No Respect

The implication is that fee-only advisors are so consumed with the “touchy-feely” aspects of working with clients that they forget about selling. That is part of the message of the fee-only movement–they serve their clients and they don’t sell. That doesn’t mean, however, that fee-only advisors aren’t good business people.

In fact, many sales organizations tend to marginalize practitioners who do not overtly or aggressively sell for a living as being “not entrepreneurial.” As a partner in a 90-year-old accounting firm, I find this especially amusing. How do they suppose firms like ours–the original fee-only business made up of non-sales people–have lasted as long and grown so large if we didn’t have an entrepreneurial bent and weren’t good businesspeople?

In the case of financial advisors, a look at the numbers shows considerable value in a business with consistent, predictable income. This is the kind of statement that will make commission-based advisors apoplectic, of course, but both sides can be quite self-righteous about which model is appropriate for their clients. That is not the point of my observations here, however. It’s fair to say that both models work under some circumstances, but those who function in a traditional brokerage platform should be careful about their assessment of the competition lest they end up feeding a monster that will eventually devour them.

For instance, the results of our 2004 FPA Financial Performance Study of Financial Advisory Practices challenge the perception that fee-only advisors are not entrepreneurial. While fee-only advisors face challenges in practice management, the reality is that they accounted for most of the practices in our study that have more than $1 million in annual revenue, and many of the businesses we classified as elite ensembles based on their operating performance.

We compared four types of advisors: fee-only, who have no contingent income at all; fee-based, who are more than 90% dependent on fees for their income, but also derive some revenues from non-fee sources such as insurance commissions or 12(b)1 trails; commission plus fees, where compensation is a hybrid of fees and commissions; and commission-only firms. In looking at the data from our 2004 study, we found that both fee-only and fee-based firms far exceeded the performance of their more commission-based brethren. On average, the fee-driven practices generated more than three times the revenue of pure commission practices, and almost three times the operating profit.

The catalyst for this differential is leverage. Every business has two kinds of leverage: financial leverage–when a business borrows money to acquire assets and drive profits; and operating leverage–adding people or technology to serve clients and drive profits. The leverage differential in fee-only firms is nothing short of stunning. The commission-only firms, which averaged 200 clients per professional, typically had five times the number of active client relationships of fee-only firms. Yet fee-only firms demonstrated a higher level of productivity, generating $238,000 per professional staff member compared to $183,000 per professional in a commission-only practice. This is a very big swing and, in itself, would be a compelling argument for those who are still heavily transaction oriented to challenge themselves on their business model.

As if productivity per staff isn’t enough, commission advisors should consider the economic relationship of the client in both models: The fee-only firms generated just under three times more revenue per client. Apparently, the nature of the relationship, the ability to be more holistic, to get deeper into the challenges that clients face, allows fee-only advisors to be compensated at a higher level for the services they provide. More likely, though, the ability of fee-only advisors to position themselve as a client advocate rather than one whose income may be dependent on the transaction is a real economic plus for those advisors.

Fee-Only Doesn’t Equal Perfect

The results of the FPA Study are only a sample of the universe of advisors–if stacked up against the high-end producers at wirehouses, these numbers may take on a different look. But if the question is whether “fee only” is a legitimate practice model from an economic standpoint, the emerging evidence shows the answer is “yes.”

That is not to say that all fee-only advisors are fabulously successful. Many have not achieved the critical mass, or created the leverage, or built a financial structure that will allow them to be effective competitors in an increasingly challenging business environment. There are real costs to being a fiduciary, which is a key difference between a fee-only RIA and a NASD-licensed registered rep. There are also real challenges in continuing to add value at a level that clients perceive justifies ongoing fees.