From the May 2004 issue of Investment Advisor • Subscribe!

May 1, 2004

Rollin' Along

Choosing a fee-based compensation route makes for a smoother revenue ride. And there are plenty of helpful signs along the way

Planners who are contemplating a switch from commissions to fees tend to sound like people about to start a strict new diet: This will probably be good for me (sigh), and I suppose it will have a positive effect on my firm's long-term health (groan), but boy, am I ever going to be hungry! Visions of nice, plump commissions dance in their heads the way images of sugary pastries and steaming pasta torment new Atkins-diet converts; the thought of giving up 2%-5% upfront commissions in favor of a fractional percentage of assets every quarter sounds about as appealing as giving up a giant hot fudge sundae in favor of a paltry, stone-cold slice of turkey.

But take heart. While transitioning to fees can and often does cause a temporary dip in income, it doesn't have to require months of living on bread and water, and most planners who have successfully completed the conversion report that the long-term benefits outweigh any short-term privation or turmoil. There's greater flexibility to call the shots yourself as an independent RIA, your rollercoaster income becomes a smooth, steady ride, and your fee-based firm will most likely command a higher price when you choose to sell it and sail off into retirement. You might even get a little more respect. "I think the biggest benefit [of going fee-only] is the perception in the client's mind that it's a better relationship," says Mike DiGirolamo, senior VP of the investment advisor division at Raymond James in St. Petersburg, Florida. "It may not always even be a better relationship, but the perception is there because of the way the fee-only advisor is held up as a model for fewer conflicts of interest." (For the record--and to calm the apoplectic NAPFA members who are now screaming at the print on this page--the term "fee-based" generally refers to a firm that is compensated primarily by fees but may accept some commissions, while a "fee-only" firm accepts fees exclusively.)

Benefits aside, it may simply be the clomping feet and looming shadows of government regulators that will finally push many commission-based advisors to throw up their hands and take the plunge. "I think the trends in the regulatory industry--more scrutiny of B and C shares, the potential for 12(b)1s to be eliminated, the desire for more disclosure in commission-based relationships--are going to finally get some of these last diehard commission-only people off the bubble, and get them to really start to look seriously at the fee-based world and wanting to go that route," says Mark Schoenbeck, VP and director of advisory services at Mutual Service Corporation (MSC) in West Palm Beach, Florida.

Still, even if you're convinced that transforming your firm into a fee-based business is the greatest idea since low-carb sliced bread, the actual process of doing it can still be daunting. So we've collected some pearls of wisdom from a variety of planners who have "been there, done that," and we've also gotten the scoop on a whole host of coaching programs, classes, seminars, software tools, and other resources now available to help you make the switch. There are helping hands out there waiting to assist you. You just have to ask.

Living to Tell the Tale

First, consider the novel idea that converting to fees may not, in fact, kill you. Indeed, you may have nothing to fear--to borrow a phrase--but fear itself. "The number-one stumbling block for advisors lies between their own two ears," says MSC's Schoenbeck. "Advisors think, 'My God, I can't bring [the idea of converting to fees] to my clients! They'll never want to pay the fee, and they're going to grill me about it, and I've never done it this way before!' They freak themselves out, when in fact, if the advisor has a good relationship with the client, the client will do almost anything the advisor asks of him." The majority of clients will make the leap with you without batting an eye, he says.

You need not necessarily fear the impact on your piggy bank, either. "There seems to be an urban legend that if you go fee-only, you'll starve," says Les Merrithew, an advisor with Merrithew and Thorsten, Inc. in San Diego who transitioned to fees six years ago. "There is a transition period, but one can plan." There's also a big misperception that if you transition to fees, "your revenues are going to drop like a rock, and I think that scares a lot of advisors, particularly since they've just been through this bear market, and margin compression, which is a very real thing," says Brent Hicks, president of Focus Point Solutions in Portland, Oregon, a firm that specializes in helping advisors transition to fees (see "Transition Game" sidebar). "So it's very scary to, on top of all that, think about completing this conversion and taking a big hit in income. But in our experience, [an income drop] doesn't have to happen." Indeed, Cathy Stegmaier, executive director of the Alliance of Cambridge Advisors, Inc., headquartered in Highland, Michigan, reports that 60% of advisors who transition to fees through the Alliance (which provides a sort of practice-in-a-box--including templates, practice management seminars, and a variety of other resources--for fee-only advisors) are profitable within their first year, and 20% actually make more money than they did before taking the leap. Three years after transitioning, the majority of Cambridge Advisors make more than their commission-based brethren, she says.

