One of the main reasons people become financial advisors is that the work is highly compensated. The average salary for an advisor is $75,320 plus bonuses but more important than that is the potential to make a great deal more. It’s commonly called a business where you make it big or not at all. In the last ten years there has been a movement from large brokerage houses to smaller independent advisory firms so the potential Return on Assets is even higher and advisors are even better compensated.
So when I look at firms I question why so many feel the need to provide things gratis: free financial plans, free Social Security analyses, free dinners and more. Is there a psychological deficiency in the industry that requires advisors to pay a penance for the sins of the few disreputable in the business? Is it a deficiency born from the “Greed is Good” pathos of the 1980s, one that fostered the likes of Madoff and Stanford? Does giving something for free assuage one’s guilt and provide permission to sell a product with a high commission or charge excessively on asset management fees? Or is the barrier to entry so low that as advisors we suffer a lack of respect for our own profession and perhaps ourselves? After all, being a financial advisor requires little initial education, no PhD or even a garden variety BA degree. And before all of you start clamoring that you need a degree to attain the CFP designation or that the CFA exam is rigorous, I continue to encounter numerous professionals in this industry without either who have very lucrative practices.
The truth is we are highly specialized in a broad discipline and clients need the knowledge and guidance of an experienced and credible financial advisor. Markets are intricate, investment selection treacherous and the design and implementation of investment strategies complicated. Just the behavioral benefits of having a professional make buy and sell decisions increases a client’s peace of mind and overall performance. Although the barrier to entry requires little formal education, advisors quickly become aware of the need to increase their knowledge base.More than 70 percent of all team practices have at least one CFP® and that does not include the other credentials many advisors hold.
So I again question the need for “free”. Free always comes at a cost. Take the common practice of offering a free financial plan. Preparing a plan requires a significant investment of time from both the client and the advisor since data needs to be collected and inputted. The investment in financial planning software is an additional cost and presenting the plan is time consuming. A free financial plan is a risky proposition since the client could ultimately decide not to do business with the advisor and walks away with a valuable plan at no cost making client acquisition costs even higher.
Then there is the cost in terms of value. Does the client value the free plan? Could it undermine the credibility and perceived value of an advisor’s service? Often enough free hints at desperation. Does it diminish the profession’s value in general? Value weighs the perception of benefits received against the price paid. What is your value as an advisor? How much attention did you pay to the pricing of your services when your advisory firm was founded?
Getting the Pricing Right
In my health and beauty business in Hungary, pricing was a crucial issue. In the early days of the movement from a communist approach to business to a capitalist one, the old pricing standard for products remained unchanged: prices for products were set only once per year. It was critical to get it right. At the time, one of our wholesalers said something that was a revelation. It had such an impact that I clearly recall the exact location. We were stepping on to the bottom of the escalator in the Frankfurt, Germany convention center when she told me “you cannot compete on price alone”.
With that in mind consider the fact that traditional firms compared to robo-advisors continue to collect asset management fees ranging from approximately 80 to 250 basis points and the pressure for lower fees doesn’t usually originate with the client. The data suggests, however, that fees are falling. The average fee as reported by PriceMetrics (2014) is 1.02% down from 1.47% in 2007 and 1.32% in 2010. This is a substantial decline although it is a slight increase over the 2013 fee average of .99%.
The regulatory push seems to focus on more transparency as evidenced by the Dodd Frank legislation requiring 401K plans to disclose fees and by the SEC’s examination focus on compensation conflicts-of-interest and the fair application of advisory fee structures. Pressure to reduce fees also comes from the conflict between fees charged based on the client’s ability to pay versus the actual services rendered. Does an advisor spend more time providing services to a client investing $3 million than $5 million and if the fee is 1% is it really worth $20,000 more per year?
The advisory business is faced with an additional quandary. As we move toward passive investment strategies from active ones, and the growth of Vanguard and proponents of passive strategies in general is an indication we are moving in that direction, then how do we justify the fees? It takes less effort to monitor and implement a passive strategy than an active one.
It is time to look anew at the way we charge for the services we provide. Like the proverbial Goldilocks, the pricing should be just right. Part two of this blog will focus on solutions for getting the pricing right.