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Practice Management

The venerable model of charging a percentage of assets under management faces challenges from a variety of contenders, including variations on flat fees, hourly billing, and charging on a percentage of other financial metrics.

This Practice Management article is intended for financial advisors only (registered representatives of broker/dealers or associated persons of Registered Investment Advisors).
 

For two decades and counting, Savant Capital, in Rockford, Illinois, has charged its clients a percentage of assets under management (AUM).

“We were charging 1% of AUM 20 years ago, and were considered the low-cost, high-value provider,” says Brent Brodeski, the firm’s chief executive. “Today, we’re still charging 1%, but we’re doing more to earn our money, and I still think we’re the high-value provider.”

But the competitive landscape is changing, notes Brodeski, a prominent industry executive. And that change is largely because of the emergence of automated investment services that charge 35 basis points (bps) or less.

“Five years from now, if you’re only doing asset allocation, it will certainly be hard to retain good clients. If a robo advisor charges 25 bps for digital service and another 25 bps for a person on the phone, am I worth much more than 50 bps?”

How Advisors Are Changing Compensation
Savant still wants to be able to charge 1% on AUM, he notes, but—as with many firms—“value” has emerged as the key for the traditional fee model’s future iteration. “We may end up being the high-cost provider,” Brodeski concludes. “I’m OK with that, if it means we remain the highest-value provider.”

Indeed, when it comes to pricing, charging clients a percentage of AUM—often around 1%—remains the heavyweight champion of the independent financial advisory world. Yet the venerable model faces challenges from a variety of contenders, including variations on flat fees, hourly billing and charging on a percentage of other financial metrics.

Roughly 59% of independent financial advisors surveyed by Financial Planning magazine in February 2015 charged on a percentage of AUM. That share rose to three-quarters among fee-only registered independent advisors (RIAs)—although another 13% charged fixed fees and 6.5% charged by the hour.

Yet about a quarter of fee-only advisory firms in the survey said they’d changed their fee structure in the past year (as did 20% of all independent firms), and another 13% said they were likely or somewhat likely to alter fees this year. (Nearly 350 advisors were surveyed.)

Over the longer term, the most significant test the popular standard will confront is likely to be from the proliferation of lower-cost, direct-to-consumer robo advisors. But it’s not clear that online rivals are at the root of many recent shifts.

When advisors who’d made a change in the past year were asked to explain their reasons, almost a third said they did so to increase profitability; 25% cited changes in operating costs; and almost 21% pointed to competition from other advisors. Less than 15%, by contrast, cited “competition from online advisory platforms.” (Advisors could choose multiple answers.)

A slightly larger group of those advisors who expected to make a change this year cited digital competition as a factor, yet other issues—profitability and rival advisors, again, as well as the implementation of a minimum—still took precedence.

Change Needed?
A recent TD Ameritrade Institutional report on pricing trends also confirmed that “downward pressure on the fee levels of independent advisory firms resulting from low-cost offerings is yet to be proven.”

Yet even if online competition isn’t turning up the heat on client fees, that doesn’t mean there aren’t good reasons for firms to rethink their pricing model.

As the industry evolves, “pricing models should evolve with it,” says Tom Nally, president of TD Ameritrade Institutional. Traditional advisors need to think of themselves more as financial life coaches, and consider charging on total net worth, or by the hour or project. “You want to advise on all things financial, not just assets,” Nally argues.

Indeed, the TDAI report concludes that, for many firms, “a pure asset-based pricing model may be limiting control over operating profit margins.”

“The AUM-linked fee has got to change and be supplemented with other pricing schemes,” argues Dan Inveen, director of research at industry consulting firm FA Insight, and co-author of the report with business partner Eliza De Pardo.

Most firms charging by percentage of AUM add many more services over time, but don’t change their pricing structure, Inveen says. What’s more, “there’s a disconnect between advisory firms’ published rates and what they actually charge,” he says.

Firms should conduct an annual review of how and why they charge clients, but fewer than one-quarter actually do, Inveen says. Options they should be looking at include retainers, an hourly rate, a minimum or flat fee, and charging on a percentage of total assets under advisement, he says.

“Firms don’t have to jettison the AUM model entirely,” Inveen says. “They can layer other fees on a percentage of AUM. But if they only charge on AUM, it puts them in a tough position versus robos, who typically offer investment management only, on prices [advisors] will never be able to compete with.”

Fixed Fees
A number of firms are already using other pricing methods. Bason Asset Management, based in Lakewood, Colorado, for example, charges nearly every client a flat $4,500 annual fee.

“I came from a traditional wealth management background, and saw that other than numbers on a spreadsheet, the services provided were usually not related to the size of the client,” says James Osborne, the firm’s owner. “We were spending the same amount of time on most clients, and it seemed like charging 1% made more for the advisors than it [delivered] to the client.”

In explaining his fee structure, Bason’s website cites a “falsehood of the financial services industry: that the relative value of an investor’s portfolio ought to determine the fees and charges the investor is subject to... [resulting in] unconscionable profit margins. Our services do not vary appreciably between clients with larger or smaller portfolios, so our fee structure reflects this,” the site continues. “This fee [$4,500 per year] is based on our costs and reasonable compensation for a professional service provider.”

