It's no surprise that in the last five years reps have moved rapidly to adopt the fee-based business model. For those not afraid of change, swapping commissions for a more predictable income stream, while offloading investment risk to separate account managers, makes a lot of sense.
There's just one problem: Many of the brokers who made the jump use a model in which their fees are based on assets under management. Though such an arrangement might seem revolutionary compared to a commission-based business, it's still a step behind the cutting edge — retainer fees.
The most aggressive users of retainer structures — in which full-service advisors are paid set amounts regardless of trading activity and asset fluctuation — are RIAs. And they are benefiting in an outsized way from the moves.
By the Numbers
According to Registered Rep's annual salary study (from the June 2003 issue), median assets under management for all reps fell almost 41 percent in 2002 to $25.5 million. Likewise, gross production fell from $269,500 to $216,379. True, some of this can be attributed to the then-tanking markets. But not all of it — the S&P 500 dropped only about 25 percent in 2002.
Meanwhile, RIAs also had a bad year, but not nearly as bad as the general population of reps. RIA assets under management dropped just 6.5 percent to $71 million, according to The Changing Face of RIA Firms (1999-2002) by AdvisorBenchmarking.com. Gross revenues dropped just 4 percent vs. almost 20 percent for registered reps.
What could possibly account for the difference? It's pretty simple, really. While RIAs watched their revenues from existing clients drop about 18 percent, they simultaneously experienced client-revenue growth of 22 percent. And where did these new clients come from? Says AdvisorBenchmarking: 25 percent of all new RIA assets came from full-service brokers — the ones most likely to be using retainer models.
Little wonder then that the Financial Research Corp., a Boston-based company, views “the unified retainer fee as a trend that is likely to accelerate.”
Reasons to Believe
Greg Curry, owner of Pillar Financial Advisors in Louisville, Ky., made the jump to a retainer model because he thinks it inappropriate for his pay to be “dependent on something completely out of my — or anyone else's — control, [i.e., the stock market].”
Scott Dellorfano, Sr., vice president of SEI Investment Advisor Network in Oaks, Pa., (who prefers the phrase “payment for advice” to “retainer fee) lends another perspective: “We're seeing a natural evolution [to retainer fees] driven by the investor's need for holistic advice.” He noted that when he was recently looking into a real estate purchase in Boston, he had to meet with three different financial professionals — his advisor, a loan officer and a CPA — to get the deal done. “A holistic advisor will perform this service as a one-step process,” and for those providing holistic services, the retainer will be the fee structure of choice, asserts Dellorfano.
In short, the most progressive business model an advisor can employ might be that of a comprehensive manager with many client financial affairs — not just their investments.
Once an advisor has made the decision to jump to this holistic model, the retainer fee starts looking more attractive.
It affords the customer a one-stop shop for his financial life and a predictability when it comes to fees. The advisor, meanwhile, gains an income stream that is less exposed to the whims of the general markets.
Of course, it's not for everyone — just for those who want their compensation firmly attached to the level of service they give the client.
David J. Drucker a fee-only financial advisor since 1981, is editor of the Virtual Office News monthly newsletter, and co-author of the book Virtual Office Tools for a High-Margin Practice.
Calculating Retainer Fees
Advisors on retainer typically use assets under management as a starting point, rather than an endpoint, for their fees to clients. They decide what fee they would have charged a client based upon the nature and size of his portfolio, then add to that additional fees for non-investment work they expect to perform over the coming year. The result is stated as a flat, annual fee (usually billed quarterly).
Says Greg Curry, of Pillar Financial Advisors in Louisville, Ky., “I begin with one percent of the client's overall financial net worth (basically all of their investments, including retirement plan accounts). Then I subjectively adjust that amount based on the size and complexity of the client's financial situation.”
Curry lets the client know that he can expect their fees to increase each year to keep pace with inflation, unless there is some sort of shock to their situation (for instance, a large inheritance).
“All fee amounts are fully disclosed in advance,” he continues. “The client is informed of the coming year's fee at the time of hiring, and any changes to the fee level are communicated and discussed 90 days before the change takes effect.”