If leading financial economists are right, the years when planners could count on stock market returns alone to fuel their firms' revenues have vanished, maybe for good. Instead, planning firms are going to have to get savvy about structuring fees to attract clients, grow revenues and strategically position their firms.
If it sounds like a bit of a stretch to put so much emphasis on the way you're paid, consider this: An increasing number of firms, both large and small, are introducing new fee structures to enhance revenues and control their futures, according to an unscientific survey conducted by Financial Advisor in early March.
The new movement? Away from volatile assets-under-management fees and toward flexible fee structures, including annual flat and retainer fees.
The decision to convert all clients to an annual retainer fee last year was as much holistic as strategic for Frank Presson III, a sole proprietor who manages $9 million in Tucson, Ariz. "By doing this, I feel like I'm getting clients to focus on the whole process-changing goals, taxes and insurance needs-and not just investment management."
The response from all of Presson's 20 clients has been positive. Ironically, they were tired of seeing higher and higher fees as the stock market rose, the planner says.
The first year, he uses a rough approximation of assets and planning needs to determine a client's fee. It's modified in subsequent years, based on changes in clients' needs, net worth and other factors. If someone has a windfall or inheritance or is facing a divorce, he'll factor in how much time he's spending on the changes.
"It's amazing how many assets have come out of the woodwork once I stopped charging an asset-based fee," says Presson, who caps his fees at 0.6% of assets up to a client's first $1 million in order to be competitive.
Most clients are in the $500,000 to $1 million range, but he'll work with those who have less if they're willing to pay $175 per hour for a financial plan. "These are the people who need a financial plan, so if they're willing to pay the freight, I'm willing to work with them," Presson says.
With the swelling ranks of financial economists predicting equity risk premiums of 4% or less, Coral Gables, Fla.-based Evensky, Katz & Brown introduced a retainer fee for new clients as a defensive move against shrinking revenues late last year. "We didn't want our income stream to be tied to assets in the event of a downturn, and we wanted to match the value of our services to costs," says the firm's president, Barton C. Francis.
New clients, who tend to be in the $5 million to $7 million range, have been receptive to the value-based fee created by the firm, which has $350 million under management and a staff of 15, Francis says. Some existing clients have also given the fee a thumbs up, though the firm has not embarked on a full-scale conversion of existing customers. To arrive at the fee, the firm developed a multiple-spreadsheet approach designed to allow it to set a fee based on the amount of work it intends to do for a client in a given year.
"If it sounds rather complex, it is, but what we've found is more folks are interested in more value and are willing to pay for it," says Francis. He joined the firm last year from Ernst & Young, where as a partner in charge of the firm's personal financial counseling, he worked with clients with up to $1 billion in assets. In contrast, for those with simpler planning needs-say older clients who have the bulk of their estate planning done-the fees Evensky charges will go down.
Evensky's new fee structure meets client needs and adds stability, while "allowing us to decouple our revenues from market movements," Francis says. "To the extent that advisors have reaped the benefits of asset management in the past, it was an excellent source of revenue, but we're not going to count on the market to provide our future lift in revenues. We're positioning the firm so clients will reap the rewards of any upturns, but our business plan is based on rational growth and appropriate pricing."
While the firm hasn't publicly announced its growth goals, Francis says revenue growth in 2002 and 2003 should be north of 20%, with only a small percentage of that dependent on market performance.
Up the road in Miami, The Enrichment Group also spent a good deal of time in 2001 on brainstorming new fee structures. The result? An innovative retainer fee the firm's planners have the ability to adjust based on a client's assets, net worths and planning needs. The change, says the firm's president, Kathleen Day, is more tied to the company's search for "ideal" clients than concern over a depressed stock market.
"We did extensive analysis to determine what clients were profitable for us and at what asset level and did screens to identify the clients we want to work with," says Day. "Our ideal client, we found, is a delegator with assets in excess of $300,000, preferably about $700,000, who wants us to do a lot of work for them." Since the firm, which has $150 million in assets under management and 18 staff members, favors a planning approach that makes family values the driver in financial decisions, these ideal clients also tend to be younger.
