In setting fees, there are five issues advisors need to consider.
Fee Type. You have lots of choices. They include, AUM fees, flat fees, hourly fees, project-based fees, a percentage of net worth or income, commissions and performance-based fees.
You may also have heard the term “subscription fee.” Subscription fees are the same as flat fees. Both terms refer to a fixed fee that covers services provided over a set period. "Subscription fee" tends to describe fees that are billed more frequently, like monthly.
Most advisors still charge some form of AUM-based fee. The Investment Adviser Association’s 2021 Industry Snapshot, which covers the practices of SEC registered advisors in 2020, says that 95.5% of all advisors charge an AUM-based fee. The 2020 Inside Information Fee Report says that 86.17% of advisors charge an AUM fee. The difference is explained by the differences in the types of advisors sampled in those surveys.
The next most frequent fee type in the IAA Industry Snapshot is fixed fees at 44.9%. The Inside Information Fee Report says that 13.98% of advisors use fixed fees as the revenue model for the “majority of their best clients”—second most frequent after AUM fees, at 72.9%.
If you are interested in performance-based fees, consult a compliance expert. They involve special regulatory considerations. The IAA Industry Snapshot says 36.6% of SEC registered advisors charge performance fees, but this figure is misleading. It includes many asset managers who are not front-line advisors. Performance fees are rare among advisors.
Commissions are also relatively rare and becoming rarer among advisors. The IAA Industry Snapshot says 2.6% of advisors charge commissions, down 8.3% from the prior year. The Inside Information Fee Report says only 1.06% of advisors use commissions for their best clients.
Fee Combinations. Very few advisors offer only one type of fee. The IAA’s Industry Snapshot says that 17.4% of SEC registered advisors charge only an AUM based fee. The Inside Information Fee Report says that 37.01% of advisors charge only an AUM based fee.
Most advisors use multiple fee types. The Inside Information Fee Report data shows that 58.8% of advisors employ a combination of fee types in their practice.
This discrepancy reflects the limits of the AUM fee model. It only works for clients who have already accumulated significant assets. For example, it doesn’t work well for HENRYs—high earners, not rich yet—who have significant income, but little in the way of accumulated liquid assets. Of advisors surveyed in the Inside Information Fee Report, 43.81% said they use a combination of fee types so they can serve less wealthy or younger clients.
Identify your target markets and create a fee schedule that is designed to appeal to the various audiences you are already serving and trying to attract. Consider having one fee schedule that covers the bulk of your more mature clients and another to attract new clients.
As you try to appeal to different audiences, keep in mind that clients value simplicity. An overly complex fee matrix can be off-putting and can lead to misunderstandings that can undermine the trust that is at the core of every successful client/advisor relationship.
Levels and Tiers. The most obvious decisions here are where to set your fees and break points for your AUM fee schedule, assuming you use one.
In the Inside Information Fee Report, just over 40% of advisors charged a 1% AUM fee for accounts ranging from $250,000 through $1 million. For a $250,000 account 15.41% of advisors charged less than 1%, 41.99% charged over 1% and 13.11% charged 1.50% or higher.
But you can also get creative. At our firm, (we are a TAMP, not an advisory firm) we charge an AUM fee until a household reaches a certain size. Then we charge a flat fee. Smaller households pay .35% of AUM until the fee reaches $1,400 per year. Then clients pay a flat annual fee of $1,400. This fee becomes more attractive as the size of the household increases.
You can also create entry-level offerings to get new clients in the door and familiarize them with your firm’s capabilities. For example, a project-based or hourly fee to do an initial financial assessment or a one-time financial plan.
Many firms use free financial planning to get clients in the door. The Inside Information Fee Report found that 48.51% of advisors use this approach. While I would not recommend it (I think financial planning is valuable), it's an increasingly popular approach in today’s competitive environment.
The key here is to think about the needs and current financial situation of the clients you want to attract for the long-term. Design an offering that will draw them in today. If you wait until they have accumulated enough assets to make your AUM fee viable, you may already have lost them to another firm that was willing to creatively invest in its own future growth.
Minimums. You need to set minimums—either minimum account size or minimum fee requirements. If you don’t, you risk drowning in small accounts that you can’t profitably service. The exception is if you have incorporated a purely robo offering into your practice.
