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Don't Fight, Switch

Moving to a fee-based model may be painful, but it' worth it.

Two years ago, Craig Cantera saw the future, and it involved fees.

After about 20 years of running a commission-based business, “it became clear to me that traditional stock transactions were becoming an old white elephant,” he says. “I had to make a change.”

So Cantera, who heads Pinnacle Investments in Biddeford, Maine, began the slow, laborious process of explaining to his approximately 300 clients (many of whom had been with him since the beginning) why he was changing his business model and of helping them navigate the paperwork.

Today, Cantera is about a third of the way through the conversion process. With about 200 clients to go, he's had precious little time to search for new prospects, and his income has been cut in half. He's even started a second business building log cabins to offset the financial pain of the transition. Yet he remains convinced that his decision was a good one. “In the long run, this will be best for my clients and for us.”

Cantera's experience is hardly unusual. More reps are moving toward fee-based services, and, like Cantera, many are finding the going tough. The transition usually takes at least a few years to complete, income typically takes a nosedive (at least temporarily), and there is a lot more work. However — and this is important — the efforts usually pay off.

Why Make the Move?

In fact, the ultimate rewards of shifting to fees are often huge. For starters, you get more loyal clients and a steadier, more regular revenue stream.

“You can rely on a certain book of business producing fees year after year, and on stickier clients,” says Philip Palaveev, senior consultant with Moss Adams, a Seattle accounting firm specializing in advisory companies.

A case in point: Les Merrithew, a financial planner who founded Partern, Merrithew & Thorstein in San Diego, started the migration to fees five years ago. About three years after his initial move in that direction, he was matching his original income. Two years later, he has bested it by at least 50 percent, according to his partner Brandon Thorstein.

Assuming you've got the constitution to tolerate that kind of short-term pain, here's how to get started: First, figure out what you have to work with — that is, how many existing clients are likely candidates for switching and how best to handle those who are not. Obviously, only clients with accounts above a certain level will make cost-effective fee-paying customers. If you're charging the usual 1 percent of assets under management, “for accounts under, say, $300,000, providing all sorts of services isn't worth it,” says Palaveev.

For those under the threshold, a fish-or-cut-bait decision is in order. For the smaller accounts that you would like to retain, think of new ways to continue the relationship — anything from retaining them as commission-based clients to charging separate fees for writing a financial plans.

Of course, account size is not the only factor to consider when vetting clients for a fee-based relationship. But the numbers do tell an important part of the tale. For instance, in building their fee-based business, Merrithew and co-founder Thorstein, first focused on the best commission clients. Then they sold less significant clients to another broker at the same broker/dealer. This initial effort produced 20 fee-based clients, says Thorstein, “enough to get us through the first year.”

Darrell Shidler, a senior financial consultant with Thrivent Financial for Lutherans in San Jose, Calif., took a similar approach. He divided his 800 clients into three groups. First were commission types, some of whom he assigned to other associates. Next were candidates for such basic fee-based services as financial planning and analysis. Finally came what he called “covenant” clients, those with complex long-term goals, like being able to spend more time with family or in community activities. This compartmentalization clarified the issue of which clients were best candidates for fee relationships.

How successful you are in maintaining old clients depends, in large part, on your past relations with them. “If you treated your clients strictly in a product sales relationship they're going to be reluctant to make a change,” says David Patchen, first vice president, national sales management for Raymond James Financial Services in St. Petersburg, Fla. After all, why should anyone trust you to plan their financial future if all you've been doing is selling mutual funds? In such a case, your best bet might be to make some preliminary changes first — taking more time with the best of these clients, for example, or adding in other advice — before attempting to convince accounts to make the switch.

If you plan to start charging for financial planning services, you have some explaining (and selling) to do to clients who have previously enjoyed such services for free. About five years before he decided to make the switch, Shidler, for example, had added an assortment of analytical services without charging for the advice. So when the time came to convert clients, he girded himself for their skepticism. In some cases, where he offered to provide larger financial life planning services, the pitch was easy. In others, “I simply explained that before I gave you free advice, but now you're going to pay me the way you would any professional,” he says. So far, about 10 percent of the clients he has approached have agreed to make the change; the rest have decided to stay with him, but on a commission basis.

Shidler, like most reps, did not make a full, cold-turkey conversion to fees. A gradual move is a way to limit the pain. “There has to be an evolution,” says Patchen.

This experience is common. In fact, many reps never make a complete switch. About 65 percent of the members of the Financial Planning Association employ some mix of fee and commission services. Only 25 percent are fee-only types. Further, a recent survey of 500 firms by Moss Adams, the FPA and SEI Investments, shows that 40 percent offer a mix of commission and fee.

Be Prepared for the Drop

However you manage the transition, be prepared for one thing: Your income is likely to drop — precipitously — for at least two to three years. Fulton's income went from “a nice amount to next to nothing,” she says.

Palaleev adds, “You'll have to focus so much effort on the transition, you won't be able to develop a lot of new business.”

A lot of your time will be consumed with client meetings and hand-holding. In his client meetings, Thorstein spends 30 to 45 minutes on his presentation, and another 20 to 30 on Q&A. In most cases, says Palaveev, you will be unable to conduct more than 50 to 60 such meetings in a year.

Then there's the paperwork. You can expect heaps of it, as you move clients in and out of various accounts. Cantera, for example, meets with each client to review documents and go over the forms. “One contract is well over 125 pages long,” he says. In fact, if you do not have at least one reliable para-planner, now is the time to get one. Of course, some advisors can lean on their broker/dealer for help with the paper-pushing.

Still, the extra effort doesn't end when the transition to fees concludes. In fact, there's evidence that it's just the beginning. Total overhead expenses for fee-based businesses are about 42 percent of revenues, compared to 33 percent for commission-only firms, according to Moss Adams. Brett Ellen's experience is illustrative. When he started converting his West Lake Village, Calif.-based practice three years ago, he had an operating staff of about five. Today, his fee-based practice employs 25.

One way to avoid hemorrhaging income is to move slowly. Five years after starting the process, Shidler has still only approached 100 of the 500 families he targeted as fee candidates. And he has yet to show anyone who refuses to the door, opting instead to keep serving them on a commission basis. The upshot: “My income didn't subside dramatically at first, and it's now growing significantly,” he says.

Still, it is a good idea to make sure you have a big emergency fund set aside before you make the transition. How much will you need? “You should have at least a year or two of expenses put aside before you do this,” says Patchen.

In addition, you'll probably need to rev up your overall level of service. “The truly successful businesses are those that devote an enormous amount of time and attention after the initial account is opened,” says Patchen. Thorstein, for example, has escorted clients to car dealers to help them buy BMWs. “We know more about our clients' personal lives than we ever could have hoped on the commission side,” he says, pointing to a female client who not only revealed she was living with a woman — something she had never discussed before — but wound up bringing in her partner for financial advice.

One way to ease the process is to use some of the tools and services available on the market. Curian Capital, a Denver-based managed accounts provider, for example, has a professional development division, offering a five-step Web-based training system for how to make the switch. The National Association of Personal Financial Advisors in Chicago has a six-hour training video and regular nuts-and-bolts courses at conferences. Ultimately, there's a lot you can do ease the pain when you make the switch. Just don't expect it to be easy.

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