The new broader fee stucture gives planners at The Enrichment Group the flexibility they were missing before, Day maintains. Now, if clients custody a large amount of assets with the firm, they are likely to be charged an asset-based fee. But if, like a growing number of clients, they are either in accumulation mode or have much of their assets locked up in trusts or elsewhere, the firm can develop an annual retainer based on their net worth and needs.
"Our clients are increasingly accumulators who are getting wealthy fast," Day says. "They're usually busy executives who need a lot of attention. They want someone to worry about the details and make sure things happen."
Luckily for the firm, this new breed of client also tends to be less cost-conscious. "They're more apt to say, 'I'll pay you whatever, just don't bug me,'" Day says. Before introducing more fee flexibility, the firm's pure assets-under-management fee approach made it unprofitable to work with accumulator clients who had only $300,000 or so in assets-even though some were investing up to $100,000 a year.
The response from clients to the rollout of the new fee structure three months ago has been overwhelmingly positive, Day says. "We didn't have anyone say no, and the new clients who've come in have been exactly the niche we're looking for."
Still, arriving at appropriate fees can be as much art as science, she admits. With some clients, it's unclear how much planning work they'll need. "It's not as calculated as it is a seat-of-the-pants kind of thing," Day says. "If we get it wrong, we'll know it and adjust accordingly."
The firm is also working to ensure fees are competitive and caps charges at 1% for clients with $1 million or less to invest and 0.75% for those with between $1 million and $4 million in assets.
The change has allowed The Enrichment Group to do away with its hourly billings. "We were never very good at billing for all our hours anyway, and the clients who would come in for hourly work just weren't profitable for us," Day adds.
She believes the fee structure is harmonious with the firm's mission and is predicting the changes will increase firm revenues by 10% this year.
Farther north, Roron Wisniewski and Barbara Clark, partners in the Ashburn, Va.-based firm Secure Financial Management Inc., are devising a new fee structure, too. "We think a flat-rate fee that factors in net worth is appropriate," Wisniewski says. "The problem is we're still determining how to calculate net worth. Some of our clients have homes worth $750,000."
The firm is in the process of eliminating commissions, but is trying to avoid the "assets-under-management" approach to client fees because of the obvious downward stock market pressure. Why the move from commissions? "We can't continue to fight it," Wisniewski says. "There's too much pressure from consumers who have been conditioned to associate fees with objectivity. If we can get the net-worth part right, we'll do no-load funds or load funds like the American Funds family at net asset value."
The partners believe the changes will position them well with the clients they covet and those with whom they currently work-30- to 50-year-olds who often are hiring an advisor for the first time. To enhance client relationships and make their services affordable, the partners also are giving clients the option of paying monthly.
The goal is to remain affordable, says Wisniewski, who will develop a plan for clients for less than $1,000 if they are just getting started. The partners remain committed, however, to avoiding the hourly approach to planning because of the piecemeal approach they believe it promotes. "My battle is this: You come in, and I'm going to ask the right questions. Maybe we can just tackle a little bit of it now, but I'm going to keep pressing the comprehensive plan. Isn't that what planners are supposed to do?" Wisniewski asks.
Flexing Your Fee Structure
The benefit of shifting to more flexible fee structures is growing in value as lagging stock market returns and investor perceptions make asset-based charges and commissions less palatable.
Refocus your practice. In an effort to get clients to focus more on the benefits of comprehensive planning and less on investment management, Frank Presson III successfully converted all of his clients to an annual retainer fee last year.
Attract different clients. The Enrichment Group in Miami sees its ideal clients as younger accumulators who may not have enough assets to make asset-based fees profitable. As a result, the firm has added a flat fee to its repertoire so planners can bill based on client needs.
Ensure you're compensated fairly-asset-based fees don't always capture the extensive planning work needed by some investors who may still be accumulating wealth or have the bulk of their assets locked up in trusts or stock option plans. A retainer or flat fee gives firms flexibility that asset-based fees don't provide.
Decouple fees from market performance. Coral Gables, Fla.-based Evensky, Brown & Katz has introduced retainer fees for newer clients to make revenues more predictable and less dependent on stock market performance.
Respond to changing client demands. Secure Financial Management Inc. in Ashburn, Va., is developing a flat-fee structure based on client net worth, which allows planners to work profitably with clients just getting started and avoid the perceived taint of commissions.