Next Generation Planner: August 2022
Christopher Woods, CFP®, CKA, is founder of LifePoint Financial Group, a comprehensive financial planning firm based in Alexandria, Virginia. He is a member of the National Capital Area FPA chapter, chair of the FPA Diversity and Inclusion Committee, host of the FPA African American Knowledge Circle, and he serves on the FPA Advisory Council Executive Committee.
Adviser compensation has evolved significantly over the last few decades. In the ’80s and ’90s when wirehouses were flourishing, advisers at those firms were primarily compensated in the form of upfront commissions from the sale of A-share mutual funds or brokerage commissions from trading individual stocks and bonds.
At the beginning of this century, C-share mutual funds and 12b-1 fees were starting to shift compensation from being earned up front in the client engagement to being spread out over time. This created the need for advisory firms to develop better client service models.
How should we think about adviser compensation in the decades to come? To answer that question, I would ask a couple of others: What does success look like in the financial planning profession? What would it look like for your individual practice? For many financial professionals, success is measured strictly by AUM. The financial services industry and the media that cover it have made AUM the metric that all advisers and firms should be judged upon. Business plans are centered around it, and clients are accepted into a practice or turned away based on the assets that they have. With that being said, it would be disingenuous if I didn’t acknowledge that I’m personally looking for large clients, and I believe that most of us are. How can we look at adviser compensation in a way that aligns with our desire to grow our businesses, support our families, and expand the reach of financial planning?
Every firm and individual will have their own definition of what success looks like to them. I would offer a few suggestions to incorporate into redefining what success looks like in our industry. What if success was measured by the number of clients who are now living a life on their terms as a result of your relationship with them? Or maybe by the number of families who had a poverty mindset for generations but are now experiencing financial freedom and instilling an abundance mindset in their children and grandchildren? Some of you will roll your eyes and say that focusing on changing lives and impacting a broader range of people doesn’t pay bills, but I would suggest that you can do both. When focusing on reach and profitability, here are a few things to consider as you develop a fee schedule for clients.
Price, Value, and Fairness
First, offer a fair and transparent fee schedule. What’s considered a fair fee is open to interpretation. I also realize that price is only an issue in the absence of value. A fair fee in my interpretation is a fee tied to a uniform metric that can be extrapolated across various types of financial planning engagements based on complexity. In my opinion, the best metric that we can use is an hourly rate. Other professional service businesses that we engage with in our daily lives, such as lawyers, CPAs, and business consultants across industries, calculate their fees for labor based on an hourly rate. Somewhere along the line in our industry, we’ve chosen to price our work based on the amount of assets that a client has. While additional assets often bring more complexity and a greater investment of our time, we all know that the correlation is not direct. The $500,000, $1 million, and $2 million client may all get an identical amount of our time, yet one client may be charged $5,000 a year and another $20,000. If my neighbor and I with identical sized houses both needed to get our roofs replaced, I would be pretty upset if I found out the same company charged me four times the amount he paid because I made more money, yet we’ve standardized this practice in the financial services industry.
A fee schedule with your hourly rate as the standard unit of measure would create fair pricing across your client base. For example, if your standard model for onboarding and servicing a new client involves 20 hours of your time at $350 an hour then a $7,000 fee would be a good starting point. Adding the spouse to the engagement may add an additional four hours, which would increase the fee to $8,400 for a couple. If one of them is a business owner, there could be another 10 hours of work, so you could be looking at a fee of $10,500 for an individual or $11,900 for a couple. This fee would be applicable to a client with $1 million or $3 million in AUM. The case complexity and time spent would determine the fee and not the amount of assets.
To be clear, I’m not advocating that we do away with the AUM fee model. I’m suggesting that we better quantify the fees being deducted from client accounts. As clients begin to demand more fee transparency, I think it will be important for advisers to evaluate their AUM fees being directly debited from client accounts and assess the fairness of the fee based on the services being delivered to the client. Most custodians will allow you to debit a fixed fee rather than a percentage-based fee from an investment account, which will help deliver a more consistent experience. You may want to consider putting a cap on the maximum amount that you’ll charge any one client in fees. For example, if you charge $350 an hour then you may decide to set a maximum fee of $28,000, which equates to 80 hours of your time (which you’re not likely spending with any one client). The fee should have inflationary adjustments and of course there could be exceptions, but I offer that as an example. As radical and even ridiculous as some of these ideas may sound to some, many advisers and asset managers are already implementing them, and I believe that we’ll see greater adoption of these strategies as advisers are looking to differentiate themselves and clients are more aware and informed about how much they’re paying in fees.
A Mixed Model Approach
Second, consider multiple fee models to meet clients where they are. With more gig economy workers and contractors in the labor force, it’s important to consider different models that may work best for their unique cash flows. The last few years have also brought a wave of early retirements, part-time work, and sabbaticals. Consider flat or hourly fees, retainers, or various investment management fees or a combination of a few of them to meet the changing incomes and cash flows of clients. Given the uneven income of gig economy workers, they may benefit from a series of limited engagements that are bundled and priced based on the hours spent. A subscription or retainer model could be a good fit for someone with consistent discretionary income who’s looking for ongoing planning but doesn’t have a need for investment management.
