September 17, 2021 | Financial Industry
Historically, financial advisory fees all followed one of a few basic structures. However, financial advisors have used several new compensation structures to remain competitive in recent years, and they can vary significantly. Understanding the various fee models is essential before deciding which financial advisory fee model or models work for your practice.
Simply put, advisory fees are not “one-size-fits-all” – a fee structure that suits one financial advisor might not be so good for another. Some financial advisors make their living from fees alone, while others supplement advising fees with commissions or may even rely on commissions alone.
And then there is client preference. Some clients opt to stick to the traditional hourly advisor fee, while others are only too happy to adopt a more modern approach such as the flat percentage rate or a hybrid model.
Some clients expect their advisors to be fiduciaries, while others are content to also pay advisors commissions on trades and the services they recommend. Other clients even prefer a temporary, solely commission-based relationship with the people helping them look after their financial assets.
Here are some of the more common advisory fee models used by financial advisors today.
The traditional hourly rate remains popular among professional financial advisors. Hourly rates can be either flat (which sometimes may represent a blend of different staff) or variable.
Flat hourly rates make customer billing simple, especially when they are a blended flat rate. Instead of charging more for work completed by senior members of a financial services team, the financial advisor charges the client a flat (and blended) hourly fee. This fee is calculated by blending the hourly rates of the senior and junior employees working on the account.
Billing of variable rates is more complicated as clients are charged different rates according to which member of the financial planning team provides the services. So, if a junior assistant performs a task, it will cost the client less than had a senior partner been involved. There is a contingency of clients that prefer this model because flat blended rates leave them wondering whether they are overpaying for minor services.
Regardless of the hourly rate structure, hourly billing may sometimes be seen to be in conflict with the client’s best interests. When clients pay for financial planning services by the hour, there is little incentive for efficiency. The longer a task drags on, the more it costs. Clients often wonder whether they are being billed for hours that were not truly focused on their account.
Clients might also suspect that not everything that is done to manage their accounts is necessary. In addition, hourly fees, where every phone call or meeting is billable, can also result in clients who are conscious of the ticking clock and in less contact with their advisors than would be in their best interests.
The flat percentage rate / AUM compensation structure is growing in popularity. Assets in this model include brokerage accounts and IRAs but not accounts like 401(k)s that don’t usually become available until a client leaves a job.
Charging clients flat percentage rate fees for assets under management (AUM) has the advantage of being very transparent and easy to understand. For example, if the advisor manages $1,000 of the client’s funds, and the flat percentage rate is 1%, the fee would be $1,000 x 0.01, which equals $10 in fees payable to the advisor’s firm.
These accounts also make financial planning easy because clients, advisors, and investment managers all know exactly what the fees will be upfront.
The more money the advisor manages, the higher the advisor’s compensation will be. A downside is that this compensation structure makes a smaller investor less attractive to some financial advisors. Indeed, some advisors opt for account minimums to avoid working on accounts that are too small to generate sufficient income for the required workload.
On the other hand, holders of accounts with higher assets might not want to pay the same percentage rate on all of their money, so a flat percentage rate account might not appeal to them. This tends to disincentivize the client from adding more assets with the advisory firm.
Another drawback is the possible perception that financial advisors may pay closer attention to the accounts with larger assets than the smaller ones. The best way to combat this is through your client messaging and marketing efforts so that your clients understand the philosophy and culture of your firm and how it provides white-glove service to every client.
Percentage-tiered fees (or multi-rate fee schedules) address some of the things that worry clients when it comes to flat percentage rates. In this model, different percentage rates kick in at different AUM breakpoints and typically incentivizes clients to invest higher levels of their assets as the rates decrease with increasing AUM.
For example, if a client has an investment portfolio valued at $3 million, the advisor or investment manager may charge a fee of 1% on AUM below $1,000,000, equaling $10,000. The remaining $2 million may then be charged at a lower rate, commonly %0.75, or $15,000. This would make the client’s annual total in fees $25,000 rather than the $30,000 that a flat percentage rate would have yielded.
Like the flat percentage rate, some worry that tired percentage rates cause advisors to encourage clients to keep money invested rather than use funds from their investment portfolio to enjoy retirement or clear debts.
Charging an account management fee at an annual rate or as a retainer allows financial advisors to guard against fluctuations in the financial markets.
