Nick Murray recently wrote about the fear some advisors have about the fees they charge, “If you are afraid to stand up proudly for the enormous gap between the great value you provide and the little you charge, you deserve to get everything you get.” It has always amazed me that many financial planners agonize over the fees they charge, while their clients, by and large, do not.
Nick got me to thinking: Why is that? While I have no way of knowing, I feel sure that we would certainly know it if our clients did not perceive value in the fees they pay us. So, as Nick suggests, perhaps we need to focus on the value we provide rather than the fees we charge. And, for financial life planners, that value is significantly greater than what we are paid to deliver it. And I do not mean providing superior returns or beating some index, which can be measured. No, I am talking about the immense value financial life planners bring to their client relationships that cannot be quantified with numbers. It is this value that results in client retention rates in the high 90s.
It was about 10 years ago that I attended a memorable FPA retreat in Missouri and was privileged to witness one of the most motivating sessions I have ever seen. Videotaped interviews of four clients of financial planners were presented. They each spoke of how important their relationship was with their planners and what it had meant to them. They recounted how the quality of their lives had improved. Some of the phrases and words they used to describe their experiences were “peace of mind,” “trust,” “friendship,” “caring,” “concern for our needs,” “availability” and “competence.”
One could not help but notice two things all of these clients had in common: They treasured the relationships they had with their planners and not one of them mentioned investments. So why should we, as financial planners, attempt to justify the fees we pay by the returns we provide? Are there potential clients out there who want to judge us solely on our ability to beat some arbitrary index? Of course. So what do we do with these prospects?
My suggestion: Do not convert them into clients. There are many more people who will appreciate the real value we provide, and the clients who concentrate on returns will most likely be unhappy at some point and attempt to find that elusive advisor who is able to deliver on those expectations. We do not need to play that game. To say people hire us mainly for superior investment results diminishes what we really do for our clients.
Alpha For Financial Life Planners
August 4, 2014
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I also want to point out that the DALBAR study does NOT differentiate between kinds of investors (individual vs. advisors vs. institutional, etc.). Data is not kept the way everyone seems to think it is and so that kind of differentiation is impossible. The DALBAR study simply looks at asset flows into and out of mutual funds, creates returns based on when assets are and aren’t invested, and then compares those returns with the underlying returns of the mutual funds themselves (basically a dollar-weighted return vs. time-weighted return analysis). Morningstar does the same thing with its Investor Return vs. investment return. It’s certainly telling, but what it’s telling us is that individuals AND professionals all are horrible at timing when to get in and out of mutual funds. The scary thing is that since the vast majority of assets are controlled by professional investors, what the study really says is that the professionals in charge of the majority of wealth in the world make really bad decisions on a very regular basis! Sorry, Roy, I wish I had nicer things to say about your post.
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I agree that planners provide services that are difficult if not impossible to measure in a way that could ever justify a percent-of-assets-under-management fee structure, but isn't that the exact reason why charging a % of AUM makes no sense at all for planning services? Why should a client pay a % of assets for one-off pieces of advice like whether to buy or lease a car, refinance their mortgage, or fund an endowment for their alma mater? No, those services should be paid for via an hourly rate, and once those services are rendered and the fee charged, that's it…go find more advice-giving business. Ongoing fees for infrequent services and advice are great for the planner, but totally unfair for the client. Why clients don't complain is a function of an informational disadvantage on their part rather than satisfaction with the relationship. And the benefit for planners of that compensation arrangement is exactly why planners (and accountants, and lawyers, etc.) have gotten into the asset management business over the years. It’s high time someone called them out on it. Stick to an hourly rate and justify it however you think is appropriate. A %-of-AUM fee should only be charged for portfolio management services, and those services are most definitely measurable relative to a mutually agreed upon benchmark. That benchmark should reflect the level of risk to which the advisor will subject the portfolio, and measurement against that benchmark should include all fees and costs of management. If over time the advisor can offer returns near that benchmark, the client should be perfectly happy. As Roy points out, one doesn't need to beat the benchmark necessarily, since the advisor has at least saved the client the trouble of investing on his/her own and that's worth something. But measurement is crucial so that if one falls noticeably short of the benchmark, clients should inquire as to why and consider having someone else manage the portfolio or do it themselves. This notion that portfolio management services can’t or shouldn't be measured against a benchmark is ridiculous…and is the argument I would expect from someone who has a reason to hide from performance measurement. And while I’m criticizing, let me also point out that planners tend to include accounting and estate planning advice as services they provide (and charge that AUM fee on) when their disclosure materials all say they are not accountants or lawyers and therefore cannot provide such advice. Why is this, and why do their clients continue to pay a % of AUM for “advice†that is indirectly related to the AUM and cannot even be offered?! ? What usually happens is the planner “quarterbacks†such advice and refers their clients to accountants and estate attorneys to whom the client then pays hourly or service-related fees. While it might be appropriate for a planner to charge a referral fee in such instances (I don’t approve of the referral fee thing, either, by the way), but including accounting and estate planning services as part of what the services included in a % of AUM fee is highly dishonest and should be illegal. Leave accounting advice to CPAs and legal advice to the lawyers. It’s their careers on the line, not the planner’s, so they should receive the fruits of their labors rather than some “quarterback.†Sorry, Roy, I just don’t think you could be more wrong.
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Bravo - well thought out article. Thank you for the perspective on alpha. Right on!