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Breaking Free

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Fee-based is the current buzz in the financial advisory business. Advisors everywhere are fleeing commissions for a seat on the fee bandwagon. The transition can be a rough ride, though, and not all advisors have what it takes to endure the journey, let alone flourish once they have arrived. How do you actually convert? If you do, what new services will you be able to offer clients? Will clients embrace the new “you?” Can you make sufficient money to survive? Do you even have a choice?

Ross Marino, a CFP and Raymond James Financial Services-affiliated advisor in Wilmington, North Carolina, knows many of the answers to those questions. A former stockbroker, Marino started getting “really aggressive” about his transition from commissions to fees four years ago. “It’s a lot of work, and you’re going to have a dip in income,” he says matter-of-factly. In the first year, his business fell by more than 50%. He was forced to jettison some clients. It took him 21/2 years to get back to where he started income-wise. He couldn’t be happier.

“There was no other option in my mind,” Marino says of what he considers his logical progression from broker to financial planner to wealth manager. “This is the best relationship structure with the client. It is the best long-term move for business, for ethics, and for being unbiased–I don’t know who can be unbiased if they’re being compensated by commissions. If they’re out there, God bless them. But fee is where the future is going.”

Frank Gleberman has been there, too. Gleberman is a CLU, CFP, and a principal of The Century Benefits Group with offices in Marino Del Rey and Los Angeles, California. When he made the shift from commission-based transactions to fee-based financial planning, he experienced “a little drop in income, maybe 10%,” at the end of the first year, and says he caught up during the second.

As with Marino, Gleberman says the desire for a higher income was not a driving factor, though he admits it is becoming a “nice outcome.” Instead, he made the leap for two critical reasons. First, much of his time was devoted to helping clients in areas having little to do with products, such as updating or obtaining wills and trusts; refinancing mortgages and other loans; advising clients on lifestyle and business issues, including succession planning; and helping with education issues for children. Second, Gleberman realized that asset classes within client portfolios often needed rebalancing and repositioning due to activity in the financial markets, not his own strokes of brilliance. He wanted to make portfolio adjustments in a way that wouldn’t result in unnecessary, let alone unearned, commission charges. “I wanted to be on the same side of the desk as my clients,” he says. Now he is.

All Aboard?

Mark Schoenbeck, VP and director of the Advisory Services Department at Mutual Service Corp. in West Palm Beach, Florida, an independent broker/dealer that he says is big on helping its people “go fee,” sees advisors he works with actually increase their income during transition, especially when garnering assets to which they had no prior access. But the truth is that not all advisors experience successful transitions. And not all advisors are hell-bent on converting. Someone who has worked successfully in the commissioned-based advisory field for 15 or 20 years may opt to comfortably “ride it out” instead of transitioning, says Schoenbeck. Or as advisor Marino notes, “If they’re established and comfortable and making a living, why risk it?”

The “younger crowd,” however, is more in tune with the fee-based concept, feeling, as they are, the pinch of dwindling commissions. The average commission-based broker in 2001 saw his revenue drop about 25% to 27%, while the average fee-based broker was down about 7%, according to Brad Fryer, VP of advisory sales and marketing at LPL Financial Services in San Diego.

“They’re looking to grow and thrive, and to do that in today’s markets, you must be working in an advisory type of relationship,” Schoenbeck says. “You must bring a different value-added to the table.”

According to Cerulli Associates, a Boston-based research and consulting firm, about 11% of independent broker/dealers derive their revenue from fee-based services, though from firm to firm, adoption of fee-based pricing can vary from more than half of revenues to less than 5%. For example, revenue from fees on assets for Cambridge Investment Research and LPL Financial Services, both broker/dealers with a fee-based bias, is 30% and 44%, respectively. Cerulli believes that commission billing won’t disappear any time soon from the B/D world. For one thing, that’s because commission pricing, such as A shares, is such a cost effective means of working with smaller-net-worth investors. The 2001 report, “The State of the Independent and Insurance Broker/Dealer Industry,” adds that “even among the CFP membership only about one-quarter are fee-only.” But in general, the gospel of fees will continue to spread, as it already has with many broker/dealers, RIAs, and independent investment advisors and planners. For example, the trade group NAPFA (National Association of Personal Financial Planners), based in Buffalo Grove, Illinois, and with about 770 members nationwide, has since its inception in 1983 espoused the concept of fee-only in conjunction with objective, comprehensive financial planning, with no commissions whatsoever.

