Harvard philosophy professor George Santayana is famously quoted as writing: "Those who cannot remember the past are condemned to repeat it." I often think of this quote as I am constantly bombarded in the news with Americans' seemingly abysmal ignorance of how we got where we are in areas ranging from history and economics, to politics and science, and technology and medicine. Apparently, despite the best efforts of many of us who have been around long enough to remember advisory "history," I need to add the independent advisory industry to that list, at least as far as advisor compensation goes.
As you may have guessed, I'm (once again) talking about the current movement to shift independent advisor comp to flat fees (as opposed to AUM fees). Some of you old timers, like me, will remember back to the mid-1980s, when the sales of tax-shelter investments literally dried up overnight (due to the Tax Reform Act of 1986), and consequently, there was a big push in the financial planning world to charge directly for financial plans (which had until then been essentially loss-leaders for the sales of investment and/or insurance products).
During the ensuing three or four years, most financial planners came to realize the "big" flaw in the planning fee strategy: not only did clients have to physically write a check for planning fees—they had to do so once a year, every year. This created an "event" during which each client had to make a decision to "buy" financial planning again, and the planner had to resell the idea of financial planning all over again, too.
Even the best salespeople did not re-close all their clients every year. So when the stock market took off, following the "correction" of Oct. 1987, and the newly created Schwab Advisor Services introduced the ability to deduct AUM fees directly from client accounts, independent advisors jumped on the AUM bus—and transformed the retail financial services industry.
In his September 21 blog post "Retainer Fees vs the AUM Model," Michael Kitces provides a comprehensive and well-reasoned analysis of the pros and cons of the retainer fee model in today's advisory world. In addition to many other salient points (including the lower value of retainer-fee firms), he comes to essentially the same conclusion about flat fees: "The fundamental problem of retainer fees is that they are more salient: the need to discuss them regularly makes them 'top of mind,' and naturally invites the client to push back on the fee and ask: 'What have you done for me lately?' [which] means in practice, it is very difficult to regularly raise retainer fees even to keep pace with inflation, much less to parallel the market growth of an AUM fee."
To my mind—and consistent with the history of independent advice—the inherent danger in creating these regular "decision points" cannot be overstated—at least for clients as a whole. No matter how well an advisor makes the case for ongoing financial planning, simply raising the issue of whether clients should continue to write a retainer check each year (actually, or automatically) will almost certainly result in some attrition.
