Fee compression or more services?

For the past three decades we’ve been hearing a great deal about the fee compression coming to the financial advice industry. For many parts of the investment advice profession, this has been a reality. But not so much for the financial advisor.

Those closest to the client have been able to maintain their fees (and in some cases, raise them). Those farthest from the client have seen the greatest reduction.

Years ago, I had a meeting in San Francisco with an equities portfolio manager. This stock manager ran a mutual fund in addition to running a series of subaccounts for variable annuities. The management fee for the subaccount was 1.86 percent – obviously very high by today’s standards, yet somewhat common at that time.

The investment manager received about 20 basis points for his work in managing the money, and was shocked when I told him the insurance company charged 186 basis points. He felt he should have more of the money the insurance company charged the client. The mutual fund he ran had higher fees than the 20 bps the insurance company was paying him, and he believed he was getting the short end of the stick. I noted that the reason he received such a small portion of the fee was because he didn’t control the client. The financial advisor who sold the variable annuity had the client relationship; the investment manager was too far removed from the client to have any pricing power.

Today, that same advisor may recommend a variable annuity, but it’s likely it is with a product that has very low expenses and management fees that are a fraction of what they once were. Yet the advisor’s comp is probably what it was 20 years ago – approximately one percent.

Fees for investment management can’t get much lower. Exchange-traded funds can be managed for three or four basis points. Stock trades are free. Actively managed mutual funds, particularly those with high fees, have seen an onslaught of redemption. Front-loaded mutual funds, with their high commissions, are a thing of the past.

So, what’s the future for fees charged by investment advisors? It’s anyone’s guess where fees will be a decade from now, but I believe clients are going to demand either lower fees from their advisors or additional services.

Consider the largest RIAs in the country. Most of them have not reduced their fees over the past decade. In fact, some have actually had fee increases. But they are also offering substantially more services for the fees they charge.

Historically, a one percent annual fee may have covered only investment advice. For those who were proficient in financial planning, it may have included that as well. Today, that same one percent fee may cover services that include tax planning, tax preparation, trust and estate planning review, estate documents, insurance reviews, Medicare advice, health care planning, and more.

Those advisors who aren’t interested in growing their client base and simply want to maintain their existing relationships can probably keep doing what they’ve been doing. Clients will slowly attrit, but investment returns will make up for those losses, and their businesses will likely continue.

But those advisors who want to land new relationships and continue to grow are going to have to compete with the larger firms, which means either providing additional services or offering a lower fee.

Scott Hanson is co-founder of Allworth Financial, formerly Hanson McClain Advisors, a fee-based RIA.