So what can you do to increase the chances that clients won't bail and your income won't plummet? To begin with, make sure that you believe in the idea, because it won't work if your heart isn't in it. "One exercise we have found to be very powerful is to have the advisor write down every single thing that they do for their clients," says MSC's Schoenbeck. "We as an industry have been giving away so much stuff over the years with the hope and intent that we could sell the client a product, that we have kind of taken [the idea of freebies] for granted." If an advisor actually sits down with a pen and paper and lists everything she does for a client--say, quarterly meetings, a client appreciation dinner, a monthly newsletter, all phone calls returned within 24 hours, assistance with home refinancing and car purchases--she may finally sit back and realize that she deserves to be compensated for those services, he says. When she approaches the client about transitioning to fees, she then needs to spell out to the client exactly what she's providing. "When providing fee-based advice, you have to present the client with a value proposition that justifies them paying you a fee," says Mark Allen of American Express Financial Advisors in Grand Island, Nebraska, who has transitioned his firm from 90% commissions to 60% fees in the past year, and hopes to reach 90% fees within the next 18 months. "Make sure you have a good understanding of what it is you're going to give the client, and spend a little time honing that idea."

Many advisors also have to convince themselves that fees are truly both in their best interests and in the best interests of the client. "It was easy to see that there was a benefit to me from a revenue and business management standpoint; for the client, it's important to realize that you're really losing a lot of potential conflicts of interest," says Ted Rich of Global Capital Advisors in Winter Park, Florida, who moved from fee-based to fee-only last year. "To me, this was the clearest way to express to them financially that we are on the same page: Any time I suggest something to them, they never have to worry that I'm doing it because there's some financial incentive for me; they know that it was made with the intention that it was a good thing for them."

It's also a good idea to approach the transition as a change in philosophy, not just a new product, says Hicks of Focus Point Solutions. "I think too many advisors approach fee business as just another type of product, rather than a new way of doing business," he says. Some broker/dealer reps start selling some mutual fund C shares and think they're suddenly fee-based advisors. Not so, says Hicks--at least not until what's truly being bought and sold is advice, not investments. "It's a different service model, not a different product model," he says.

Making Your Pitch

Okay, so you're ready to make your big pitch to your clients. You should probably call all of them immediately and shoehorn them into your new system pronto, right? Heck, maybe you should hold a big seminar so you can inform everyone simultaneously! No way, says MSC's Schoenbeck. "Don't do it cold turkey," he says. Tim Welsh, director of strategic programs at Schwab Institutional, agrees. "What we've learned from our clients [advisors] is that it's not a revolutionary thing: You can't just go out one day and switch from commissions to fees." Instead, suggests Welsh, bring in new clients under the new system one by one, and then take your time transitioning your existing clients a few at a time.

Many advisors concur that a slow transition is better, but some disagree about which clients you should start with. DiGirolamo of Raymond James suggests starting with your top 10% of clients and then working your way down through your list; Rick Rodgers of Rodgers & Associates, PC, in Lancaster, Pennsylvania, suggests starting at the bottom and working your way up. "Practice your presentation with your 'C' clients first," he advises. Schoenbeck, too, suggests starting anywhere but the top. "We wouldn't suggest that an advisor start at the top, because if they totally mess up or [their presentation] blows up on them, they haven't just imploded one of their top relationships," he says. "After three or four successes in the middle tier, they realize that the clients have no problem with it, they've heard the objections, they've honed their pitch, and then they can start working up the list toward the top clients."

While a gradual shift will build your confidence and help you polish your story, it has the added benefit of cushioning any hits your revenues make take. "You're still able to do some business every once in a while that involves an up-front payment, and that really smoothes out the [income level] between your quarterly fees," says Global Capital Advisors' Rich.

Of course, not all fee-based advisors charge quarterly fees based on a percentage of assets under management (AUM). Determining the type of fees you want to charge--hourly, AUM, annual retainer, or project fee--is another decision to make. There are arguments on both sides of the fence for each type of fee, so the short answer to this question is, "It's up to you."

How May We Help You?

Perhaps the most heartening thing about making the switch to fees these days is the fact that many have gone before you, and plenty are willing to show you how it's done. Broker/dealers (see our annual directory of fee-based B/Ds that follows this article), custodians, advisor networks, professional associations, and even some private firms have developed a variety of resources to help advisors transition to fees.

