Not So Fast: A Cautionary Tale on Changing Your Advisory Fees

There’s been a lot of discussion in the media lately about advisory fees, especially the combination of a flat fee or retainer with the customary AUM fee. Years ago, after watching firm revenues plummet in the wake of the dot.com crash of 2001, I also became an advocate of advisors receiving a portion of their fees from a flat annual retainer. In fact, many of my clients went to just such a combined fee structure to smooth out their revenues. However, even though it seemed like a good idea at the time, our experience with mixed fees hasn’t been very good—many of my clients have subsequently stopped using flat fees—and I would caution advisors who are considering this “new” fee structure to reconsider. Here’s why. 

The first problem we ran into stemmed from separating advisory services. Most of my clients justified charging a flat fee to their clients by separating financial planning from investment management. The advisors then changed an annual flat fee for the planning, and then reduced their AUM fee so that the total worked out be about the same dollar amount (at least until the assets showed significant growth). So far so good: the clients understood the rationale, and we got virtually no resistance to the change. 

However, the seed had been planted in the clients’ minds that financial planning and investment management were separate services, paid for separately. So, after a couple of years of this combined payment, many clients began to feel that they weren’t really getting much ongoing benefit from the financial planning (which had largely been done on the front end), so they stopped paying the planning fee, but continued to get their assets managed at the new, discounted rate. 

I’d like to say we were smart enough to see this predictable aspect of human nature coming, but in fact, we weren’t. Consequently, our attempt to smooth out revenues merely resulted in decreasing the amount of market dependent reviews that our advisors received. 

Brilliant. 

But wait, it gets worse. Our new fee structure also had an adverse effect on the clients who continued to happily pay the annual financial planning fee along with the asset management fee. It seems that when the markets dropped dramatically in 2007-2008, many of those clients had a problem continuing to pay the unchanging financial planning fee. Even though the amount of the AUM fee declined in line with the decline in asset values, and even though the financial planning fee was clearly for financial planning only, the clients still had a problem with it. In fact, our firms lost a number of clients over this issue. It seems that many clients, whether they know it or not, have a strong attachment to the identity of interest that comes from AUM fees: when their values go down, they like to see their advisory fees go down as well. 

The moral to this story is that advisory fees are serious business that should not be trifled with lightly. Of course, there are very compelling business reasons to try to disconnect revenues from market volatility. Yet as we all search for a better fee model for advisory, it’s important to be mindful of the reasons that the current fee structure (with all its flaws) is the basis for our current client relationships, and try not to do anything to jeopardize them.

Reprints Discuss this story
This is where the comments go.