Earlier this year Omaha, Nebraska-based CLS Investments published a white paper on the benefits of switching to a fee-based model. The stats reported in the paper show that as of year-end 2014 and for the first time, fees exceeded commissions (46 percent versus 45 percent, respectively) as components of advisors’ revenues. Only 11 percent of the survey respondents were commission-only; the remainder were either fee-only (23 percent) or using a mix of fees and commissions in varying degrees (66 percent).
“The upcoming Department of Labor (DOL) fiduciary ruling is likely to accelerate the switch to fees,” says Gabriel Garcia, head of relationship management at Pershing Advisor Solutions in Jersey City, New Jersey. “Whether you’re a registered representative or a hybrid or a dually registered (advisor), you’re going to be faced with having to deal with the DOL proposal in some way, shape or form. Most likely (it) will be addressed not through the BIC (best interest contract) exemption but through some sort of leveled compensation, fee-based advisory services, if you will.”
John Anderson, head of practice management solutions, SEI Advisor Network in Oaks, Pennsylvania, also sees the DOL ruling as an impetus for the shift to fees. Additionally, he maintains, existing compensation models overall are evolving. “I think we’re kind of at that crossroads right now or, frankly, within the next couple of years, where advisors are going to be pressured by their clients to justify why you’re getting a commission for selling a product versus what I’m really looking for, (which) is advice,” he says.
Changing your business model entails risks, though, even if you’re adapting to major industry trends. If your transition plan is sound, the move can pay off for clients and you. But if you plan inadequately, you risk ruining a good business and setting yourself back for years. We asked several experts and advisors for their insights on making a successful transition.
Understand your motivation
Ryan Shanks, CEO of Finetooth Consulting in Longmeadow, Massachusetts, says advisors should first consider the nonfinancial reasons behind their decision. Do they want independence? Do they want the ability to charge fees for financial planning? What is it that they are missing in their current model and what would make them happier? “If you do it based upon all the right reasons, the financial rewards follow,” he says.
Advisors also need to view the transition from the clients’ perspective, says Shannon Reid, CRPC, vice president of Raymond James private client group education and practice management group in St. Petersburg, Florida. Commission-based compensation is transactional in nature, she notes. If you’re going to start charging fees, what value will you add to the relationship to justify those fees? How will you define the value proposition you intend to deliver to fee-based clients?
Forecast your finances
Detailed income and expense projections are essential because fee-based cash flows’ timing differs from commission earnings. Should you decide to give up commissions completely, there will be a lag from start date to your first payments. Reid describes this as a transition from a fairly steady stream of commissions to “lumpy” quarterly fee-based payments. “You can’t go out and sell something to raise revenue in the short term,” she says. “You have to plan for it.”
Brandon Grundy, CFP, a principal with Ridgeview Financial Planning in Sonoma County, California, was working 100 percent on commission when he started contemplating the fee-only model in 2008. He reviewed his client roster to project which clients would follow him. While he was optimistic about the long-term outlook for starting his own registered investment advisory (RIA), he anticipated his income would fall by about two-thirds in his first year and began building up his savings cushion.
He left his former employer in August 2014 and dropped his insurance licenses. His detailed financial projections proved to be accurate, as was his forecast of which clients would stay with him. The new business model allows him to offer hourly planning consultations, which he couldn’t provide previously, and those engagements generate additional fee income and bring in new clients. Overall, he’s very satisfied with his first 18 months’ results.