Should Advisors Change How They Charge?

“Within a year, three-quarters of my business came from just three other advisors who had minimums and wanted to refer to someone trustworthy,” she said. Leveraging with other professionals helped her serve more clients and generate more revenue than she could have done by herself. Soon afterward she founded the national Garrett Planning Network, to which some 300 like-minded advisors now belong.

Model(s) 5: Other

In some cases, advisory firms have stitched together a patchwork of revenue from AUM, 12b-1 fees, annuity trails and so on. As desirable as it may be to simplify this crazy quilt (if only to have a single regulator), Simply Money’s Bachrach noted that older income sources, such as mutual fund 12b-1 trails, may contribute disproportionately to profits. Some advisors may not be eager to throw out this baby with the bathwater.

How Transparent Are Your Charges?

In a June 20 Wall Street Journal article, Bert Whitehead, president of Cambridge Connection in Bloomfield Hills, Michigan, and founder of the fee-only Alliance of Comprehensive Planners, reported being told by a prospective $5 million client that his current advisor charged him 1.5% a year. When Whitehead asked how much money that was, the client guessed, “$7,000 or $8,000?” Sadly, he was off by a factor of 10; 1.5% of $5 million is an eye-opening $75,000 a year.

Similarly, John Dominge, managing partner of Uptrex Wealth Advisors in Sunnyvale, California, was told by a long-time client of a Morgan Stanley broker that her account was free. “Why would you think there’s no fee? How could they afford to do that?” Dominge asked. Unfazed, the woman insisted that she was paying nothing for the firm’s services.

According to Bachrach, almost 50% of investors with $500,000 and under in assets don’t know how they’re being charged or think it’s free. “Nobody reads ADVs, which are incredibly informative documents,” he lamented. For example, a client who thinks he’s paying his advisor 1% of assets might learn from the ADV that he’s paying another 1% to an outside money manager. If you don’t know the total cost of ownership, Bachrach said, you’re probably paying too much.

“The most important thing is that people can trust you,” he said. “Everything should be out there in a way that people can understand it and later feel good about it.” If there’s a problem with the ADV, it’s TMI — too much information. “Too much disclosure is the worst form of disclosure,” Bachrach said. “Disclosure needs to happen in a way that’s digestible.”

“A client should be able to say, ‘Oh, so that’s how you make your money,’” Helfrich agreed. “It’s the responsibility of the financial advisor to educate the client. [The model of] commissions — not telling the client what they’re paying, giving the impression of working for free — that’s going by the wayside.” A prospect or client shouldn’t have to ask, “So how do you get paid?”

Recapping his point that consumers want more transparency, Lynch said, “Advisors need to consider if their pricing model will stand up to scrutiny. If not, perhaps they should reconsider [that model]. For example, if most investment services can be done by computer and your client just needs your help to keep from making bad decisions, perhaps you shouldn’t charge by AUM.” In the final analysis, he said, “If the light of day shone on what you’re actually being paid, would your client still choose to do business with you?”

Kitces, whose XY Planning Network advisors primarily use monthly retainers, likes the fact that “a retainer is very transparent in a world where most payments are a complex percentage-of-assets calculation. You also have the opportunity to take financial planning to places that can’t be served by the AUM model.”

However, the greater visibility (or saliency, in Kitces’ term) of retainer payments can backfire, especially when they’re paid annually. He was once told by a fellow planner, “I loved the idea of [a retainer]. But no matter how much work I did for my clients, they really pushed back on writing that annual check.”

In Kitces’ view, AUM is still easier for many clients to accept. “Would you rather pay 1% of AUM or a $10,000 retainer? AUM pricing doesn’t feel like a big fee slap in the face.” As a result, he noted, “I’m skeptical about whether AUM will be replaced. It may have far more longevity than some suspect.”

But in a 2012 comment on a Kitces blog post about fee saliency, Cambridge Connection’s Whitehead objected, “AUM is easier for most clients because: 1) they cannot convert a percentage to a dollar amount […]; and 2) most clients can’t or don’t read their brokerage statements so they are never aware of how much they are paying. To me, this just doesn’t square with a true fiduciary relationship.”

Hourly-fee advocate Garrett summed up tersely, “As fiduciaries, transparency is our reality. So embrace it.”

In the Client’s Best Interest

Transparency is one aspect of a quality shared by many RIAs: a moral commitment not just to put clients’ interests first, but to help them live more financially secure lives. Dominge is baffled by debates about the fiduciary standard. “Don’t I have a fiduciary responsibility every day? Shouldn’t it go without saying?” he said. “Imagine an ad where a firm says, ‘We put our own interest ahead of yours.’ You think we’ll ever see that ad?” He wants consumers to expect their advisor to be a fiduciary. “This is a tough way to make a living if you’re not interested in doing the right thing.”

“I’m 100% behind the SEC and DOL,” Garrett agreed. “There should be one set of rules, a high standard of care.”

