One way to align your pay practices with your business plan and firm culture is to create a compensation philosophy statement that describes the firm’s core values that are important to its future success.

Once established, the framework can be used to drive compensation decisions.

All employee compensation must be tied to objectives and performance against those objectives to maximize the value of your most important investment — your people.

Kelli Cruz is a Financial Planning columnist and the founder of Cruz Consulting Group in San Francisco. Follow her on Twitter at @KelliCruzSF.

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