Less than a month after I recommended that an organization – specifically NAPFA – set new membership standards regarding an RIA firm’s revenue model, one has risen to take up the challenge.
My article talked generally about the next evolutionary stage of the financial planning/investment advisory profession, and one area ripe for change is the most popular revenue model. I said that the switch from commissions to an assets-under-management (AUM) fee model was a long, hard, transition that might never have happened but for an association of brave volunteers who publicly gave up commissions. They formed NAPFA, and it waged a very successful campaign in the consumer press arguing that individual investors were better off working with an advisor who charged fees rather than getting paid by product companies to recommend their mutual funds, annuities and life insurance contracts.
I said the next evolutionary step is to replace the AUM revenue model with…
I’m not sure what.
It could be hourly, fixed monthly or quarterly fees, or some combination of these. Advisors could manage client assets as a convenience under these fee arrangements, perhaps adding some extra compensation for the extra work. There’s a great discussion of the various potential fee arrangements organized by business consultant Matthew Jackson that you can find here. To see a lot more go here.
There are several reasons why abandoning the AUM model would benefit the profession, but the most important is that it is much too easy for asset gatherers to continue their former sales activities after they switch from commissions to AUM. They just shift from selling annuities to selling the services of a TAMP (or in the case of wirehouse brokers, their firm’s investment platform). They can tell clients that they’re paid entirely by fees, and obscure the difference between salespeople and professional, fiduciary advisors.
But they could not so easily obscure the difference between asset-gathering and professional advice if the professionals were all paid some other way than AUM. That’s the main reason why I have periodically beaten what many readers consider to be a dead horse.
Straying from the herd
Making this shift in revenue models faces two challenges. We humans (and advisors) are herd animals. Nobody wants to step out and pioneer a new way to charge clients when everybody else is charging a different way.
Lest you think this is a trivial obstacle, there were two sessions at our annual Insider’s Forum conference, where a prominent advisor and early fee-only pioneer confessed several times that he believed that the profession would inevitably move away from AUM. But, he said, as a matter of policy, he didn’t want his firm to be among the first to step too far away from the professional pack. Until there is the safety of a new ”herd,” few advisors are going to give up their comfortable revenue model.
That’s why NAPFA was so important in the early days of the transition from commissions to fees: it created a visible community of advisors who were willing to forego the conflicts of interest and higher income associated with commissions to sit on the same side of the table as their clients. Just as importantly, it allowed members to compare notes and solve the inevitable kinks in the new model. There are more than a few kinks in the alternative revenue models, including how to adjust the fees for inflation and how to charge the client who presents one situation and then, after being quoted a fee, turns out to be far more needy than you realized.
How do we meet this challenge? As I mentioned in my opening line, there is already a nascent community forming around the idea of an advice-only business model, whose members would be exclusively advisors who charge hourly or flat fees – no AUM allowed. I recently attended one of the first virtual meetings of what is called the Transparent Advisor Movement, created with lightning speed by LinkedIn marketing consultant Sara Grillo, who writes a regular column on these pages. (The next meeting is November 9, and interested parties can sign up here.)
This new community may not get immediate traction, but it’s helping advisors find each other in this quest to move beyond AUM. Another organization called The Hourly Exchange, for financial planners who charge by the hour, is also worth looking at.
Gathering data – Before jumping to a new model
The second challenge is bigger and less easily addressed. After a generation of charging in what can only be considered a lazy manner (How much do you have? Okay, here’s how much we’re going to charge.), the planning community is going to have to start matching effort and value with pricing. This is not a trivial challenge. How much time is your firm spending with each of your clients – counting the founder, the lead and associate advisors, the operations people who are handling check requests and the investment team that is managing the portfolios? What are the relative values of an hour of each of those persons’ time?
Layer onto that: What is the value of your advice and service to each client’s life?
Most advisory firms don’t have the data they need to match time spent, complexity and value with price – it’s something this profession hasn’t explored.
The few firms that have this data are tracking the time that everyone spends in the office, and assigning those time expenditures by task and by client. (Too much of a hassle? There are a variety of programs that make this process far less intrusive than the paper process most of us remember; see TimeClock Plus, Connecteam and Synerion as a few examples.) .
If an RIA firm tracks its time for a 12-month period and gains a reasonably precise view of how much time the various staff members are spending with and on behalf of each client (make sure you include all those one-off phone calls), and where they’re spending their time on which tasks for those clients, then that becomes a baseline way to determine how profitable different clients are. It also tells you how much time is being spent on unproductive or low-value tasks, which is surely a valuable input to your practice management decisions.
In the year-end report, you would assume that the lead advisor ”costs” a certain hourly rate ($300 an hour?), the associate advisor a different rate ($175 an hour?), various members of the ops team other rates, and you see how much each client was “costing” the firm over the course of that year. The spreadsheet would also include a column that assigns all the overhead costs like rent and the computer systems etc. equally across all clients.
Then, of course, you compare the sum of these internal costs for each individual client with what each client is paying. You look at the time spent on various types of analysis and tasks performed, and decide where your staff is spending too much or too little time, or what tasks or analytical activities should be billed out at higher rates. You might see that some services should be priced at a flat rate, and others hourly. You might decide to add or subtract services that are high or low value.
You can start making other decisions based on data, not on the lazy calculation of a percentage of a client’s portfolio. Such as: Should less wealthy or less complex clients pay different rates than those who are wealthier or more complex? Should there be a baseline menu of services, with add-ons where you will charge extra?
My point here is not to say that advisors should switch from AUM to some other arrangement. I happen to believe that eventually the herd will move in that direction, and (this is my ulterior motive) I would dearly like to draw a clearer line between asset-gathering brokers and fiduciary professional advisors.
My point is that most advisory firms would be unwise to make this AUM-to-something-else switch with the meager data they have at their disposal. I concede (with my arm twisted) that my friend and colleague at our conference was right not to move away from AUM until he saw a trend and a community forming around it.
I’m going to be following this Transparent Advisor Movement with interest. The braver, more forward-thinking advisory firms should adopt one of the time-tracking software apps develop the habit of finally getting the information we need to more closely match time spent and value provided with fees charged.
That will be a milestone, an evolutionary step forward in the long march toward true professionalism.
Bob Veres' Inside Information service is the best practice management, marketing, client service resource for financial services professionals. Check out his blog at: www.bobveres.com.
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Less than a month after I recommended that an organization – specifically NAPFA – set new membership standards regarding an RIA firm’s revenue model, one has risen to take up the challenge.