Annual retainer fees cover a wide range of financial management tasks, including investing in stocks and bonds per the client’s long-term financial goals and risk tolerance. For clients who favor the traditional asset allocation investment model, annual rates or retainer fees allow the advisor more flexibility than a percentage fee structure.
Clients with an annual rate or retainer agreements are usually charged monthly or quarterly. Hence, the financial advisor knows what money is coming in and when which is an important consideration when deciding on your model of choice. The expense predictability of the annual rate or retainer is also attractive to many clients. In addition to knowing how much to budget for financial advisor fees, the fee will remain the same, even if their investment portfolio overperforms.
However, some clients may be concerned that because the portfolio’s performance doesn’t affect the financial advisor’s fees, a lack of incentive might mean that the advisor won’t always make decisions based on the client’s best interests.
Another option for financial advisors is to charge a fixed fee for a specific service or work completed on a limited project. Examples include creating a financial plan for long-term care, estate planning, or planning to guard against tax loss.
The benefit of the fixed-fee/project-based compensation structure is that the client knows what the service will cost, and the advisor knows how much they will earn performing it.
However, because the financial advisor will receive the same fee no matter the amount of time they spend on the project, this fee structure presents the possibility of conflicts of interest. Clients may worry that unscrupulous advisors could take advantage of the guaranteed income and do as little work as they can get away with, potentially resulting in poor advice and subpar results.
For clients, the best form of financial advice delivery often depends on circumstances, and these may change from year to year. This is why many financial advisory firms offer clients a mixture of the fee structures detailed above.
For example, an investor who normally pays for personal capital management on an hourly basis might negotiate a fixed flat fee for a specific project such as retirement planning or to finance long-term care. This way, the client knows up front what the particular service will cost.
Another example of the hybrid payment model upfront is when a fixed-fee project such as estate planning is complete, but situations change, and the plan must be updated. In this case, additional work can be charged by the hour.
With so many options to choose from and hybrid compensation structures to consider, finding the right model for your business comes down to personal preference and what you think your target clients may prefer and therefore make your firm stand out from the rest.
For example, financial advisors who act as fiduciaries must put their clients’ best interests first without making any third-party commission on investments they advise or services they recommend. This means they should operate under one of the above fee-only compensation structures.
An alternative to fee-only advising is fee-based advising. Here the financial advisor retains the right to make a small percentage of their money from commissions on, for example, exchange-traded funds (ETFs) they advise clients to purchase or insurance policies they recommend clients buy.
Advisors whose entire earnings come in the form of commissions on investment accounts they open or products they sell are known as “commission-based”, and are typically referred to more as brokers.
Both commission- and fee-based compensation allows advisors to make money from the trades they recommend and the products and services they advise clients to purchase. The big difference between commission-based and fee-based financial advising is that the former makes money based on the number of individual services sold (e.g., usually trades), regardless of their performance. The only requirement the commission-based broker or advisor has to meet is that the products they sell are considered “suitable” to the client.
While fee-based advisors can make some money in this way if they prefer, they are required by the SEC to hold the client’s best interest in e the management of clients’ investment assets. Although this is not the same legal standard the SEC holds fee-only advisors to, it still supposes greater advisor/client trust than commission-based services. It is, therefore, more likely to lead to a longer, less one-sided relationship.
This depends on the fee structure the client opts for and, often, the size of the financial portfolio.
Hourly advisor fees are calculated according to the financial advisor’s log of the work done on the account.
Fees for financial advisors under AUM agreements are a percentage of the assets the advisor manages at a given time during the billing period. These are usually collected quarterly and are based on the AUM at the end of a quarter.
Retainer and project-based fees are proposed by the financial advisor and agreed on by the client at the start of their business relationship.
Yes. To be licensed by the SEC (the U.S. Securities and Exchange Commission), all fee-only financial advisors must act as fiduciaries. That is, they are required by law to act in a client’s best interests.
Certified financial planners (CFPs) are also fiduciaries who have earned special licenses that attest to their expertise in financial planning services, including for investments, education, and retirement.
A fee-only investment advisor earns money only from the fees their clients pay them. They do not supplement this with commissions or kickbacks. Therefore, the higher the AUM the advisor manages for their clients, the higher the fees.
A fee-based investment advisor, on the other hand, may also earn commissions for selling products such as mutual funds or insurance products, which may potentially put them in conflict with clients’ best interests.
No matter how complex your advisory fee billing structure may be, BillFin will simplify your fee billing processes. BillFin has a wide range of features that allow you to make your billing flexible, scalable, and transparent for your clients.
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