Financial advisory practices have changed over the years and are increasingly shifting away from commission-based models toward fee-based models. To understand this trend and the forces that are influencing it, we examine the pros and cons of different compensation models.
We also look at why the current economic environment is a good time to reevaluate which model makes the most sense for advisors and their clients.
Financial advisory compensation models vary in terms of income structure and complexity. Advisors who work for a bank or brokerage firm may receive a base salary with bonuses tied to new business wins or product sales. On the other hand, independent advisors might use one of three primary compensation models to bill their clients: commission-based, fee-based, or fee-only.
The commission-based model is transactional, and compensation is tied to an investment action with an upfront or backend sales charge. The advisor is only compensated when a client chooses to take action (e.g., buy or sell an asset) in their portfolio.
Commission-based is the oldest compensation model for financial advisors. Commissions are typically wrapped into the product cost as a percentage of the sale.
Fee-based compensation models aren't tied to a product. A fee-based advisor is compensated for their time and financial guidance regardless of specific investment recommendations or actions taken by the client. Commonly, pricing is based on a percentage of the assets under management, hourly rates, or a flat fee, and is ideally outlined in a set fee schedule. With a fee-based structure, advisors who are dually registered, can still generate commissions from investment recommendations, if the client’s investment needs are more transactional in nature.
A fee-only advisor does not generally receive any commissions or third-party fees. The fixed retainer fee is based solely on the assets under management or the advisor's hourly rate.
Fee structures can be tiered, and an advisor may provide certain services to clients with larger accounts. Some advisors allow smaller clients to add on services for an additional fee without meeting the larger account size requirements.
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There are clear differences when comparing fee-based to commission-based financial advisor compensation models. In most cases, the fee-based model offers fewer conflicts of interest. Fee-based advisors tend to offer a more holistic service that goes beyond asset activity. Advisors in this capacity are tied to a fiduciary standard of acting in the best interests of their clients.
Advisors using a fee-based structure are more likely to support clients on the best moves forward without a motive tied to account activity. Typically, a fee-based advisor already has a long-term financial plan in place with each client. Encouraging clients to stay the course reduces the likelihood of making emotion-based decisions amid sudden market changes.
According to a recent J.D. Power study, nearly three out of four millennials prefer a one-time fee for service (74% of investors) or a subscription model (73% of investors). Today's client tends to want a supportive advisor who is going to give comprehensive financial advice beyond investment recommendations. Many clients prefer fee-based financial advisors for a variety of reasons, but it boils down to changing client needs.
One of the biggest changes in client expectations is the desire for financial planning beyond investment management. Today's client wants financial advice that helps them achieve their goals – including things like retirement planning, tax management, estate planning, saving for children's college tuition, and more.
As opposed to being transactional, fee-based advisors are generally relationship- and service-oriented. Because they are earning recurring revenue, there may be less pressure on new business development, allowing them the opportunity to provide a deeper level of ongoing service to their clients.
Unless investors are combing through the prospectus, the all-in cost of purchasing and selling a specific investment may not be clear or obvious. With a fee-based advisor, the client is generally regularly invoiced, so the fees are more transparent.
With a set fee schedule, clients agree to the services and costs ahead of time. For the client, knowing the cost and services included can help them make a more informed decision.
A fee-based advisor isn't motivated to buy or sell because of a commission attached to a product. Instead, clients benefit from a future-focused approach to financial planning with many fee-based advisors.
Advisors working on a set fee schedule are more incentivized to establish long-term relationships with their clients for ongoing business. This means that a fee-based advisor is typically dedicated to a long-term plan that isn't swayed by market volatility or commissions.
Furthermore, fee-based advisors are required to do their due diligence and are held to a fiduciary standard to take the best possible path forward for their clients.
When evaluating compensation models, there are several key advantages for advisors who elect to use a fee-based structure.
Imagine trying to decide between two appropriate investment options – both make sense for the client, but one generates a higher commission. When you put yourself in the situation of commission-based payouts, you increase the opportunity to make moves that aren't truly in the best interest of the client.
With a fee-based model, the fee is independent of the investment recommendation, and the advisor can take the best possible path forward for the client.
Commission advisors need to continue to find new business to help create a revenue steam.
With a fee-based approach, clients enter into contract agreements for continued services, so an established business is generally generating revenue. Advisors may shift their focus to retaining clients – the cost of retaining clients is far lower than the cost of attracting new clients.
The fee-based model allows advisors to focus on clients, keeping their best interests at the forefront of business. A client-centric focus means advisors are compensated for the time spent researching market trends, analyzing assets, providing recommendations, meeting with the client, and more.
Similar to the returning client base from above, the fee-based business generates ongoing revenue, typically based on a percentage of assets under management. This can provide dependable income that can be used to build infrastructure in or grow the business.
Based on regulations and recent legislation changes covering broker-dealers and investment advisers, it seems clear that the financial advisory industry is heading towards more of a fee-based approach. There are three main reasons that may be contributing to this model’s rising popularity:
Shifting to a fee-based model may help keep advisors stay abreast with these industry trends.
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The Future of Advice is Fee-BasedGreat things rarely occur within your comfort zone. Earning revenue via commission-based mutual funds or annuities might seem straightforward and familiar, but it isn’t a sustainable way to grow your practice. Listen to Gaining Perspective featuring Jen Gloss. |
There are downsides to everything in life, and the fee-based model is no exception. Here are the biggest barriers and challenges in the fee-based model.
To act in a fee-based or fiduciary capacity, advisors will also need to develop new competencies. For example, if an advisor had only been providing investment management, they may need to add other services like financial planning.
Additionally, an increased expectation to act by the fiduciary standard of care, necessitates that advisors learn the laws, regulations, and ethics surrounding investment advisory practices. In some states, the CFP may be sufficient, but in other states, Series 7, 63, 65, or 66 may be required. These licenses are focused on understanding investment risks, tax laws, equity, and more. The registration requirements to sell investment products as a fee-based investment advisor representative (IAR) varies from state to state.
While the fee-based model has many advantages, it assumes that the client wants ongoing advisory support. This model isn't always compatible with clients who only want transactional support. The fee-based model may require more research and bigger time investment from the advisor on the account.
Additionally, advisors can become overly focused on their larger clients with the fee-based model. Segmenting clients into tiers based on account size can help provide a fee structure and expectations that align with different account sizes.
Finally, there is an increased chance of running into problems with ramping up too quickly as a fee-based advisor. Because fee-based models typically have a more robust service model, some professionals find themselves taking on too much.
Most professionals should consider a transition by identifying existing commission clients that have more holistic needs beyond investment management and start the conversation with them. If advisors want to scale their business quickly, it's important to get the right support in place.
If you are thinking about shifting into a fee-based model, it's a good idea to start by assessing your current client base and determining which accounts are the best fit for a fee-based structure. Once you've gone through the necessary requirements to be licensed in your state for fee-based advisory work, you will want to evaluate the changeover to address scaling issues. Start with the clients who will benefit the most from ongoing advisory services.
If you want additional support in getting started, AssetMark coaches can help you benchmark your fees against peer advisors to ensure reasonableness and profitability for your business. In some cases, outsourcing part of your services creates scale in your business, so that you can allocate your time to growing your business. AssetMark is a turnkey asset management platform that maintains robust due diligence on portfolio selection so you can spend more time on other advisory services and business activities.
We can help you provide your clients with innovative and cutting-edge technology to support investment management. Learn how our platform can help you increase client success. Talk to our team today.