From a compliance perspective, it’s cleaner to offer flat, hourly, or retainer fees for financial planning that clients pay out of pocket and directly bill client accounts for asset management. If you bundle your financial planning with asset management, then you should consult your compliance professional before you directly debit a client account for your fee. You should never debit a qualified account for a fee unless it is directly tied to managing the assets in that account (Levine 2019).
If you’re not a fee-only adviser, then another method of compensation to consider for certain client cases is—make sure you’re sitting down for this—commissions. Yes, I said commissions. Hear me out: I recently had a client who needed term insurance. I’m currently working with a company that offers commission-free insurance and annuities to RIAs. I had them price a term policy for a client, and I compared it to a quote that I received for a commissioned product from a brokerage general agency. The quotes were identical because the company offering commission-free products shops their term out to other insurance agencies. With the quotes being the same, it was better for the client if I used the commissioned product and received a commission rather than charging the client a fee that would be paid in addition to the insurance premium. We’ve arrived at a place where some advisers are demonized for offering products that pay commissions. In many cases, collecting a fee from a client in lieu of offering a product that pays commissions can save the client more money over time. However, you should not write off commissions entirely, particularly if your analysis as a fiduciary determines that being paid a commission is in the best interest of the client as I determined in my term insurance case. As you consider different models, the best model for you will be the one that your target market will benefit from. Put in the time to research the pain points, needs, and cash flows of your target market to deliver a fee structure that will best cater to them. It’s also important to be open to the idea that the best model for the client could change over time.
When to Charge Nothing
The third and final suggestion for developing a fee schedule is to determine how you will implement some pro bono planning into your practice. I once heard a speaker say that you should charge a prospective client full price or nothing. Assuming that you’ve done the research and you’re charging a fee that’s appropriately priced for your target market, you should charge them full price. Instead of discounting your fee for someone who doesn’t see your value, set aside some time each week or month to deliver pro bono planning to those who need it most and will appreciate the time you spend with them. Start with an hour a month and try to increase the frequency if you’re able. On your website or calendar app, indicate that you offer two 30-minute appointments (or one 1-hour appointment) per month. Consider reaching out to the communities that you want to serve in this capacity to let them know what you’re doing.
As part of this process, you should also seek out other advisers or financial coaches who may be a fit for the pro bono clients who would like to engage a financial planner but can’t afford your fee. Keep a list of these advisers and coaches that you can refer pro bono clients to where appropriate and share it with other advisers who may also be looking for referral sources to better serve these clients.
Most of us have received some free advice in our careers that has had a profound impact on our lives or maybe even changed the trajectory of our careers. Make some time each month to give some of your advice away for free. The time that you take to give back can change the trajectory of someone’s financial life potentially for generations to come. Some of the knowledge that has become second nature for us can be life changing for someone in need.
The Wider Impact of Fee Models
I believe the changes that I mentioned above would yield positive results for our industry and for the population at large in a few ways.
First, we’ll be able to serve a younger, more diverse clientele. Removing asset minimums and offering different fee models will create more opportunities for those in different phases of life to be able to gain access to quality financial advice.
Another benefit of these models is that we’ll see a more diverse group of advisers enter and remain in the business. New hires at some investment firms are asked to show up on day one with a list of names of people who can immediately move assets to the firm. Due to the wealth gap in this country, advisers of color are at a disadvantage to their peers when fees on asset gathering is the primary method of compensation and the depth and wealth of your network becomes one of the primary drivers of success. As a result, many advisers of color choose not to enter the industry in the first place because they fear they may not be able to support or sustain themselves in the business. Flat fee, hourly, and subscription models will allow more younger and diverse advisers the ability to profitably build a book of business by targeting their natural markets. Along with RIAs, I hope the wirehouses and independent broker–dealer channels also embrace these models so more opportunities will be created for new advisers.
I’m not writing this as an authority on adviser compensation who has it all figured out. I’m writing this as a peer who’s experimenting with different fee models to figure out how to profitably grow my business while better engaging my target market and making a broader impact on society through the work that I do. I’m in this business because what we do changes lives. By offering a range of fairly priced fee models to meet people where they are and finding opportunities to give some of our time and talent to those who need it most, I believe that we will change even more lives through our financial advice. Also, a younger, more diverse group of advisers will see and realize a pathway to success with the adoption of these models.
Reference
Levine, Jeffrey. 2019, March 6. “Maximizing the Pre-Tax Treatment of Investment Advisory Fees After TCJA.” Nerd’s Eye View. www.kitces.com/blog/investment-advisory-fee-deduction-post-tcja-ira-expense-ratio-etf-limited-partnership/.