“We’ve seen a huge boom in fee-based assets,” says Schoenbeck, “but I don’t really think we’ve scratched the tip of the iceberg yet,” he says. Mutual Service CEO John Dixon notes that the company’s CLASS program, which is offered to the broker/dealer’s 1,600 reps, has amassed some $2.5 billion in assets and is “still growing.”Toss in fees on managed accounts, and the opportunities for fee-based converts are wondrous indeed.

What these data portend is both good and bad for advisors, depending upon how prepared they are for the brave new fee-based world, and how wedded they are to the old. High-net-worth clients are migrating to managed accounts because they no longer accept the limited services offered by financial-product salespeople and the off-the-rack investment advice they often provide. And advisors can no longer enjoy the scant competition they faced during the past decade, when a bull market made everyone look good and there was a greater supply of potential clients than advisors to serve them. Today, as HNWs, and the public in general, become increasingly savvy investors and aware of the commoditization of the financial services industry, they are demanding to know exactly what they’re getting for that 1% or 2% fee the financial advisor is pocketing for managing their assets.

Clients want even more than no-nonsense accountability. They want truly personalized service, a piece of your intellectual property, and they want you to be unique. It’s not enough to be a good golfer, and funny and honest and punctual. “Most advisors are out there sort of swimming in a pool of sameness,” says Terry Gronbeck-Jones, senior managing director of Pareto Systems (see “Enjoying the Spoils” sidebar) and Duncan MacPherson & Associates, both in Ottawa, Canada. “Clients are starting to compare one advisor to another, which they didn’t often do before.” Pareto Systems, named after an Italian economist and based on the principle that in every business 80% of one’s livelihood derives from 20% of the customer base, is a business development and contact management program designed for financial advisors focused on growing their businesses. The program was developed by Duncan MacPherson and Associates, a consulting firm specializing in marketing and business development.

How you differentiate yourself from other advisors–whether you’ve billed yourself as an investment manager or comprehensive planner or both–is a function of your readiness to shed commission personas and sales models for those that give more than lip service to the philosophy and practice of fees. As MacPherson & Associates President Duncan MacPherson says, “it’s hard to charge a fee when you’re perceived as a salesperson.”

Not So Fast

At first glance, bringing to the table what clients are coming to expect from a fee-based advisor would seem simple enough. As Gronbeck-Jones points out, there’s nothing new about transitioning–RIAs pioneered the concept ten years ago, he says–and most advisors are fairly clear on what they should be doing. “The problem is that it’s easy to conceptualize about but hard to put into play when you’re back in the office running a business,” he says. “The law of diminishing intent takes over.” The result is that not as many advisors convert as could, and when they try, they tend to approach what is a deceptively complex subject with a naive, simplistic plan.

Two “glaring holes” Gronbeck-Jones encounters regularly are the lack of a documented, structured system of service delivery, and a financial planning process that, as MacPherson puts it, “reflects the dynamic and fluid nature of clients’ financial lives.” The result is that interactions with clients aren’t very productive.

“The client leaves the advisor’s office going, ‘What was that all about?’ Well, is there a story the client can follow? Is there a process the advisor can recreate?” says Gronbeck-Jones. Too many advisors, he feels, lack any kind of process that would enable advisor and client to see at a glance where they’ve been, where they are, and where they’re going. The client should come away from the first advisor meeting with a complete understanding of short- and long-term goals, along with what it will cost to get him there, and what each step of the journey will likely entail. “I’d say eight out of ten people don’t come away with much of this at all,” he notes. Other things to keep in mind: Keep it simple. Remove the mystique. Unbundle the fee, show what percent is going to the advisor, what portion to the money manager. He suggests that new fee-based advisors pick out a couple of target markets and master them. “Don’t try to be all things to all people.”

