If you're not rethinking how you charge for your planning services, you probably should be. That's the inescapable conclusion I draw from a fee survey I conducted recently with advisors across the country. Not only did responses show a surprisingly wide spectrum of fee structures (both upfront and ongoing), but many of the 150 advisors who responded to my survey volunteered a deep dissatisfaction with their current revenue models.
The first thing to understand about advisory fees is that there isn't much consistency across the industry, despite what we've all heard about the "standard" 1% of AUM.
The 119 fee schedules I tallied in my report included wildly different upfront planning fees that were sometimes waived if prospects decided to become AUM clients. Ongoing fees ranged broadly from 50 basis points a year to just under 200 on the first dollars under management.
There was considerable inconsistency in the breakpoints - that is, the dollar amounts where a client portfolio qualifies for stepped-down percentage fees. Other advisors worked off retainer structures that were so complicated I had to create charts and graphs to explain them.
(To see the full report, click on this link.)
The most interesting part of the exercise was the unexpected comments, which revealed deep ambivalence about everything from conflicts in the AUM business model to the fact that an advisor down the street could get away with charging more for less service. I first became aware of some of the worst contradictions with the AUM fee model when a newspaper reporter called me after profiling two local advisory firms.
One of the firms provided detailed planning work for clients, including a retirement and goal analysis using Monte Carlo simulations, cash flow and budgeting analysis, review of all insurance coverages, estate and charitable gift planning, tax planning and loss harvesting - plus portfolio management. The fee was 1% of each client's first $1 million, and scaled down from there.
The other advisor did nothing more than manage client portfolios - using some of the same mutual funds as the first advisor - with no planning work at all. His fee: 0.9% of each client's total assets under management, with less generous breakpoints than the first advisor. This second advisor described himself as the low-cost provider in town.
"Speaking as a consumer," the newspaper reporter asked me, "isn't the first advisor offering a lot more value per dollar than the second one? But how would I know the difference unless I signed on to work with both of them?"
Behind the curtain of the pure AUM fee model, some advisors have gotten away with providing a lot less service than others. But to many consumers, the second advisor looks like a bargain.
AUM FEE DRAWBACK
There are other problems with the AUM fee compensation model. Mitchell Keil of Integrity Financial Advisory in Fountain Valley, Calif., reported that he met with a prospect who had recently sold his business and was looking for somebody to manage a $5 million windfall.
"I told him I would charge him 1% of his assets a year, which would include all my services," Keil says. "Then he floored me with a simple observation - the client basically said, 'Why should I give you all my money? Would I get substantially different service if I gave you $2.5 million than if you were managing $5 million? Couldn't I just replicate what you're doing with the other half of my money at a cheap discount broker?'"
Keil could not deny the man's point. "The truth is that we don't give appreciably better or more comprehensive service at those AUM levels," he says. "Even with the tiers, scaling down to next to nothing for the last dollars of his money, the fees for managing everything would still be higher than what he was proposing."
Keil landed the client but then lost him, because the man thought he was paying Keil to outperform the markets - and, of course, the AUM fee structure communicated this message. The blanket AUM fee also doesn't take into account many variables, such as the complexity of different client situations and how much hand-holding a client requires. A person with a $10 million portfolio often requires less work than a person with $1 million to manage. As a result, many wealthier clients are subsidizing the services provided to everyone else. Is that fair?
FINDING A GOLDILOCKS MODEL
Sometimes advisors need to try several fee strategies before finding one that fits. Early in his career, Mark Berg of Timothy Financial Counsel in Wheaton, Ill., dealt with the limitations of the AUM model. "I found that I had to constantly fight an asset-gathering mentality and focus on the needs and goals of the [existing] clients," he says.
Beyond that, he says, "What incentive was there to work with a client I truly enjoyed but I only charged $2,500 per year, versus a client who was less enjoyable but [from whom] the firm earned $40,000 per year?"
When he switched to a flat-fee model, the results were nearly as unsatisfying. "Our annual retainer was a loss-leader the first few years, and the client received a lot of benefit up front," Berg recalls. "As the line was crossed toward profitability, that was also the time the client started questioning the ongoing value." Eventually, Berg shifted to a subscription-based hourly model, where a certain number of hours are bundled into different packages - not unlike certain cell phone plans. Clients can sign up for 10 to 14 hours a year at a package rate; if their situations become more complicated, they can buy more hours per year.
The concept turned out to be a home run. "My time was quickly filled to the point that I had to hire another advisor about 18 months into this new adventure," Berg says. "I tracked our prospect close rate, and one year it was 100%."
The second part of Berg's story is just as interesting, and suggests that clients are not as averse to having their fees raised as many advisors seem to think. Berg says that when he raised his hourly fee from $150 to $180, he saw almost no drop-off in his close rate. A few years later, he raised his per-hour rate again, to $195, and still encountered no resistance.
"It was when I went to $210 that we settled on an 80% close rate," he says. "We are now at $240 an hour as a firm, and I'm billing at $320 an hour, and we still close 80% of the people we talk to. We have not seen a shrinking of our target market as a result of the rate increase, which was one of my concerns."
Despite the problems with traditional compensation methods that these stories illustrate, Berg doesn't think his hourly model is for everyone. "There isn't a right or wrong answer to the fee structure question," he says.
"Ultimately," he adds, "for me it came down to creating a fee structure that matched the firm's philosophy and a service offering that was also attractive to the clientele that we hope to attract."
After having looked over - and categorized in detail - more than 100 different fee arrangements of all shapes and sizes, I believe the profession might finally be ready to push aside the messy clutter to become more intentional, realistic and clear about its fees.
Advisors whose firms aren't profitable will make adjustments that allow them to invest in staff and create more sustainable businesses. Others will reduce conflicts of interest, and more clearly differentiate the fees paid for planning versus asset management.
If you're an advisor who is not completely satisfied with the way you're being paid by your clients, you now have fresh research to review to map out changes.
Bob Veres, a Financial Planning columnist, publishes Inside Information at bobveres.com and co-produces Bob Veres' Insider's Forum, set for Sept. 17-19 in Dallas. Post comments on his column at financial-planning.com or email them to firstname.lastname@example.org.