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Setting the Perfect Price: a Fool's Errand?

ARE YOU CHARGING ENOUGH? That's hard to say. These days, discounting runs rampant in the financial-advisory industry: Firms allow giant haircuts on commissions, wrap-account fees and even fully waived mutual fund loads. Meanwhile, fees on assets for advice can range from as low as 0.75 percent, to as high as 2 percent, though that spread is narrowing. In short, there isn't really any set industry


That's hard to say. These days, discounting runs rampant in the financial-advisory industry: Firms allow giant haircuts on commissions, wrap-account fees and even fully waived mutual fund loads. Meanwhile, fees on assets for advice can range from as low as 0.75 percent, to as high as 2 percent, though that spread is narrowing.

In short, there isn't really any set industry standard for pricing. Indeed, some advisors claim that the way their friends and rivals price typically gets leaked during water cooler scuttlebutt, on the golf course and over drinks. But the rest of the time, they pretty much have to guess what they're up against.

Most advisors these days use a combination of different pricing methods for different client needs. But knowing how much to charge in fees versus commissions and loads, and for which services, can be tough to decode.

Dropping Zeros Like They're Hot

Some argue that advisors are vastly under-pricing their services. One of those people is Doug Trott, CEO and president of Pricemetrix, a Toronto-based firm that helps brokerage firms establish effective pricing. Pricemetrix has a database of pricing data on the firm's nine broker/dealer clients (and their 4,380 financial advisors) that shows, for example, that almost one-third of advisors (at least among Pricemetrix clients) are actually out-discounting the discount brokerages on broker-assisted retail trades.

In fact, most wirehouse firms try to curb this discounting behavior, requiring advisors to share in discounts by docking their pay. Dennis Gallant, of Gallant Distribution Consulting in Sherborn, Mass., calls the firms' discount-sharing policies “behavioral compensation”: a mix of sticks and carrots to drive advisors to build efficient and profitable businesses.

“They're trying to drive advisors into higher-margin businesses,” says Gallant. “I think most firms recognize that the margins get compressed as you move toward wealth management, and as we start competing for more and more clients. The firms are trying to maintain their margins as well.”

Under discount-sharing policies, firms slice the payout of the advisor on a sliding scale. UBS, for example, docks 1 percent of an advisor's payout for each 5-percent commission discount he offers a client. When it comes to wrap-fee accounts, one 30-year industry veteran at UBS says the firm offers pricing guidelines, but these can be undercut with manager approval. For example, the firm may recommend a 1.5 percent commission on a mutual fund wrap account, giving brokers the discretion to cut that to 0.75 percent. Advisors with big clients can push it even lower, but they need approval from firm management.

How Much Are You Worth?

Of course some advisors, particularly those who don't rely heavily on commissions for their pay, claim that discounting on trade commissions, for example, makes plenty of sense. John Robinson, branch manager and managing director of Wachovia affiliate Hawaii Wealth Management, says he tends to discount commissions on trades of individual stocks because they are not the focus of his business. Mutual funds, managed accounts, and asset-allocation models are his meat and potatoes.

“Personally, I feel like I would be taking advantage of a client if I charged full-retail commissions just to execute a stock trade when they can do it for anywhere between $10 and $20 bucks,” he says. “That's not really how I view the way I should be paid. In many cases I will just sell a stock at cost (generally $50), so that I don't have to pay the ticket charge myself. That's not a profit center for me.”

At the other end of the extreme, there are some advisors who do lose an immense amount of revenue when they discount. The UBS broker, for instance, says discounting is probably costing him over one-third of his annual pay: While the average broker may make over $100,000 a year, he says he earns more like $50,000 or $60,000 after discounts. But because he is nearing retirement (and slowly shedding his book of business), he claims he's ok with that.

That said, he's always been gung-ho on discounting. In fact, he was so gung-ho that he left Merrill Lynch after 15 years because Merrill would not break the commission rates for him enough. At UBS, he says it is basically up to him what he charges clients. (Merrill Lynch declined to comment on its discounting policies.)

“The way I do my business is I cut the price down as much as I can,” he says. “I think pricing is up to the individual. I don't think I have a client to date who has asked me for a discount — ever. But I don't charge them full either,” he says. The typical annual wrap fee at UBS is about 3 percent, and without cutting commissions he would get a 44-percent payout on that revenue. But because of the way he discounts for clients, he says he gets more like 18 or 19 percent.

What Fees?

The thing is, discounting doesn't necessarily make clients happier: They seem to care more about how they're being charged, and less about how much. In fact, low cost is the least important consideration for clients when selecting an advisor, according to a study released by the University of Pennsylvania's Wharton School of Business. “Leading financial advisors interviewed for this report say that most of their clients aren't all that concerned about the absolute levels of the fees,” wrote the study's authors. “What they are concerned about is clarity; this isn't surprising. Financial advisors and marketing experts at Wharton suggest that for most people, the issue isn't really whether fees are high or low, but that they know what they are.”

Even the very wealthy feel they're being duped. Charlotte Beyer, CEO of the Institute for Private Investors, told Wharton researchers that in a recent survey, members of her organization — who are generally worth $50 million or more — expressed confidence in the objectivity of the financial advice they receive, but were concerned that they're not getting the full story on the fees they pay for that advice.