But do know where you’re going. At Mutual Services, Schoenbeck has transitioning advisors define the value and vision of their practices, around which marketing literature and pieces subsequently can be developed to share with old clients and attract new ones. He starts by having advisors “take a step backwards,” helping them take stock of “who they are,” and pinpointing unique offerings they possess that can be brought to the client relationship while formulating ways to effectively articulate these offerings to the client.

Are You Worthy?

MacPherson says transitioning advisors must ask themselves, “Am I fee worthy?” In other words, they must identify if they are providing clients with the necessary level of service and professionalism to justify charging clients a set fee or retainer for their services. Oddly, many transitioning advisors don’t consider themselves worthy: they lack confidence. Gronbeck-Jones says they are “scared” to make that transition because “deep down they don’t believe in what they’re providing, and don’t think their clients value what they do” either. Other advisors halt their transitioning efforts mid-stream because, as Schoenbeck notes, they are worried their client is going to “laugh them out of the office, saying, ‘You’re kidding? Now you’re going to charge me a fee?’”

But the majority of clients are not thinking this at all, Schoenbeck maintains, and are disinclined to balk at a change in business model. He cites an example of an advisor going through the transitioning process with Mutual Service, who over a two-month period spoke to 20 of his existing clients about his intent to go fee. Only one client put up a fight. Fryer at LPL Financial Services (see “The LPL Way” sidebar), says that 95% to 98% of LPL clients make the “leap of faith off the commission ledge into the fee-based pool” with their transitioning advisors. Both Schoenbeck and Fryer believe the reason most of these clients have stayed with most of these advisors for as long as they have in a commission-driven model is because of the relationship, not because of performance or because they’re necessarily selling the best product.

To bolster confidence and alter mindsets–the latter a major obstacle, since many commission advisors naturally see themselves as salespersons–Schoenbeck has advisors list the myriad tasks they perform on a daily basis. It doesn’t take long, he says, before these advisors realize that they are, in fact, providing valuable services to their clients, and need to be fairly compensated for their work like any other professional. “When you sit down to show them how much they’re making per client per hour, they’re shocked to see that for the most part they’ve been giving away their services for a long time,” Schoenbeck says.

While too little confidence can quickly sabotage even a well-designed transitioning effort, a lot of confidence can go a long, long way. Advisor Frank Gle- berman was quick to discover that fee-based services put him on the same compensation basis as his clients’ attorneys, CPAs, and physicians. The attitude adjustment that comes with transitioning seems to make advisors more proactive with clients as well. Gleberman says there have been several cases when he has called a client, asking him to come to his office as soon as possible. The conversation might go like this, he says. “You’re paying me for advice and you need to take advantage of rebalancing and upgrading your assets in three specific asset classes. I don’t want you paying additional fees to have pages and pages of written explanation prepared and mailed out to you that can be covered in an hour’s lunch meeting in my office.” Gleberman allows that this “may seem a little bit harsh,” but that he has yet to be refused.

It’s important, too, for newly-transitioned advisors to not overlook intangible add-ons, Schoenbeck cautions. These include simple things such as having a human being answer the office phone, and returning calls within 24 hours. If the advisor knows his client’s favorite drink is Dr. Pepper, for example, Dr. Pepper should be on the table at the next client meeting. Transitioning advisors should also exercise patience. Change can be hard and frustrating, and you don’t learn it in a one-day workshop, maintains Schoenbeck, whose company runs intensive, long-term training programs. He finds it generally takes advisors six to nine months to get going with their new system. It then takes another year to reach a point where they’ve got their top clients on board, and from an asset-level standpoint are realizing significant recurring revenue. LPL’s Fryer finds the “crossover point” with his transitioning advisors to be somewhere around the three-year mark.

Dropping the Bomb

We’ve noted that most clients aren’t particularly averse to advisors radically changing the way they do business, but it helps if you break the news in a manner conducive to clients’ understanding and acceptance. There are significant advantages–some not so obvious–associated with fee-based billing that can help win clients over, says advisor Marino.