The levels you set should be determined by the nature of your practice and the level at which you can profitably service a relationship. For example, if you provide only investment management services and no financial planning, you can set your minimums lower than a firm that provides both services. The Inside Information Fee Report found that the median time to produce a financial plan is 10.5 hours and ranges from 2.25 hours to 40 hours. Firms that provide financial planning must set their minimums so they are compensated for that time.
Respondents to the Inside Information survey believed an hour of a senior advisor’s time was worth between $25 and $1,500, with a median response of $300. They felt an associate advisor’s time was worth between $15 and $800, with a median response of $175. If a senior advisor prepares a financial plan in 10.5 hours (the median response), the advisor should receive just over $3,000, which is the median fee advisors said they charged for a plan.
Also, keep in mind that even large relationships often come with small accounts attached. A $5 million client may have a $17,000 IRA and a $12,000 UGMA in tow. You risk alienating or even losing that client if you tell the client you won’t service their smaller accounts.
Consider setting your minimums based on household size, rather than account size. This approach will allow you to bring smaller accounts into the relationship without having to make an exception to your fee schedule. You could even go farther and extend your minimums to encompass an entire family, rather than just a household. That way you can bring the younger generation into the relationship, even if they are no longer technically part of their parent’s household.
Here are some rough guidelines that surfaced in the Inside Information Fee Report: Only 9% of the advisors surveyed would turn down a $250,000 account. Only 3% would turn down a $500,000 account.
Retain the flexibility to make exceptions to your minimums in your Form ADV or state regulatory forms. No matter how much time you spend designing your fee schedule, you will encounter situations where you want to make an exception. Add catch-all language like “fees are subject to negotiation” to provide the needed wiggle room.
Frequency. How frequently should you bill your clients?
Based on my experience, quarterly billing is by far the most common approach (remember, I come from the TAMP world). But a 2018 AdvicePay blog says that 80% of the advisors using their services (younger financial planning-oriented advisors) bill monthly, and 20% bill quarterly. Billing software provider Smart KX reports that 95% of the advisors who use its software bill on a quarterly basis. They primarily charge AUM fees deducted directly from client accounts.
In determining how frequently you bill, consider client perceptions. Billing too frequently may be annoying to the client, but billing infrequently makes the price tag appear higher.
The answer to this question may depend somewhat on how you bill your clients. If fees are automatically deducted from a client’s account, they may be less noticeable to the client than if you invoice the client directly and they are required to write you a check. For this reason, monthly fees may be palatable in the former situation and less so in the latter.
You will also need to decide if you are going to bill in advance or in arrears. Again, in my experience, billing in advance is the more frequent choice, but many advisors bill in arrears. Remember, if you bill in advance, you will need to rebate any unused portion of the fee if a client leaves mid-month or mid-quarter.
You will also need to determine how you will calculate fees. Will fees be calculated based on quarter-end balances? Month-end balances? Average daily balance? How and when will you bill for partial time periods?
The key is to make sure that your client agreement and your billing practices are consistent. The SEC is always on the lookout for inconsistencies in this area.
One other thing to keep in mind is that if you collect $1,200 or more in fees more than six months in advance, you may be deemed to have custody of client assets and may be required to provide an audited balance sheet along with your Form ADV. Some states have similar requirements. Check with your compliance consultant so you don’t run afoul of these requirements.
Ultimately, your firm must be profitable to survive. Don’t be afraid to charge a reasonable fee for the value you provide. Also, consider keeping track of how you spend your time, so you can more accurately assess the profitability of each relationship.
You should consider the competition. Every firm operates within an ecosystem that has characteristics that may differ from those captured in broad, national averages. Understand who you are competing with and price your services in that context. It’s OK to charge more or less than your competition, but be prepared to rationalize the differences if clients ask.
How will you raise fees in the future? This is less of an issue with AUM fees because account balances tend to rise over time with growth in the securities markets. But flat fee and hourly fee advisors should consider building fee increases into their client agreements.
Finally, make sure your client agreements and disclosure documents capture the specifics of your fee schedule and keep them updated as relationships change over time. This includes the math behind the fee calculations.
Your billing procedures should be clear and well-documented, so clients know what to expect. There is nothing more detrimental to a client relationship than billing surprises. And you don’t want there to be any ambiguity about your billing practices when the regulators show up for their periodic exams.
Scott MacKillop is CEO of First Ascent Asset Management, the first TAMP to provide investment management services to financial advisors and their clients on a flat-fee basis. He is an ambassador for the Institute for the Fiduciary Standard and a 45-year veteran of the financial services industry. He can be reached at [email protected]