Written by: John Anderson
This article originally appeared on SEI's Practically Speaking Blog.
Earlier this week in Practically Speaking, my colleague and favorite sparring partner Raef Lee posted an introduction to our upcoming webinar and white paper “Advisor Fees at a Crossroads.” If you know me well or have read this blog over the last almost five years, you know two things:
At SEI, we are passionate about helping advisors figure out the best model for their business I always like to get the last word in any debate
Next Wave Debate
Since we completed the work on Next Wave of Financial Planning and after every time we presented the whitepaper, advisory fees seemed to be the most controversial and debated topic. Raef’s post did a nice job of outlining the challenges today’s advisors face regarding fees. He and I agree that there is a lot of noise about fees today and we don’t think it is going to stop. Some of the fee pressures for advisors are:
The robo-advisor effect – To me, more important is the effect of the firms that call themselves robo-advisors but are, in reality, virtual advisors offering limited planning, aggregation, risk tolerance questionnaire, asset allocation advice and cheap (i.e., passive) implementation all for about 25 basis points. Educated clients, validators and the investment commoditization – As Raef suggested, we are living in a world where consumers use WebMD and Turbo Tax to educate themselves before meeting with the doctor or CPA. We also have tons of information and advice available via the internet that enables clients to validate opinions, shop for best prices and confirm costs. In fact, there are very few products that a consumer can’t purchase without the help of an advisor. With the multitude of offerings and the ease of access, investment vehicles are becoming more commoditized every day. Regulation – The upcoming DOL Fiduciary rule means how advisors get paid is only going to get more media coverage and more scrutiny in the coming weeks, months and years. Obviously, we have to wait until the rule is implemented, but to me, we are nearing the end of commission-based products (at least in qualified accounts), and advisors need to understand that advisory compensation will always be a concern of regulators.
While Raef’s post argued for the status quo and laid out good reasons and business models that would encourage staying put with a traditional AUM fee, I would like to argue for change.
Fee for Advice or Something Else
We start the paper with a simple yet interesting point that I have been trying to make for years:
I find it interesting that we are the only industry I know of that typically takes a highly valued asset (advice), and for the most part, gives it away for free. Yet we charge on what has become a commodity (investments). And you can get the valued asset only if you pay for the non-valued asset.
To me, the dichotomy of our business models is only going to be called in to more question as the disrupters (robo, educated/validators and regulations) evolve more into the public consciousness.
First, let me be clear—there is no right model for everyone. If there were a perfect model, we would all be implementing the same way and there would be no need for white papers or debates. What is important is that each advisor, each firm, has to develop and implement a clear value proposition that resonates with their target clients. The value proposition is foundational to who you are, who you serve and how you will charge. (We discuss the value proposition at length in the paper, so I will leave it there.)
A Model for Change
There are many options for alternative fee structures other than 100 basis points on AUM. Some advisors use hourly, others look at retainers. But for today, I want to look at a modular fee structure.
One of the more popular modular fees that we look at is the following:
Initial planning fee with annual retainer fee thereafter. (Flat fee charged in increments over the year) A lower “investment oversight or coordination fee” of about 15 – 25 basis points Other service-related fees as necessary, such as an aggregated performance fee or special projects related to the niche.
Advantages of a Modular Fee
There are several advantages of the modular fee schedule:
The fee schedule is clearly more in line with what the client values. Study after study shows that access to advice is more valued by clients than investment advice. The modular fee schedule shows your emphasis on advice and deemphasizes focus on things an advisors has little control over (volatile markets or economy). The modular fee schedule is fairer to the consumer (think regulators). The current model (AUM) traditionally has larger clients, where more revenue is generated, subsidizing the smaller clients, where less revenue generated, for similar if not the same services. Additionally, if clients add additional assets to their portfolios, the advisor can get a substantial revenue increase for doing essentially the same thing, causing client/advisor fee friction. The modular fee schedule has the ability to increase the revenue for the advisor in good markets, albeit slightly, but the retainer maintains the revenue and cushions the downslide in bad markets as opposed to the all-AUM model.
Whom Does the Modular Fee Schedule Work For?
Obviously this model does not work for everyone. As Raef suggested in his post, legacy AUM advisors, investment advisors and lifestyle advisors would not need or benefit from changing their fee schedules today. And for some, clients are not demanding a change today, so having the fee discussion (especially about change) can be a difficult exercise. For those advisors, “If it ain’t broke, don’t fix it.” So whom does it work for?
Advisors with younger clients: Setting up a fee schedule focused on advice will be very attractive to the HENRYs (High Earning, Not Rich Yet) clients who need advice but don’t have the large asset pool for the traditional AUM model to work on their behalf. Advisors who want to test a small account solution for kids/grandkids of current clients —similar to above, it allows advisor to get paid for advice while providing service to clients Advisors who are concerned about future regulations and client reaction: Value is tied to specific services. Puts advisor on the moral high ground with complete transparency and focus on what the advisor can control (advice). I think the question is for many, “Do we want to be ahead of any proposed changes or behind?”. Newer advisors looking for differentiation: New model sets the advisor apart in a crowded business. The model allows for a focus on the value proposition instead of the industry definitions of fee-based vs. commission-based—we call the new model Advice Based.
My usual ending would be to say Raef is wrong, my way is right and that is that. But not today. In fact, there is no right answer to the business models that we discussed here or others that are referenced in the upcoming white paper. The right answer is the one that works best for you and your clients. I think we can all agree that fees are at a crossroads. Which path you decide to take is up to you. Our job is to lay out a road map for each path. We would love to hear your comments, concerns or questions.
