A recent article in The Wall Street Journal described a probe securities regulators have launched into fee-based accounts. I paid extra attention, because charging a percentage of assets under management is the advice-and-compensation model I view as most appropriate for family financial planners — and for their clients.
The concerns detailed in the article were valid. It's true, for instance, that some clients have been paying advisors management fees for years, while receiving little or no follow-up advice. Also troubling were stories of brokers combining margin accounts with overly aggressive trading “strategies,” ostensibly to jack up billable assets.
In public, many in the securities industry are decrying these investigations as the latest in a string of witch hunts designed to take political advantage of the brokerage industry's vulnerable status. But behind closed doors, many know that the allegations carry some weight.
Still, in the long run, fee-based relationships render the most common client/advisor problems less likely. Ongoing fees help ensure clients get continued advisor attention, and happy fee-based clients serve as a “golden goose” to the financial services industry.
However, we on the front lines of investment advice need to adopt principles of upfront disclosure and ongoing discipline to ensure the eggs keep coming.
Why Fees Rule
Client satisfaction guaranteed
…or the advisor loses his revenue stream. The road to earning client trust is shorter for the advisor when he points out that at, say, 1 percent per year, the advisor must keep the client for several years just to equal the revenue that a transaction-based investment would pay upfront.
Flexibility for clients
If clients are unhappy with a fee-based advisor or with his investment choices, they can ditch one or both with little or no cost. This inexpensive exit strategy compares favorably to the transaction commissions a disgruntled investor would incur by revamping a portfolio of stocks and bonds, or the several percentage points charged when buying and selling A- or B-share mutual funds.
Flexibility for advisors
Every client relationship is different and can mutate several times over the years. Most firms give advisors leeway to set fees in accordance with how much time the client will occupy, how many transactions will be made and how excited the advisor is to start and maintain the relationship. As those factors change, advisors can raise and lower fees to a level that hopefully satisfies the clients, the firms and the advisors alike.
A-share mutual fund breakpoints typically are available only to accounts at the same mailing address. But when negotiating what percentage of assets under management to charge, advisors have the discretion to include the accounts they oversee for other family members and cut the cost accordingly. This is a great way to attract and retain new clients.
More service, less sales
Most advisors would prefer to spend every day doing just what the clients hired us to do: manage their money. Unfortunately transaction-model compensation arrangements compel some advisors to adopt a “what-have-you-paid-me-lately” attitude when serving clients. One broker I know crystallized this problem by telling me about a client who several years ago deposited a large amount of money in the A shares of a well-regarded mutual fund family. When his assistant told the advisor the client wanted to meet to go over his portfolio, the advisor snapped, “Doesn't he know I already spent the commission money I earned from his account?” The advisor was kidding. I think.
“No commission” doesn't mean “no responsibility.” But these three steps go a long way to justifying fee-based relationships to investing clients, to firms and to regulating bodies.
Explain pricing options upfront
Nobody, including client prospects and the NASD, resents the idea of a good advisor making a living. But it's best for everyone involved if clients are informed in advance of their options with regard to advice and the costs associated with each option. The most basic options are per-transaction fees, or fees based on the annual percentage of assets. It's also good for clients to be briefed in advance on the inherent benefits and drawbacks of each choice. When they're given objective information at the outset, the majority of people will opt for a fee-based or C-share relationship.
I'm not sure how someone without a process of monitoring clients and their money can still be called a “financial advisor,” but there are few better ways to maintain relationships, discover new ways to help clients and bring in referrals. Recurring get-togethers also give advisors the chance to trot out their respective firms' latest no-cost value-added tool, whether that be estate planning, tax reduction, asset allocation, risk management or insurance analysis. These enhancements to traditional investment advice provide an easy answer when someone asks, “Tell me again what I'm getting for the 1 percent I pay each year?”
Keep notes from both the initial and the ongoing conversations with fee-based clients. These files will prove that you talked regularly and that you provided service, advice and recommendations. The reasons behind decisions to buy, sell or hold certain investments also should be noted, backing up the notion that whatever was (or wasn't) done was an attempt to serve the client's best interests.
It's almost inevitable that fee-based arrangements will come under more scrutiny in the coming months, but that doesn't mean advisors should shun them out of fear. Instead, use the tips above to establish and maintain fee-based relationships the right way. Clients will thank you for it.
Writer's BIO: Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future.