It took six months for the partners and advisors at LLBH Partners to complete a free diagnostic for a wealthy prospective family client. That's the same amount of time economists take to reliably assess whether the nation's economy is in a recession.
In this case, the family was the picture of wealth, but its portfolio needed urgent pruning. It had engaged about a dozen different firms to manage its $30 million, which was held in multiple family trusts, accounts for the children, retirement accounts and rolled-over pension accounts, among other instruments. Also, the family had money invested in several mutual funds, which Jim Pratt-Heaney, a partner at Greenwich, Conn.-based LLBH, says was a poor choice for a household with that much wealth.
"We don't feel that they are tax efficient, and the costs are high, when you look at what mutual funds really cost," Pratt-Heaney says. Further, the family ended up replicating the underlying equity holdings across its mutual funds, and concentrating its risks.
The family originally wanted LLBH to supervise the dozen firms that handled its finances, for a fee, Pratt-Heaney says. But LLBH did much more than that. It recommended selling all of the family's mutual fund holdings and putting the proceeds under individual money managers, a less expensive tactic. The firm started working on the family's financial plan around Thanksgiving, meeting for about six hours a week. It completed the plan the following March, producing three thick binders with the family's financial lives neatly mapped out and condensed. At that point, the family had decided to transfer its wealth management to LLBH.
They also accepted a recent change in the firm's compensation structure, agreeing to pay a minimum fee on top of a standard percentage of assets under management. "We are heavily planning based," Pratt-Heaney says. "We dig very deep into our clients' lives. We are very forward thinking, and we believe that what we do is extremely valuable."
Yet many advisors are squeamish about taking anything other than a flat percentage fee for assets under management. That does not mean advisors like LLBH should overlook the value of their planning, according to Pershing Advisor Solutions. If a firm saves its clients money by consolidating household debts, restructuring insurance policies or reducing a household's tax burden by restructuring assets, the fees the firm charges should reflect that. This is particularly true if the firm wants to hit profit targets and weather market changes that destabilize pure AUM percentage models.
Pershing, a Jersey City, N.J.-based asset custodian, created a guidebook, Pricing Strategies to Create Growth: An Independent Advisor's Guide, to help advisors develop profitable service pricing models. The guidebook helps advisors think through four major types of fee schedules, ranging from a flat percentage of assets to one that varies fees based on the perceived value of the firm's advice. The custodian, however, clearly favors combining methods to account for the extra work planning firms put into their clients' portfolios.
"We found that advisors were delivering a lot of services beyond asset management and not charging a fee," says Kim Dellarocca, head of practice management at Pershing. "We tell advisors they need to understand the cost of delivering services, and how it impacts their profitability."
Pershing recommends advisors charge a quarterly minimum service fee to shore up their firm's profit base. As they grow, firms will inevitably deal with increasing compliance responsibilities such as advisor monitoring, procedural management, licensing and insurance expenses, and new technology.
Ways and Means
Pershing and FA Insight, Pershing's partner on the study, broke out four major service-pricing models principals should consider: There is the traditional and widely used percentage of AUMs. Pershing also found that firms use a flat, scalable fee according to advice needs. It could include one fee or a tiered structure based on client advice needs. Firms could also charge an initial fee to start an advisory relationship and an annual fee for ongoing advice.
The third model, the hourly fee, calculates the time and resources involved in delivering advice. The fourth is a value-based fee, in which the firm charges each client based on the value of advice delivered. This fee varies according to the client's unique needs.
"We recommend a combination of different types of fee structures," Dellarocca says. "One of the things we ask folks to consider is a minimum fee that you'll bill that account each quarter, to protect the firm's profit."
The research found that many advisors are adapting this model to their practices. According to a survey by FA Insight, 57% of all firms use a minimum dollar fee to protect profits and, of those firms, 80% of the clients are meeting or exceeding the minimum.
Before imposing a minimum service fee, a firm should perform a detailed analysis of how much it costs to deliver services to clients consistently, and what its profit targets are. For firms with $75,000 to $500,000 in revenue, the lowest range, the median minimum is $2,000 per quarter. For firms that pull in between $500,000 and $1.5 million in revenue, it's $5,000; and firms with more than $3 million in revenue charge a median minimum of $9,000.
Nickels and Dimes
Some advisors, though, chafe at the idea of a minimum fee, thinking clients have enough to worry about with volatile financial markets. Advisors do not want to worry that their clients feel overcharged, Dellarocca says.
Even if advisors realize a minimum or value-driven fee is warranted, they sometimes feel awkward about broaching the topic with clients. For that, Pershing came up with prompts to help advisors handle client objections.
If a client has a portfolio that's produced low performance numbers over the last three years, an advisor could remind the client that returns are expected to vary over the course of long-term investment horizons. Further, the advisor could point out that the firm has also provided estate planning and other holistic planning services that incur costs. Should a long-standing client object to a new minimum, the advisor could point to technological improvements at the firm intended to upgrade the client's access to financial information.
Remember that selling a service is a lot different from being paid by a company, such as a large brokerage firm, to sell products, Dellarocca says. "There is no conflict here. The advisor is still acting as a fiduciary."
The minimum annual fee LLBH instituted this year is $15,000 per household. The practice, whose advisors have broken away from private banking at Merrill Lynch, is accustomed to providing detailed, high-level service to wealthy clients. Pratt-Heaney says the firm did a lot of research into pricing structures that would support its operations and not prompt clients to leave.
"We did not want to be too expensive or a discount firm," Pratt-Heaney says. The partners will review the pricing structure regularly, he adds.
The group added the minimum fee because it limits the number of families and size of new accounts that come in, Pratt-Heaney says. "Our value proposition is clear to us and clients so the fees never become a discussion."
Donna Mitchell is a senior editor of Financial Planning.