Pay models evolve beyond 1% of AUM

The fee-only advice industry that emerged as brokers deserted a commission-reliant business model is now evolving, with advisers working out the best way to get compensated for their services.
Charging a percentage — usually 1% — of assets under management was once considered the “pure” way to charge clients for advice and investment management.
But critics point to potential conflicts of interest in such a structure and emphasize that it doesn’t pay advisers enough to handle clients with fewer assets.
Financial adviser Konstantin Litovsky charged clients based on AUM when he started his firm in 2007. After three years, though, he concluded that the approach didn’t mesh with the specialty he had developed serving young doctors and dentists.
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These professionals have little in terms of assets to manage, but they have strong cash flow and some complicated needs, such as help restructuring debt and tax planning.
He now charges a flat fee of $4,800 a year.
“A flat fee is fair to the clients and compensates me adequately for my work,” Mr. Litovsky said.
While 95% of investment advisers set fees based on AUM, according to the 2014 InvestmentNews Financial Performance Study of Advisory Firms, several other compensation methods are gaining traction. These models are especially popular with new and young advisers who don’t want to join most of the industry in targeting wealthy individuals and families.

ANNUAL RETAINERS

Advisers who charge an annual retainer that covers asset management and financial planning services — including tax, college and retirement — say the approach reduces the possibility of conflicts of interest.

Jacob Kuebler, an adviser and partner with Bluestem Financial Advisors, said advisers who charge clients based on AUM can be conflicted when decisions that would be in clients’ best interest would also reduce their portfolio assets — and therefore the adviser’s income.

Mr. Kuebler wondered if advisers charging 1% on AUM would be willing to recommend that clients sell securities to pay off their mortgage. What if clients have farmland? Would the adviser be tempted to recommend its sale to turn it into financial assets that could become part of a portfolio and generate fee income?

The retainer model is becoming increasingly popular with advisers who serve clients in the wealth-accumulation phase of life. It lets them base their fees not just on the assets they manage for a client, but on the client’s total financial picture, according to Mr. Kuebler. It also generates stable revenue that won’t decline if clients’ investment value drops amid difficult markets.

In addition to the annual fee, which most expect clients to pay upfront or quarterly, they can charge for services with extra complexity.

The model’s biggest downside is that it can be difficult to explain to clients how the fee is calculated, and, as a result, hard for clients to compare prices, Mr. Kuebler said.

Clients also have to pay the retainer out of cash flow instead of having it deducted from an investment account, as happens when the fee is based on a percentage of assets, Mr. Kuebler added.

“We don’t see that as a bad thing, but it means you have to show your value more regularly,” he said.

His clients pay annual retainers based on their assets and income. For instance, a couple in their 30s with a household income of about $250,000 and assets of between $500,000 and $1 million will pay $4,000 to $6,000 a year. Retirees who may have a net worth of $3 million to $5 million will pay between $10,000 and $20,000 a year, Mr. Kuebler said.

Another approach, the subscription model, is similar to the annual retainer system.

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Mary Beth Storjohann, chief executive of Workable Wealth, said it is especially suited to advisers working with younger clients, specifically those from Generations X and Y, who are used to paying monthly bills.

Ms. Storjohann charges an upfront fee of $999 to $1,249 that covers the cost of completing a financial plan. Clients also pay a monthly fee of $149. She has raised that amount incrementally over the past two years and hopes to get it to about $200. It covers advice provided over the course of the year, and she commits to communicating with them via email or phone calls each month.

“It’s easy to explain to clients when it works just like their cellphone bill,” Ms. Storjohann said. “It makes the sale easier.”

MONTHLY PAYMENTS

The monthly payment system is easier on clients’ cash flow and produces a monthly paycheck for the adviser.

The biggest concern with the model is its sustainability. How many clients can advisers accept when they agree to monthly check-ins?

Another way subscriptions can backfire: Clients can go online and cancel services at any time, without even talking with the adviser, according to Ms. Storjohann.

“It’s easier for them to leave,” she said.

Charging by the hour is gaining supporters, too.

Sheryl Garrett, who started a network of hourly based, fee-only financial advisers in 2000, said it is the best way to serve middle-income households.

“Focusing on middle-income clientele is where my heart and passion always have been,” said Ms. Garrett, whom President Barack Obama has recognized as an adviser who puts clients first.

Such an approach can work especially well with these clients, who typically don’t have many complicated planning needs.

The Garrett Planning Network now has about 320 members.

Supporters say the approach is understandable to clients and lets advisers be paid while they get to know a client — avoiding becoming involved with someone who may not be a good fit for them.

Tracking hours spent with clients, and billing and collecting for those hours, is a challenging aspect of this method.

Advisers using it generally charge between $180 and $300 an hour, with the average being just under $200 an hour, according to the network.

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