Why only 14% of RIAs volunteer complete pricing information to clients and why selective fee disclosure is not a winning strategy

Brooke’s Note: Jack Nicholson made the phrase famous in “A Few Good Men” but on some level we all live by the words “You can’t handle the truth”. What better reason to tell white lies, untruths or — that tried-and-true go-to — simply not bringing certain things up? Kids have long used that strategy when dealing with their parents. Many advisors are no better than kids in this regard. Why bring up all those layers of expense you charge that include not only what you charge but that TAMP you use and, oh yeah, the fees that the mutual funds use inside the TAMP? Why have that thorny discussion when it needn’t happen at all, especially with old Mrs. Jones? Well, here Jack Waymire takes on Jack Nicholson and gives good reasons why clients can handle the truth and a little about what can be done to make fee facts more palatable.

Advisors need to do a much better job educating investors about their compensation, the cost of their investment recommendations, and the value investors receive for their money when dealing with an investment advisor.

Here’s how we know: A recent survey conducted by our firm, Paladin Advisor Research & Registry, of 100 RIAs and IARs found that a mere 14% voluntarily discussed their method of compensation when marketing financial advice and services to investors, and a majority said they tried to minimize discussion about these topics. See: How RIAs can maximize their web marketing with nary a 'friend-ing’ or tweet.

In fact, a lot of advisors are so concerned about what they make that they withhold total expenses from investors, thereby increasing confusion and reducing their credibility.

It’s the advisor, not the fees

When we asked 421 investors about advisor compensation, a whopping 80.7% said they were “most concerned” about the various fees and commissions that were deducted from their accounts. An even higher percentage — 86.2% of those investors — said they were “very confused” by the array of expenses that were deducted from their accounts.

When dealing with multiple advisors, investor bewilderment only intensified: Only 18.8% said they were comfortable comparing the combined expenses of multiple advisors; there were too many different fees, bundled fees, sliding fee schedules, wrap fees, types of commissions, and a variety of minimum fees.

By contrast, only 47.3% of investors said they were “concerned” about the percentage of the combined expenses that was paid to advisors.

But here is perhaps the most surprising result of our survey: When multiple advisors proposed various combinations of investment expenses, only 26.3% of investors said they selected the low-cost service provider and 66.3% said they selected the advisors they trusted the most.

The bottom line is that a lot of advisors are so concerned about what they make that they withhold total expenses from investors, thereby increasing confusion and reducing their credibility. They are missing the forest for the trees: The majority of investors do not care how much advisors make as long as the total expenses deducted from their accounts are reasonable. See: Morningstar gives advisors a glimpse of fees RIAs are charging clients using PriceMetrix data.

Having 'the conversation’

Consequently, a key marketing tactic in differentiating yourself from brokers and from other RIAs is to create trust that tips the scale in your favor by doing what your competitors are not willing to do — provide complete, accurate information about expenses and how you are compensated.

It can start with giving prospective clients five reasons why they are better off paying fees for your financial knowledge, advice and services. In doing so, you will be educating them about the appropriate way to pay for financial advice, your expenses and why they should trust you, all at the same time. See: What exactly is an RIA?.

1. Why select a financial fiduciary?

You are an RIA or an IAR. These registrations permit you to provide financial advice and ongoing services for fees. This is the foundation of your business model. The frosting on this particular cake is that RIAs and IARs are financial fiduciaries. Consequently, you are held to the highest ethical standards in the financial services industry.

The combination of ongoing advice, highest ethical standards and fee for service is a very compelling package — but not one that investors will necessarily grasp on their own. See: Veteran Merrill Lynch manager leaves seven registrations on the table to return to his pure-RIA roots.

2. What services do you provide?

Investors should know exactly what they get when they pay you. For example, they pay a fixed or hourly fee for a financial plan. Or, you wrap the planning expense into your asset-based fee. Make sure you describe all of the services that the investors receive for the monies that are deducted from their accounts: planning, investment advisory services, money management, custody and transactions. By fully disclosing fees and expenses, you are building a solid foundation for a lasting relationship.

3. The link between continuous services and continuous expenses

Investors do not need one-time services; they need continuous advice and services that help them achieve their long-term financial goals. These services can be divided into two categories: investment advice and servicing (meetings and reports). Continuous investment services include: strategy, asset allocation, manager selection and risk management. Servicing includes: performance reports, quarterly meetings, brokerage statements and investment outlooks. These services and reports justify the payment of a continuous advisory fee. Only RIAs and IARs are allowed to provide continuous advice and services. This is a major education opportunity: Only 18.3% of investors we surveyed made the connection between continuous services and specific continuous expenses.

4. The case for asset-based fees

There are four compelling arguments for asset-based fees.

1, Commissions are paid to advisors at the time of the sale and before any services are provided to investors. Let’s call it “paid in advance.” Fees, on the other hand, are paid at the beginning or end of each quarter, so it is “pay as you go.” Advisors who are paid in advance have no economic incentive to provide ongoing advice and services. See: How the new 12b(1) fee restrictions could transform the financial advisory industry.

2. Your fee goes up and down with the market value of investor assets. Your clients’ assets must increase in value for you to make more money — not counting reinvested income and contributions. You, therefore, have a major economic incentive to increase the market value of your clients’ assets. See: The SEC needs to clean up its semantics before accusing RIAs of inflating AUM.

3. Then there is the 99:1 ratio. If your fee is 1% and the market value of your client’s assets increases by $100,000, your client makes $99,000 and you make $1,000. This division of market appreciation creates perspective for your 1% fee.

4. Your compensation stops if your results do not meet investor expectations (performance, risk management, servicing). This is a compelling argument for why investors should pay fees. Advisors who are paid in advance have no consequences for failure to meet the expectations that they created during the sales process.

5. Conflicts of interest: Why you work for the client

A lot of advisors we work with tell investors “Professionals who work for fees have fewer conflicts of interest”. But, they do not take the extra and crucial step of explaining exactly what those potential conflicts of interest are. As an example, advisors who are paid by investors work for investors. Advisors who are paid by third parties (broker-dealers, mutual fund companies) work for themselves or the third parties.

Three additional points drive this point home for investors:

1. You are required to put the interests of investors (e.g., achieving their goals) ahead of your interests (producing revenue).

2. Your advice does not affect your compensation.

3. Finally, the interests of third parties do not affect your advice the way, for example, a B-D that holds securities licenses may influence or control advisor recommendations.

Jack Waymire spent 28 years in the financial services industry. For 21 of those years he was the president of an RIA that provided advice and services to more than 50,000 individual and institutional investors. He is the founder of Paladin Registry (https://www.paladinregistry.com/for-advisor/about-us) that provides free tools and information to investors who use the services of financial advisors.