Noting LIMRA’s low ranking of consumer confidence in financial advisors, Kitces pointed to the industry itself. “Anyone who wants to be a financial advisor only needs to earn a high school diploma and take a one- to two-hour regulatory — not competency — exam,” he said. “We don’t evaluate new advisors for knowledge. That’s why so many do a terrible job and produce terrible outcomes.”

So fiduciaries’ “best interests” standard alone isn’t the answer. As Kitces cautioned, an advisor who adheres to the duty of loyalty can still cause massive financial harm if he’s ignorant. In any comparison with what it takes to qualify for a securities license, he said, CFP certification is “light years ahead” as a competency standard.

Consumer Expectations: Be Transparent

“If the industry doesn’t lead and come up with reasonable changes going forward, then the government will step in and make changes for us,” Lynch predicted. He blames weak industry leadership on a lack of pressure so far from confused consumers. “Consumers don’t understand the difference between suitability and a fiduciary standard,” he said. “And because of the way regulation has worked, consumers can’t get access to information. The infrastructure hinders transparency.”

Advisors need to get ahead of the regulatory curve by making sure that the way they charge and the services they deliver are in sync with what consumers expect. “The consumer needs to know, ‘What is it costing me to do business with you, the advisor?’” he emphasized. “Advisors need to draw the supply chain for the client, showing the components and explaining what each one does and how they add value.”

“If you’re forthright, you’ll never have to worry about buyer’s remorse or sticker shock,” agreed Simply Money’s Bachrach. “Every quarter, your client will have a chance to say, ‘Were they worth it?’”

It appears that no advisors or consulting firms have ever polled clients to ask if what they’re being charged feels fair. High retention rates may imply that clients are satisfied with what they pay — but it’s questionable how many of them really know what that is.

“In school, there are two things we never learn: how to raise children and how to manage money,” Bachrach noted.

Lynch concurred: “High school students are receiving little education in economics. And we see little interest in financial services careers. The industry needs to step up to its responsibility to get out there and educate them.”

“I’ve given talks to 13- to 14-year-olds in junior high school who had credit cards, but couldn’t explain how credit card companies make their money,” Dominge said. “And in pro bono seminars at senior centers, I quickly learned that I was talking at too high a level. People didn’t know the difference between a stock and a bond.”

Get Going or Get Out of the Way

“Given that different elements of our industry have different rules and different regulators,” argued Dominge, “advisors need to figure out ‘How do we build trust while better regulating ourselves?’”

There’s no advantage to further delay. “In response to a few bad apples, the common reaction is more regulations — ‘Let’s have clients sign three more forms,’” he said. “But this emphasis on disclosures is burdensome and sometimes confusing. More forms don’t always equate to more clarity, as every home buyer knows who’s been handed a stack of mortgage documents to sign.

“I believe most advisors are trying to do the right thing to the best of their ability,” Dominge continued. “It starts with being up-front about how you’re paid. The more people understand what they are paying for and why, that’s what will move us forward.”

Lynch, too, contended that consumer education is necessary to rebuild trust in financial advisors. “The industry has a job to do to win back the confidence of the consumer with greater transparency, unbundling [of services], compensation per product and retainers.”

“Ours is the last great industry not touched by consumerism,” added Bachrach. “It will be interesting to watch how it affects our business.”

Where Do We Go From Here?

At Waldron Private Wealth, Helfrich sees the most significant change in advisory compensation occurring in the mass affluent segment. “Wealthfront and other robo-advisors are creating a payment ceiling for investment-only financial services,” he said. Robos’ AUM-based fees, currently ranging from 0.15% (Betterment) to 0.50% (SigFig), will compress revenue for professionals dependent on portfolio management for their bread and butter. “There will be real pressure on business models in the $250,000 to $1 million space,” Helfrich said, “but less so with high-net-worth and ultra-high-net-worth accounts, given their inherent increase in complexity.”

Uptrex’s Dominge is optimistic about the impact of the robos. “I think they’ll make us better as an industry. They’re going to pull people into investing in their 20s and 30s. It may not be profitable, but it’s a very positive thing.” Will robos’ clients recognize if and when they need more comprehensive, hands-on advice from a trained financial professional? Dominge acknowledged a lot of discussion on that point. “My guess is yes, when their life becomes more complicated with home and family needs.” A bear market might also drive investors from an impersonal robo to an empathetic advisor who has guided clients through previous downturns.

Bachrach sees robos in a future hybrid role with advisors, doing the power lifting of data crunches and account administration. “We’re money-life managers,” he said. “That’s what CFPs should be spending their time doing. When a client is trying to decide, ‘Should I lease or buy, take out a HELOC or get a low-rate auto loan?’ you want them to say, ‘Wait a minute. Let’s call Simply Money.’”

— Related on ThinkAdvisor:

• Flat Fees vs. AUM Recap: The Good, the Bad and the Really?
• AUM or Flat Fees? Start and End With Your Clients’ Needs
• The Case for Charging Both AUM and Flat Fees