He explains to clients that being a fee advisor makes him flexible, enabling him to “make appropriate moves without any additional cost to the client.” If the market changes, or if a mutual fund manager leaves and Marino doesn’t think much of the replacement, he can pull out without “a big surrender charge like a B-share, and I wouldn’t have just paid a large commission like an A-share.”

But he cautions the newly transitioned advisor to be careful not to make it sound as though the services the client received previously were not unbiased, and that the advisor wasn’t “doing the right thing.” As for clients’ reactions when Marino broached the fee-based subject, he says “they of course appreciated hearing it; they trust you as an advisor anyway.”

Schoenbeck offers these tips. When first converting to fees, don’t use your top clients as guinea pigs. Rather, segment clients into the top 25%, next 50%, and bottom 25%. Transition first with those clients who you wouldn’t lose any sleep over losing if you bungle a presentation. As you become comfortable with how a fee relationship works, get your feet wetter with the middle group. After you’ve overcome client objections a few times, take the show to your top clients. Some advisors find they can only talk about their new business model to new clients, so they maintain a mix of commission and fee compensation in their practices, with good results.

What do commission advisors tell clients, especially those with whom they have had long and fruitful relationships? Schoenbeck recommends simply saying, “This is the business model I have been working under, but there is a better model out there that’s going to allow me to provide you with a higher quality of service, and this is how the model is going to work going forward.” Once they’ve had their talk, advisors will be “shocked” to see how receptive their clients are, he says.

Of course, the advisor must be ready to talk. Gronbeck-Jones has his in-training advisors picture him asking their clients why they should do business with those advisors. “Often the advisor can’t even spit out the reasons,” he says. When they do articulate their promises, advisors must deliver on them.

Not only should detailed plans exist for all client interactions, providing as MacPherson & Associates’ Duncan MacPherson suggests, a “next steps outline,” but a carefully wrought financial planning process must be set in motion. This, says MacPherson, “requires preparing for and reacting to critical financial events in your client’s lives.” He adds that “any material change in a client’s life can result in a critical financial event that requires both the client and advisor to re-evaluate goals and objectives.”

Show Me the Money

Doctors and lawyers have mastered the professional structure, notes Gronbeck-Jones. “You get a bill from them, you hardly ever question it. It’s that mystique they’ve built for themselves.” If advisors want parity with other professionals, the way they calculate and tally fee charges becomes important for both the clients and themselves.

Here’s the system advisor Marino feels comfortable with. First, he won’t take on clients with assets south of $100,000, unless they are family or friends. For managing money, he charges 1%, maybe 1.25% of assets, which drops to around 0.9% in the half-million-dollar range, scaling downward from there. He is quick to point out that this fee is for assets under his management, “assets we’re touching and working with.” It is not unheard of for an advisor to include “stagnant” assets, say a client’s GE stock that has sat idle for 15 years, a practice which Marino find entirely unethical. “If you’re trying to charge 2% a year just to have some funds that you don’t really touch, I think you’ve got a problem.” He will also charge a client to draw up a financial plan. This fee is at least $500; for estate plans it can be several thousand dollars.

Once each year Marino performs a “full update” to each client’s account (many smaller adjustments are made throughout the year). The question he asks himself at that point is, should he charge extra for this service? “If we have X amount of assets under management, will we do the update for free, or charge, say, $250, and generate a whole new report, print out documents and so forth?” He has decided to answer the question on a case-by-case basis. Regarding any variety of “extra” work, if he’s “got something necessary to do, that’s fine, I’ll put the time in and charge him.”

What’s helped Marino’s bottom line most, however, is transitioning not just to fees but to comprehensive financial planning, which can generate a modest number of commission dollars. “When you have long-term care policies and insurance policies and annuities, they of course pay commissions,” he says, “and I think that makes a huge difference and has helped us.” He says that while the commissions are not “an enormous amount,” they add up to 10% to 20% of his office revenue. A fee and commission mix is a good way to insulate your business and annuitize your revenue stream.

About 25% of current income at advisor Gleberman’s fee-based practice derives from commissions. He’ll use a commission product only when it is “in the best interest of the client and the client agrees.” He also receives a “very nice” stream of renewal commissions deriving from sales made in previous years. Most of the income will continue for life, he explains, as long as the premiums are paid on what are mostly insurance products. Some of this renewal income will reduce after 10 years to a lower “service fee” level.

