In the last issue of Practice Edge, we examined the current sentiments in the advisor marketplace concerning wealth management, as well as the key trends driving advisors to expand their practices and offer a holistic range of wealth management services.
In this issue, we discuss those considerations in more detail and address the challenges facing advisors in building a successful wealth management practice. We also examine the financial makeup and best business practices of a typical wealth management firm.
For any advisory firm aspiring to become a wealth manager, there are three primary considerations:
- Demand: Is there a need among my clients for my wealth management services?
- Economics: How will this affect my financial performance?
- Products and Services: Will I able to offer these services competently to my clients, and should I do wealth management in-house or outsource some or all of it?
While offering wealth management services will most certainty increase your chances of attracting new and bigger clients, it is critical to understand that your existing client base is the sole market for your new wealth management services in its early phases. There is no point in incorporating into your practice an executive compensation advisory service, for example, if none of your current clients are executives with complicated compensation packages. The potential that this new service will lure new executive clients does not alone justify the cost, time, and risks associated with adding such a service.
Therefore, you should first determine which clients might potentially need your new services; what kind of services they are likely to require; and to what degree or how often they are likely to utilize such services. If you know your clients as well as successful advisors should, then you probably have the answers to some of these basic questions. But then again, if you’re aspiring to become a wealth manager, you likely are currently offering a narrow range of services, such as investment management, and are not deeply involved in the rest of their financial matters. But the fix for that is rather simple: Ask them. Survey your clients, especially the big ones, and learn more about their other financial needs beyond the current scope of your services. Once you quantify the demand, zero in on the specific range of services they need. Do they just need estate planning and tax planning? Or Do some of them require more sophisticated trust services and business advisory counseling? After you have gauged and confirmed the need for your new services, move on to the next step: determining the financials.
Before we delve into the financial aspect, remember this equation: if you determine that offering a new service, such as tax preparation, will be profitable to your firm, but none of your clients demand it, then don’t offer it. However, if you determine that your clients demand tax preparation, but you conclude that there is no clear profit potential in offering it, then do consider offering it. What, operate at a loss? No, we’re not suggesting that. Offering your clients an additional service that they need–provided you can do it competently, which we will discuss in the next section–will pay off in more ways than immediate profits. For one, your client retention rate is likely to increase. More directly, however, you may be able to increase your AUM fees under an all-inclusive type of pricing in light of these added services. To be sure, as chart 1 below shows, according to AdvisorBenchmarking.com research, the average wealth management firm (defined as one offering two or more services) charges average AUM fees of 1.21%, compared to 1.12% by the average single-offering advisory shop. For a firm with $50 million in assets, this nine-basis-point difference amounts to $45,000 in additional revenues. (See Chart 1: Average AUM-Fees)
On that note, there are various pricing options available to advisors offering comprehensive wealth management. Most wealth management firms usually offer a combination of the pricing models listed below to the same clients or offer different pricing models to different clients, based on their size and other factors:
- All-Inclusive Fee: An AUM fee that gives clients access to the entire range of wealth management services. This fee should be higher than what would otherwise be charged for asset management only.
- Two-Tier Pricing: Certain clients are charged an all-inclusive AUM fee, while others who require fewer service or only one service (usually asset management) are charged a lower fee. Those clients would have to pay separate project fees if they ever need additional services.
- Project Fees: Charged to all or some clients who require separate services beyond asset management. As mentioned in the two-tier pricing model above, clients who pay an all-inclusive AUM fee do not get charged project fees.
- Retainer: Clients who meet a certain asset size requirement may pay a fixed dollar amount upfront, in addition to or in lieu of an AUM fee, that covers the entire range of services.
No matter which option you choose, new wealth managers have to make sure their clients understand that their value extends beyond asset management. Charging a retainer, a trend that has been on the rise lately, is one pricing model that serves to boost the perceived value of the advisory firm since it takes the focus away from asset management as being the main determinant of cost to the client.
The more crucial economics question to ask, though, is this: How will offering wealth management services affect my firm’s profitability? Below are a series of charts comparing the average wealth management firm against single-offering firms in areas of financial performance and organizational structure, based on 2001 financial performance data from AdvisorBenchmarking.com. The data reveals much about the financial make-up of wealth management firms. (See Chart 2: Average Assets Under Management, Chart 3: Profits, Chart 4: Profit Margins, and Chart 5: Number of Employees.)
As the charts above show, the average wealth management firm is much larger than the single-offering shop ($129 million in assets vs. $79 million) and employs 14.7 associates compared to 6.3. Needless to say, this is not to suggest that your firm will balloon in size over night, but it’s a clear indication of the growth potential of offering wealth management services. Further, one notable statistic not shown above that further suggests this growth optimism is that the average wealth management firm has a business tenure of 7.1 years versus 6.4 for the single-offering firm. This minute difference in tenure indicates that the large asset size and number of employees of wealth management firms are not simply driven by their longevity in the business.
Not surprisingly, the average profit margin for wealth management firms is higher (24.25% vs. 21.22%.) This is directly attributable to the higher fees charged as mentioned earlier, 1.21% vs. 1.12%. With such a broad array of offerings, wealth managers can justify this higher fee and garner healthier bottom lines accordingly. In 2001, the average wealth management firm saw net profits of $378,049 versus $187,033 for the single-offering firm.