Based on our experience in providing digital marketing for financial advisors, we can tell you that less than 10% of these professionals publish their fee schedules on their websites. However, 35% describe how they are compensated if they are fee only or fee based. This may lead you to believe that disclosure of fees and other compensation methods are an important strategic decision for them.
This article will breakdown the various methods of compensation for financial advisors and describe how the methods are disclosed to investors, such as:
- The most popular type of fee that financial advisors market to investors
- The primary rationale for an asset-based fee that is marketed by most fee-only and fee-based advisors
- Why an asset-based fee is so popular
- The best way to explain an asset-based fee to investors
- Minimum asset and fee requirements
- Down markets
- Services covered by the asset-based fee
- Who is marketing their fee schedules online
- What else advisors should be marketing about their asset-based fees
- An increasingly popular alternative to the asset-based fee
What is the most popular type of fee that financial advisors market to investors?
The most popular type of fee is based on a percentage of the investors’ assets. Just about every advisor uses a sliding schedule of fees to encourage investors to place more assets with them. An example of a popular fee schedule is:
- 1% on the first $1,000,000
- .75% on the next $2,000,000
- .50% on amounts over $3,000,000
This type of fee structure also recognizes that the advisor’s work does not double when client assets increase from $1,000,000 to $2,000,000. In fact, there may be very little additional work, but the financial advisor is responsible for a larger sum of money.
What is the primary rationale for an asset-based fee that is marketed by most fee-only and fee-based financial advisors?
The asset-based fee rewards advisors when the market value of their clients’ assets go up and penalizes advisors when the market value of their clients’ assets go down.
Why is an asset-based fee so popular with financial advisors?
Simply stated, it is a recurring fee. And, since the securities markets go up more than they go down, advisors’ fees can automatically increase over time.
In a good year, a 15% market return increases the advisors’ revenue by 15%. And, this does not include performance that beats the market, additional contributions from current clients, reinvested dividends and interest, and new clients.
What is the best way to explain an asset-based fee to investors?
Many advisors tell their clients an asset-based fee puts them on the same side of the table. They both win or lose at the same time when securities markets go up and down. This is true, but there is a better way.
Let’s say the financial advisor’s asset based fee is 1% and the client’s assets appreciate $100,000. The advisor’s compensation increases $1,000 and the client’s net worth increases $99,000. Very few clients would argue that a 99:1 ratio in their favor is unfair. However, that is exactly how the asset-based fee rewards investors and their financial advisors.
And, the more assets investors place with financial advisors, the more the ratio benefits them. This happens because most advisors have sliding schedules of fees.
What about minimum asset and fee requirements?
Based on our studies, more than 85% of financial advisors have minimum asset requirements for their client relationships. As you might imagine the lowest minimum is none and the highest minimum is millions of dollars. The most frequent minimums are: $100,000, $250,000, $500,000, and $1,000,000.
Most advisors have minimums because they impact the amount of the asset-based fee that is paid to them by their clients.
The other alternative compensation method is an asset-based fee that also has a minimum fee. For example, the advisor may charge a 1% asset-based fee with a minimum fee of $5,000. This means clients with less than $500,000 will be paying more than 1% until their asset amounts reach or exceed $500,000. This strategy can also encourage investors to place more money with their financial advisors.
What about down markets?
This can be a source of consternation for many clients. They absorb 99% of the market losses (realized or unrealized) and their advisors absorb 1%. However, since markets go up more than they go down this description of financial advisor compensation still works in the favor of investors.
What services are covered by the asset-based fee?
Asset-based fees are designed to cover the cost of the advisor’s investment advice and services. It has also been our experience that more than 80% of the time this fee also covers the cost of the advisor’s planning services.
This also helps justify the asset-based fee that advisors charge their clients. In particular, when they are using passive management and ETFs to invest their clients’ assets.
An extension of this strategy is the wrap fee that can cover the costs of planning, investing, custody, and trading.
Which financial advisors are marketing their fee schedules on their websites?
The only financial advisors who market their fee schedules on their financial advisor websites are those firms that charge less than 1% on the first million dollars. They believe lower fees will give them a competitive marketing advantage over firms that charge 1% or more.
This is slightly flawed reasoning because the firms that charge more than 1% (1.25%, 1.50%) do not market their schedules on their websites.
The principal examples of firms that market fee schedules to compete with other financial advisors are the robos. In this case, their fees are substantially lower than traditional financial advisors.
What else should advisors be marketing about their asset-based fees on their websites?
Let’s assume financial advisor firms charge a typical 1% fee for their investment advice and services (may also include planning). The firms have made the decision not to market their fee schedules on their websites.
What could the advisors market on their websites that would make investors feel more comfortable without disclosing their fee schedules? They could market some combination of the following ten types of information:
- Their “only” method of compensation is a fee (fee-only)
- Their “preferred” method of compensation is a fee (fee-based)
- There may be no reference to commissions (investment, insurance)
- Advisors do not have physical possession of their client assets
- Advisors bill custodians, and not clients, for their fees
- Their billing frequency is monthly or quarterly
- The billing is in advance or arrears
- There is no termination fee
- Some fees may be tax deductible (all or partial)
- Termination requires 30 days notice
Very few advisors will disclose or even mention the other layers of potential fees that may be deducted from the investors’ assets.
Now investors know how financial advisors bill for their advice and services without knowing the exact fee. This can mean the advisor is practicing more disclosure than other advisors.
This strategy will require compliance approval before any information is published online.
What is an increasingly popular alternative to the asset-based fee?
It is reasonable to assume most advisors prefer recurring revenue streams, which is one of the key features of the asset-based fee.
Consequently, fixed fees are relatively unpopular with the possible exception of charging a fixed fee ($3600) for a financial plan. This example would equate to 12 hours of work at $300 per hour. Annual reviews could create another revenue stream.
Unlike CPAs and attorneys, very few financial advisors charge an hourly fee for their services. They have alternatives that they prefer.
A method of compensation that is rising in popularity is the subscription fee. For example, financial advisors charge $300 per month for their advice and services. This has two advantages: it is a recurring fee and it is not based on the clients’ assets.
This is particularly popular with younger investors who have substantial incomes, but limited assets available for investment. The subscription fee gives them access to higher quality financial advisors they otherwise could not afford.
Conclusion
The more financial advisors disclose what they are paid or how they are paid, the more pressure there will be on other advisors to disclose their compensation methods and amounts. Non-disclosure is a risky marketing strategy for financial advisors.
Only the best advisors can market full disclosure as a feature of their firm. They have nothing to hide.