“I think it's probably fair to say that the investment industry in general, not just the investment-advisory business, has some of the most convoluted pricing ever invented. It's just confusing,” says Philip Palaveev, senior manager of Moss Adams, a Seattle-based accounting firm with a financial-services consulting unit. “I've heard this question asked a million times, sort of a classical question from clients: ‘If I had a million dollars and you (the advisor) charge me 100 basis points, I'm paying you $10,000. If somehow I get more money, and now I have $5 million dollars, you charge me 85 basis points, and I'm paying you $45,000 now. My fee has almost quintupled — are you actually doing any more for me?’ The answer is probably no, so clients then ask, ‘Why am I paying such a dramatically higher number?’”

It's basically a matter of poor communication, say consultants. “Clients are wanting more, and they're willing to pay for it, but they want to make sure they're getting their value,” says Gallant. Too many advisors aren't getting their “value message” across: Only one-third of clients (31 percent) say they “somewhat understand” the value of the fees advisors charge, according to the Wharton study. Nearly half of advisors say they discuss fees with clients on an annual basis (44 percent), but over a third of clients (39 percent) say advisors discuss fees only when they raise the subject.

Sorting It Out

In the end, consultants say that when it comes to pricing, advisors need to be flexible. Some advisors agree. “My sense is the best model for the client is one that doesn't handcuff the advisor,” says Robinson.

“In some cases a transaction-based product may be the best solution for the client, or it's unavoidable; in other cases it may be a fee-based model,” Robinson adds. Robinson, who manages $125 million for 180 clients, says between 70 and 80 percent of his revenues come from fees on assets, while the other 20 percent comes from commissions.

“When you think about how you offer mortgage advice or insurance guidance, if you advertise yourself as an RIA with purely asset-based fees or purely flat-fee planning, how do you then justify recommending a product to a client that is only available on a commission basis?”

But how an advisor chooses to charge also depends on a determination of what each client is worth. Pricemetrix data suggests there are a lot of clients out there who are generating just barely enough revenue in a year to pay for a 12-pack of imported beer. Check it out: Almost half of the more than 1 million retail-client households in Pricemetrix's database have less than $55,000 in assets, and over half of these households generated less than $20 in revenue over the past year.

John Comer, of advisory-consulting business Comer Consulting, says many advisors do not know how to figure out how profitable their individual clients are, and that's largely because of simple miscalculations.

Typically, Comer says advisors take all of their revenue, divide it by the number of clients they have, and think that's the amount of service they can afford to provide everyone. As a result, Comer says advisors tend to over-serve the clients who have the fewest assets, and quite probably the least-complicated needs.

Furthermore, he says many advisors don't know how much of their time should be billable, though he estimates it is probably about 40 percent across the industry, since so much of their time is dedicated to administration, continuing education and marketing. “If they work 3,000 hours a year, they think, ‘If I got $100 an hour and multiplied it by 3,000 hours then that is a lot of money,’ not realizing that most of that can't be billed,” he says.

Fees, Commission, Fees

Of course, it won't surprise anyone to learn that most advisors are using commissions less and less these days — and fees on assets more and more. That's partly because fees provide recurring revenue, and partly because financial advisors are providing different kinds of services these days: not trading, but planning and wealth management.

“Anyone who is mildly successful has moved on to managed money, and selling clients stocks and bonds is just a convenience they offer to the client from time to time,” says Andre Cappon, an analyst at the CBM Group. Some 77 percent of the advisors at wirehouse and regional firms today say they charge both fees and commissions, while just 15 percent say their primary method of compensation is commissions only, according to a survey by J.D. Power and Associates commissioned by Registered Rep.

In the RIA channel, the emphasis on fees is more pronounced. Currently, fees on assets account for 71 percent of total revenue for RIAs, according to a survey of 800 firms recently released by consulting firm Moss Adams. Meanwhile, 49 percent of RIAs say they are going to increase their use of AUM fees in the future; only 4 percent say they're planning to decrease their use of AUM fees.

Other types of fees (including hourly fees, retainers and commissions) currently make up 29 percent of RIA business, and 39 percent of firms say they're going to use more retainer/relationship fees in the future. These kinds of fees are far less common at the independent and wirehouse firms, where highly structured payout grids make it difficult to charge for services in this manner.

Perhaps because of the move away from commissions and toward fees, the range of asset-based fees that advisors charge, at least at independent b/d and RIA firms, has actually narrowed over the past four years. These days, clients typically pay between 88 and 94 basis points on a million-dollar account, says Moss Adams' Palaveev. More than half of the firms surveyed by Moss Adams say they charge at or within 100 basis points (though the remainder charge anywhere from 75 basis points or less to 125 basis points or more).

Could that be a sign of things to come? Perhaps as the industry matures, pricing across the industry will become more standardized and the differences will iron themselves out.


Here's what percentage of the wealthy think financial advice from the following firms is worth a little extra dosh.

Full Service Brokers Percentage
Smith Barney 62%
Edward Jones 59
UBS 54
A.G. Edwards 51
Merrill Lynch 49
Premium Brokers Percentage
E* Trade 71%
TD Ameritrade 70
Banc of America 61
Fidelity 59
Charles Schwab 58
Ameriprise Financial 54
Wells Fargo Securities 53
Source: The Luxury Institue
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