The flat fee has helped differentiate Bason in the Denver market since Osborne founded the firm in 2012, he says. The firm is profitable, has about $73 million in assets under management and a waiting list for clients—who come primarily from referrals and attention generated from Osborne’s blog and Twitter feeds, he adds.

Income and Net Worth
In Moline, Illinois, the Planning Center also offers clients an unusual pricing proposition. The fee-only firm’s annual retainer is based on a combination of half of the client’s net worth up to $2.5 million (0.25% up to $10 million, and 0.10% beyond) and 1% of the client’s adjusted gross income. There is also a minimum fee.

Charging on a percentage of AUM “wasn’t representing what we believed our value was to the client,” says Marty Kurtz, the firm’s founder. What’s more, the net worth and gross income model, which the firm instituted in 2008, eliminates what Kurtz says are conflicts of interest embedded in the AUM model—when, for instance, a client should be using assets to pay off a mortgage or build an emergency fund.

The firm’s net worth/gross income model charges the same whether emergency fund assets are in a bank or in an AUM portfolio, and taking money out of an investment account to pay down debt won’t cut the fee, Kurtz explains.

Reaction from clients has been extremely favorable, says Andrew Sivertsen, one of the firms’ six principals. “It’s slightly changed who we have as clients,” he says. “There’s more of a commitment because they have to really buy into the value of our services.”

The firm’s model also attracts younger clients, Kurtz says, and “filters out clients who are not fee averse.”

Internally, the pricing model has normalized the firm’s revenue stream, adds its chief compliance officer, Eric Kies. He explains that traditional advisors might wind up doing some planning work they won’t be adequately compensated for—and then get a spike in income after, say, a 401(k) rollover raises AUM.

“During a working career, an AUM advisor might manage a small portion of the investable assets,” Kies says. Instead, with his firm’s model, “the revenue stream will be a much more steady curve that more closely aligns with the financial planning work that we do.”

Hybrid Options
Other advisors have opted for less drastic breaks with tradition, creating hybrid fee models that incorporate AUM charges as well as other discrete fees.

FPA president Ed Gjertsen II, for instance, uses a hybrid compensation model that includes a flat minimum fee of at least $2,500 as well as a percentage of AUM, says Gjertsen, vice president of Mack Investment Securities, based in Northfield, Illinois. Charging only the latter can too easily lead advisors to give away planning work for free in hopes of gaining more business, he says. Gjertsen’s flat fee is based on planning complexity; he also offers clients the option of a $250 hourly fee.

“My impact on a client as a true planner will far outweigh what may be a blip on their portfolio as an asset manager,” he says.

At Lincoln Financial Group, planning director Dianna Parker also advocates a separate planning fee based on a client’s needs. Some of the IBD’s advisors bill a planning fee based on 10–20 basis points of net worth; clients also pay a percentage of AUM. Some advisors also get additional revenue from selling commission-based products.

“We want to work with clients on their entire financial picture,” Parker says. “We haven’t felt any pressure to change [our fee model]. Our pricing is very reasonable, and account sizes have gotten higher.”

Change Is Hard
Substituting new pricing models for the tried-and-true AUM percentage, however, is easier said than done.

“Clients want to keep it simple,” says Marty Bicknell, CEO of Leawood, Kansas, firm Mariner Wealth Advisors, which has more than $10 billion in AUM. Nearly all of Mariner’s clients are charged on a percentage of AUM, he says; while they “want to understand what they’re paying for, they don’t want fees to be unbundled.”

Clients are often uncomfortable with the hourly billing and project-based fees they pay for other professional services, adds Steve Rehmus, principal of the Silicon Valley wealth management firm Brownson Rehmus & Foxworth. “It’s a constant refrain that we hear,” Rehmus says. “The hourly numbers seem high, and projects take longer than expected.”

It’s also harder for clients to pay separately than to simply have a percentage taken out of their account every month, Gjertsen says. “The AUM model is less painful,” he says. “It’s like using a credit card. Unbundling fees is a harder sell.”

When reassessing what to offer and how to charge clients, advisors must weigh what the competition is doing, the cost of the service and the value of the service based on outcomes, experts say. “Change should be based on how you’re helping clients achieve life goals, which has a bigger realm of value than portfolio performance—although more subjective,” Inveen says.

For those advisors who do stick with a traditional fee model, a relentless focus on value to the client will be critical, Bicknell says: “There’s no question that advisors who want to charge on assets going forward are going to have to articulate and prove their value.”

David Canter, executive vice president of practice management and consulting for Fidelity Institutional Wealth Services, agrees. “The non-commoditized elements of advice—that’s where the puck is going,” he says.

Whatever changes are made to a firm’s pricing model and service offerings, a transition plan centered on communication and review meetings with clients (and preparing for their objections) “is key to supporting the implementation,” the TDAI report concludes.

Or as Canter puts it: “All fees can be appropriate—as long as they are explained by the advisor and understood by the client.” 

— Charles Paikert 

 

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