Much has been written and researched this past year on how advisors price their services, which is raising strategic questions not only from the advisory industry, but also from the investing public as to what they are actually getting from their advisor for the compensation they are paying.
The asset-based fee is in fact coming under pressure. The reasons abound, including robo and other low-cost options and the bundling of investment management with financial planning and wealth services. In particular, there are three specific challenges related to asset-based fees that are coming into focus as the wealth management industry and market conditions continue to change.
First, advisors who use an asset-based fee are not communicating, nor charging for, the actual value they typically add to client relationships. Educating clients on complex financial decisions, making sense of their overall financial situation, helping to navigate a complex tax and investing landscape, planning for life-long goals and ensuring discipline to sticking to those plans are the invaluable and resource-intensive deliverables that financial advisors are known for.
However, by using an asset-based fee as the basis for charging for that advice brings the focus back onto the actual account and investments, which as the industry is beginning to realize, are becoming commoditized to zero. This movement is beginning to create urgency in the industry, yet only a small segment of advisors are taking action.
According to a recent benchmarking study from Fidelity, only 9% of RIAs have changed their pricing structure to accommodate the changing landscape. Additionally, the study points out that 70% of firms surveyed do not feel that these industry trends will drive pricing changes, a potentially dangerous sense of comfort.
Second, the Fidelity report points out that most (71%) advisors think that clients easily understand how they are charged, yet due to the many variations of break points based on account sizes, asset classes and other variables, the resulting calculus is anything but simple to understand. As evidence, 51% of investors think they pay no fees or are unsure of the fees that they pay, according to the report.
This disconnect between advisor and client understanding of compensation issues contributes to feelings of mistrust and the inability to align pricing and value in a consistent way, especially when it comes to reaching the next generation of investors, who have different expectations and a demand for greater transparency.
Third, asset-based fees provide a hidden subsidy in rising markets and a devastating drag on revenues in declining markets. When times are good and markets are going up, the asset-based fee creates incremental revenues that are not directly attributable to the overall operations and organic growth of the firm. This phenomenon can create a false sense of security for the health of the firm, masking inefficiencies and taking the eyes off of the ball when it comes to marketing and business development.
As we approach Dow 20,000 in an aging bull-market, the industry is experiencing this scenario in real time as organic growth in the industry has dropped 6.7% to its lowest level in the last five years, according to the Fidelity report.
In declining markets, the asset-based fee rears its ugly head as revenues decline in lock step with the markets, yet the amount of work and resources necessary to service clients does not go down in a parallel fashion. In fact, client work often goes up during declining markets, driven by increasing inquiries and service requests from client unease, yet there is no pricing facility under the asset-based fee model to make up for these increased costs and lowered revenues.
According to industry experts, what is needed is a more flexible and transparent fee schedule that directly bifurcates the costs for investment management from financial planning and overall wealth management services. This can be done via retainer fees, discrete service fees or a combination so that clients can readily understand what they are paying for and what they are receiving.
Additionally, consulting and valuation experts continue to place a high premium on having an efficient, scalable technology infrastructure that can help firms adapt to and take advantage of changing market conditions. To learn more about how leading firms are using the Black Diamond Wealth Platform to harness these efficiencies and enhanced client service tools, check out the many stories here.