Does Your Fee Schedule Need an Overhaul?

Fee-based advisors in increasing numbers are grappling with these issues and some are migrating to hourly or retainer-based fees. These alternative fee models seek to deal with some of the potential conflicts of interest inherent in the AUM pricing model and provide a more rational connection to the service provided and the fee charged.       

But do they? Is there such a thing as a conflict-free fee schedule? When I practiced law many years ago fees were usually charged on an hourly basis and I witnessed many abuses as young associates struggled to reach their quota of billable hours. 

Whenever money is exchanged in return for services there is the potential for chicanery.

Some industry observers question the viability of advisory businesses that charge on an hourly or retainer basis. But a growing number of firms prove this business model is quite viable. And going back to my law firm days again, I can tell you that we lived quite well off of hourly fees and retainers. You simply have to set your fees at an appropriate level. 

Perhaps the real fear among some advisors about hourly and retainer-based fees is their transparency. The client sees very clearly what they pay for advisory services. In contrast, the AUM pricing model has a way of masking fees by translating them into mysterious units called "basis points."

Our firm has tried to address these problems by developing a hybrid of the AUM and retainer-based pricing models. We charge a percentage of assets under management up to a certain asset level and then cap the annual investment management fee. Once the account reaches the cap, the client pays a flat annual fee no matter how large the account becomes. 

The evolution of the fee-based model will, no doubt, continue, but the truth is, there is no such thing as the perfect fee schedule. Well-intentioned advisors can serve their clients' needs well using commissions, AUM pricing, hourly/retainer-based pricing or a combination of all of them. 

The "best" pricing model depends on the particular situation and the needs of the client.

A New World of Pricing

We are entering a new era where client sensitivity to, and government scrutiny of, fees will be ever increasing.  You can see it in the move to passive investment strategies, the DOL's fiduciary regulations and low pricing offered by robo-advisors.  You can also see it in the industry's own efforts to seek out alternative pricing models.

Many clients today are clueless about the fees they pay.  Some still believe their broker works for free because fees are so well hidden. But those days are rapidly coming to an end; the Internet has increased fee transparency and the financial press has focused on the importance of fees and one of the few things that investors can control. 

We will all be held accountable for the compensation we receive.  And the focus will be less on the structure of our fee schedule—commissions vs. AUM pricing vs. hourly vs. retainers—and more on the impact our fee schedules have on our clients in specific situations.  

You can see this in the new DOL fiduciary rules. The rules go into excruciating detail on the impact various fee structures have on the best interests of the client. Don't think for a moment that you are immune from scrutiny simply because you are a fee-based advisor. It may be a government regulator or it may be your clients asking the questions, but we all need to justify our fees in the context of how they apply to our clients in specific situations.

You can wait until you are forced to defend how you charge clients, or you can get ahead of the issue.  Now is the time to re-examine your fee schedule and its impact on each of your clients. Your fees don't need to be rock bottom. It is still acceptable to charge premium prices for premium service.  But you should be able to demonstrate a reasonable relationship between the fees charged and the services delivered. Can you justify your fees in terms of the value you provide your clients? Saying "Those index funds won't pick themselves," won't cut it.