Asset-based fee models are 'lazy' — and flawed

The good news for the financial advice business is that there is almost no evidence the trend toward fee compression spreading across financial services is impacting advisory fees.

The bad news, according to the latest research from Bob Veres of Inside Information, is that most advisers don’t know what their services are worth and, therefore, many are not reaching their full earning potential.

The research, which includes results from a survey of more than 1,000 advisers in May and June, shows that about half of the financial advice industry doesn’t charge for putting together an initial financial plan for clients.

Yet, the median initial fee for those that do charge is between $2,500 and $3,000.

Some might argue that using the initial plan as a loss leader to attract new clients makes good business sense, and that might work for some advisers. But Veres believes advisers are grossly underestimating the value of those initial plans.

And, sometimes, that’s just because advisers don’t take the time to figure out what their work is worth, which gets to Veres’ bigger gripe about asset-based fee models.

“We found that 73% of advisers are primarily using an AUM model, which would have probably been 90% five years ago,” he said, citing the “glimmer of a trend” toward flat-fee and hourly pricing models. “I think people are moving away from AUM, it’s just not a stampede,” he added.

Veres, who believes all fee models have their problems, describes asset-based pricing as popular for the wrong reasons.

“Charging AUM is fundamentally a lazy way to charge,” he said. “There’s never been a profession where they charge you based on how much money you have.”

No doubt asset-based pricing is popular because it’s easy and because it stands in stark contrast to the commission-based pricing model.

But as the financial advice industry migrates toward holistic planning and outsourced portfolio management services, it will get increasingly difficult for advisers to make the case for charging clients based on the size of their portfolios.

This is where Veres says advisers need to roll up their sleeves and start the challenging work of determining how much they’re really worth, and then don’t be afraid to claim it.

He tells a story of a client challenging an advisory fee based on the lower fees charged by a competitor. Veres said the savvy adviser will respond by saying nobody knows better than the lower-cost adviser how much he is worth.

ILLOGICAL FEES

Back to that initial financial plan that so many advisers are giving away, when broken down by fee model it begs the question as to when clients will realize the potential for advisory-fee arbitrage.

For example, only 36% of commission-based advisers and about 48% of asset-based advisers charge for the initial plan, but more than 90% of hourly-fee advisers are charging for the service.

In the middle of the mix, 62% of subscription-fee advisers, and 52% of flat-fee advisers charge for the initial plan.

Part of the hard work that Veres wants advisers to do in determining their value begins with tracking the time spent by staff working on client plans, which is something 81% of respondents say they don’t currently do.

Assuming the hourly tracking is done, firms are still all over the map when it comes to gauging value. When asked to list the appropriate hourly value for a principal or senior adviser, the responses ranged from $25 to $1,500, with a median $300 hourly rate.

Regarding the appropriate hourly rate for an associate adviser, the range was from $15 to $800, with a median $175 hourly rate.

If that doesn’t drive the point home about the illogical state of advisory fees, consider that factors like experience and the size of an advisory firm have almost no impact on fees. Across the board, for client portfolios ranging from $250,000 to $5 million, the research shows no advantage of having more than 20 years’ experience over the newbie with one year under her belt.

“I thought larger firms would charge more per hour and I thought more expected advisers would charge more, and I think they should,” Veres said. “But, because most firms charge primarily AUM fees, they’re not sure how to answer that question.”