Gleberman places a ceiling on charges to his managed-account clients, and then provides discounts from these maximums. Clients have reported to him that they “appreciate the consideration.” Discounts come into play when Gleberman performs tasks such as research and analysis for funding asset classes that can be shared among clients who have similar goals, such as retirement. He tells his clients, “I do not believe it is ethical to charge each of you the same hours spent on your collective behalf.”

Meanwhile, at the Wirehouses

When it comes to wirehouse advisors, not all have the latitude to charge for their intellectual property in the form of financial advice, notes Gronbeck-Jones, but they generally have the discretionary power to raise or lower their fees for managing money. Unlike many broker/dealers, a spokesperson from Solomon Smith Barney noted that the firm has no training program or special services for broker/advisors who want to boost the fee portion of their business. Numerous calls seeking comment on this subject from UBS PaineWebber, Merrill Lynch, and Morgan Stanley Dean Witter were not returned.

To counter the effect of a sluggish financial market, Schoenbeck suggests that transitioning advisors initially adopt a combination of asset fees and flat planning fees. He advises charging new clients a flat fee of $5,000 to “get everything up and running,” and after the first year, segue into more of an asset-based fee structure. But long term, this will not be enough, he says.

Offering clients the choice of various levels of fee-based service is worth considering, too. Schoenbeck had an advisor who in his methodically laid-out business plan, had decided on the following compensation scheme: For top clients he would do tax returns, investment management, yearly financial-plan updates, and if necessary, meet with the clients’ CPAs and attorneys (he planned to include these professionals at his client appreciation dinner). This advisor figured out how much all of this would cost him, how much profit he wanted to make, and how much he could charge in fees. This, in turn, indicated to him that his minimum account size had to be, for example, $400,000 for that level of service.

The advisor created a marketing piece explaining his approach, saying, in effect: “This is the minimum account size, the fee, and if you want that service, you’re a Platinum client. If you’re a Gold client, you might get the financial plan free the first year, but we’re not going to renew it on an ongoing basis; if Silver, you have to pay to get your financial plan done the first time.” If a client didn’t want any of the plans, he could avail himself of ? la carte-type services. Clients appreciate this advisor’s approach, says Schoenbeck, because it gives them options, and “makes it easy for them to see what the advisor is getting paid to do.”

Troubled Waters?

By definition fee advisors charge a percentage fee of client assets under management, and the majority stick to just that. But there is already a growing trend away from relying exclusively on this method of billing. This is a rude awakening to some who recently abandoned the commission world, though the solution is clear. Mutual Service’s John Dixon warns that if the stock market continues to move sideways for the next four to five years, fee-based advisors who have focused on market performance could face serious troubles. Dixon sees fees as being compressed under this scenario. Marino believes that fees will also trend down over the next decade because money management is becoming more efficient and will take less time–and says only those advisors with “a lot of money under management” will be successful. LPL’s Brad Fryer notes that while the average fee has come down–he sees it settling firmly at 1%–the average account size has gone up.

Of course not all advisors have clients with huge assets. Looking toward the future, many experts are quick to agree with Schoenbeck that what’s next is a “movement back” toward more comprehensive financial planning. As Fryer puts it, “He who adds the most value will win the client.” Along with that trend will be an intensified embrace of technology as a means to achieve economies of scale. “I look at September 11 as the clearest example of why comprehensive financial planning is going to become important again,” Schoenbeck says, adding that at present, “most financial advisors aren’t doing true financial planning.”

Advisor Marino, whom we noted earlier as having lost 50% of his business during his first year transitioning from commissions to fees, has built a successful business combining fees for managing assets with comprehensive planning. Last year, market and economic doldrums notwithstanding, his company enjoyed its largest revenue increase ever–up 60%. “A lot of that is directly related to the fact that we provided more services,” he explains. “We did planning, we were diversified, and didn’t chase the tech stocks. For those who are doing a lot more for the fee, the opportunities are great.”


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