A recent whitepaper by Commonwealth Financial Services attempts to explain how advisors can determine if they are charging the right fee or not. Even small changes to your fee schedule can potentially provide a buffer against market volatility and withdrawals—and allow clients to benefit from consolidating assets with your firm, says the whitepaper.
How do you charge?
In a fee based model, how an advisor charges a fee is a crucial determinant to the profitability of the practice. While a few may charge a fixed fee, few may charge a percentage of AUM. Whatever be the structure, the whitepaper says it is important to analyse how much you are charging clients of different ticket sizes.
The impact of under-pricing
The whitepaper says that under-pricing is a serious problem for advisors. If the advisor is under-pricing his/her services by a small margin in the HNI segment, there is still a chance of earning a profit. However, under-pricing services for retail clients can be detrimental to the entire practice.
“If you’re like the majority of advisors, you probably have quite a few accounts in the lower tiers. This is where you need to get the pricing right, as these accounts are drastically less profitable, though probably just as much work to service, compared with your larger accounts,” says the paper.
Giving an example, the whitepaper says, if we consider an account worth Rs2 lakh for which you charge a 1% fee to manage, means that your annual fee is Rs2,000. If you are worth Rs250 per hour—based on your credentials and experience, you may be worth far more—that equates to eight hours per year of work to remain profitable. If you add up the number of hours you spend on average in meetings, prepping, researching, and talking with these clients annually, do you come up with more than eight hours? “So, if you think you are ready to make a pricing change, this is the client tier you should target,” it says.
Ideal pricing method
According to Commonwealth Financial Services, using a blended pricing schedule is the best way to charge fees.
The whitepaper explains that in a blended pricing schedule, an advisor can charge fees based on a weighted average.
For example, if you plan to charge 1.15% for an AUM of less than Rs50,000, 1% from Rs50,000 to Rs1 lakh and 0.9% for Rs1 to 2 lakh, etc. For a client who has an AUM of Rs90,000, you must calculate your fee at 1.15% for the first Rs50,000 and 1% for the additional Rs40,000 which is Rs575+Rs400 = Rs975.
The whitepaper says most advisors make the mistake of calculating their fee as Rs90,000 x 1%, which is Rs900, thereby losing out on a significant amount of profit.
The whitepaper says that the blended pricing schedule is profitable and has the potential to add some downside protection against market losses or client withdrawals. “If you are thinking about increasing your advisory fee, moving to a blended schedule could be an ideal way to do it. Typically, it is fair and equitable. It also encourages clients to consolidate assets under your management, as new money (or portions of new money) they bring to you may be managed at a lower rate,” it says.
Knowing is half the battle
We are not suggesting that you raise your AUM fees and start charging for financial planning merely because you may be charging a lesser fee, or that you rip up your existing contracts with clients and have them sign on with you at a higher rate, says the whitepaper.
It points out that advisors considering raising their fees are always worried about losing clients. “If you are uncomfortable approaching existing clients to modify their fee structure, consider adopting a blended schedule for all new client relationships. Many advisors have found this method easier to implement. Just be sure that you completely commit to the new pricing going forward and bill all new accounts at the revised rates,” says the whitepaper.
“As you become more comfortable with the new pricing, you can gradually introduce it to existing clients as you meet with them for periodic reviews. With sensitive matters such as fees, it is usually best to discuss the topic during a face-to-face meeting. This helps reduce miscommunication and gives you the opportunity to address any client concerns immediately. It is also the time to reiterate your value proposition and commitment to service,” it says.
If you are comfortable with your fee schedule as it stands, that’s fine; but now that you know how you compare with the competition, you’ll be better prepared—and therefore more confident—to discuss and stand firm on your fees if clients or prospects attempt to negotiate.