If you're looking for a purely educational offering, one option to consider is the multi-part coaching program offered by NAPFA, a trade association of fee-only advisors based in Arlington Heights, Illinois. NAPFA's so-called FOSTER program includes 20 modules on a variety of practice management topics, one of which is "transitioning to a fee-only practice." Each module includes a conference call led by an experienced NAPFA advisor; approximately 8-10 "student" advisors can listen in, follow along on a Web-based PowerPoint presentation, and pose their own questions to the session leader. All 12 sessions, which cost $75 apiece, can be completed in three months, and each module can be purchased separately. "The program is really geared toward people who have just passed the CFP exam and are about to start their fee-only financial practice," says Eric Georgevich, membership outreach coordinator for NAPFA. "The small groups make it really neat, because the participants' questions really determine the direction of the presentation, and people can find out about whatever they're interested in learning about." Ironically, the module, or session, about transitioning to a fee-only practice hasn't been in much demand lately--not because advisors aren't interested in fee-only work, but because FOSTER program participants are generally already sold on the idea.

On the advisor network front, two major players in the fee-only advisory arena are the Garrett Network, which favors hourly fees for advisors, and the Alliance of Cambridge Advisors, which favors annual retainers. Both provide a smorgasbord of practice management seminars, educational training sessions, and coaching, and both provide a version of a practice-in-a-box: templates, sample documents, and detailed guidance on how to set up office systems. In both cases, new members are allowed one year to convert entirely to fees. Interestingly, only about 20% of the Garrett Net-work's and 25% of the Cambridge network's advisors come from commission-based backgrounds; many Garrett Network advisors have started their firms from scratch, coming to planning from entirely unrelated fields, says Marie Swift, communications director for the Garrett Network. Neither network has a formal program tailored to help advisors transition from commissions to fees, but both provide significant practice management coaching that would be helpful to an advisor looking to convert. "Transitioning advisors are drawn to the turnkey nature of our program," says Cathy Stegmaier of Cambridge. "They are used to receiving support from their broker/dealer, and we help them get their practices up and running. They are able to avoid the high costs of mistakes, learning from the experience of other members of the alliance."

Several independent B/Ds provide significant help with transitioning as well. Mutual Service Corp. has for three years offered an intensive yearlong coaching program whose participants generally end up converting to fees. "It's marketed as a practice management program to help advisors build their ideal practice," says MSC's Schoenbeck, "but as we go through the process, they start to realize that to do all the things we're talking about, you need to have some sort of recurring revenue...which ultimately means they need to convert to fees. So it's really about transitioning your business." The program includes four two-day meetings, peer-group conference calls, Web-based training sessions, outside reading, and homework. "We're basically trying to hold them accountable for actually implementing the things they're learning at the meetings," he says. It's not a huge program; approximately 30 advisors participate at any one time, out of a total of 1,600 reps at MSC. But MSC is clearly making fee business a priority: 60% of the B/D's reps are fee-based, and "in the past two years, we helped over 300 advisors open their first fee-based account," says Schoenbeck.

Although Raymond James doesn't have a formal program to encourage advisors to switch to fees, it is well equipped to help advisors once they make the decision, says DiGirolamo of Raymond James. The company has divisions for advisors of all stripes, from employees (Raymond James & Associates) to registered reps (Raymond James Financial Services) to independent RIAs looking for custodial services (Raymond James Investment Advisors' Division). "We provide an open platform so they can transition as their business evolves," says DiGirolamo. "Let's say you start as a commission-based advisor, and then you develop a portfolio-manager approach to your business. We can help you transition into our investment advisors' division, and you can operate under our RIA until you can get your own set up." Raymond James offers education on fee-oriented investment tools, and assistance with documents and agreements associated with setting up one's own RIA.

As for the custodial arena, Mark Avers, senior VP of national sales for TD Waterhouse, says that his company has a special accounts transfer team to help oversee the transition of accounts to the firm, while Schwab's Tim Welsh reports that his company provides several services: business planning seminars and workshops, consulting services, and software to help advisors model the impact of changing their compensation structure.

No one claims that it won't be a fair amount of work to convert to a fee-based business. But given the number of advisors who have survived the transition, the number of programs available to assist with the transition, and the number of regulatory storm clouds gathering over the commission-based world, advisors would do well to at least seriously examine the possibility of taking the plunge.

Assistant Managing Editor Karen Hansen Weese can be reached at khansen@ia-mag.com.

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