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Michael Kitces names his price for RIAs to charge the other 80% of investors and it's a 1% fee but on income, not 1% on assets under management

The Columbia, Md.-based guru and entrepreneur sees a seminal shift in the industry -- and a life raft from dependence on the AUM fee model -- because a critical statistical mass of advisors are converging on a rate where consumers see value

Thursday, February 14, 2019 – 11:39 PM by Guest Columnist Michael Kitces
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Michael Kitces: The AUM model happens to be remarkably robust and scalable… it doesn’t work when all financial advisors converge on the same model at the same time!

Brooke's Note: Everybody talks about working with millennials. Stupidly, it seems, the conversation digresses into psychobabble about what millennials want. What they want from a financial advisor, it seems, is someone willing to offer a useful service at a price they can afford from a source of funds that they can access. Go figure.  Strangely, the price usually came down to 1% to 2% of assets annually-- about the norm in an AUM model all these years. The key difference now: Some advisors are charging a fee that works out to 1% on income. So, when I saw this all spelled out in a column written by Michael Kitces, I wasted not five seconds emailing him to see if we could run it on RIABiz. We bought the article at his standard syndication rate, and I did so on the condition I could interview him to put a little more context around why this seminal piece is appearing now. The short Kitces answer: "It's holding up empirically." Though virtually no advisors actually market a 1% fee on income, many are charging fees to low asset, high-earners (and some low earners) that, upon inspection, fall squarely on, or near, the 1%-of-income mark. Kitces's sample derives largely from the 863 advisors in his XY Planning Network, but also from other research, he says. One caveat to all this blue-ocean thinking is that Kitces has financial incentives to green light this market. It's not only another lure for XYPN but planning fees also drive revenues for his software firm, AdvicePay. See: Funded to the teeth by RIAs, Michael Kitces and Alan Moore now have a second big play--modernizing plan payments--and broker-dealers are beating down the door Kitces, himself, offered an additional caveat for RIAs who get paid based on income for clients with no assets to manage. "What do I do with them?" His answer is that while conventional planners deal with three events typically for boomers -- illness, retirement and death -- millennials tend to have events every six to 18 months including births, divorces and aging parents. So, yes, advisors need to be trained for the trials of the suburban warrior. But that is doable and opens a market of the other 80%. The shift is from a business where certain wealthy people get fiduciary care to one where the RIA business can start talking about giving fiduciary care to the society of investors and wage earners as a whole.

The Assets Under Management (AUM) model has experienced a tremendous growth cycle over the past 20 years, as the entire advisory industry has increasingly shifted from its commission-based roots to an AUM-based model instead.

From the explosive rise of the independent RIA channel to more than $4 trillion in assets, to the recent crossover in Financial Planning magazine’s tracking of the top-50 Independent Broker-Dealers that now generate more of their revenue from fees than commissions, it seems the entire industry is shifting to the AUM model.

Which isn’t entirely surprising, given both the AUM’s reduced conflicts of interest (at least compared to a commission-based model), the superior scalability of building a recurring-revenue-based advisory firm, and the appealing combination of being both a transparent pricing model for consumers but also a low-saliency one that doesn’t amplify fee sensitivity.

The caveat, however, is that the AUM model doesn’t work for everyone.

By definition, in order to charge a percentage of assets under management, the prospective client needs to have assets available to manage in the first place. And if an advisor can only manage about 100 households in an ongoing financial planning relationship, the advisors needs to generate at least about $1,000 – $2,000 per year in fees [per client], to have reasonable advisor compensation after business expenses (given the risk of running an independent advisory business in the first place).

Which helps to explain why most financial advisors only work with households at least wealthy enough to be part of the “mass affluent” – those with at least $100,000 of net worth (outside of their primary residence). A 1%+ advisory fee will generate at least $1,000/year in fees to the advisor to support the relationship.

Traditional AUM model
How an AUM model restricts an advisor's client base

And according to market sizing estimates from industry researcher Spectrem Group, that means advisors can only effectively work with the top one-third of households or so. An estimated 31 million households are mass affluent, plus another 10 million that have at least $1M in net worth, and 1.5 million more that are ultra-high-net-worth ($5M+ net worth), out of a total of nearly 120M households in the US.

Of course, the caveat is that not all of that net worth is necessarily held in the form of a liquid investment account that an advisor can actually manage. In some cases, it may be illiquid (e.g., the value of a small business). More often, though, it’s simply not available to be managed because it’s tied up in an employer retirement plan, and the individual is still working!

If we assume these constraints represent half of all the households that meet the definition of mass affluent (or higher), it does still leave about 21 million households that financial advisors can serve with the AUM model.

However, not all of those households necessarily want to work with an advisor! 

Limits on the AUM model 

Nearly 20 years ago, Forrester research segmented consumers into three distinct categories: self-directed investors (“soloists”) who tend to do it themselves; “validators” who do a lot of their own research but may also seek out a professional advisor for some support (to “validate” their current plan); and “delegators” who prefer to just pass the buck entirely to a financial advisor.

Or in advisor terms, there are good clients (delegators), clients who will never work with an advisor (do-it-yourselfers), and problem clients (validators who have a tense relationship with their advisors because they didn’t really want to turn over their portfolios but it was the “only” way to get access to the advisor).

With delegators estimated to be no more than one-third of consumers, only about 7 million of the 21 million remaining households who might have the liquid investable assets to work with a financial advisor will actually want to turn them over (i.e., delegate them) to an advisor!

Defining the marketplace of investors

Given that Cerulli Associates estimates only about 311,000 financial advisors in total  are available to serve those roughly 7-million households… it means only about 23 AUM-fee clients are available per financial advisor in the marketplace, of which (only) 5 will be millionaires!

In the past, these limitations on the size of the mass affluent (and wealthier) marketplace weren’t necessarily as problematic for financial advisors. That's because advisors served a wider range of clientele under the commission-based model than “just” those who had at least $100,000 of liquid investable assets.

But ironically, while the AUM model happens to be remarkably robust and scalable… it doesn’t work when all financial advisors converge on the same model at the same time!

Expanding the AUM model to AUA and net-worth billing

While the AUM model can be effective to provide financial advice for those who have investment assets to be managed, the big caveats – as noted above – are that even if clients otherwise have the financial wherewithal to pay (i.e., they have the net worth outside of their primary residence), they don’t necessarily have a liquid investment portfolio to transfer, and/or don’t want to transfer it just to receive financial advice.  That's because they want financial planning advice outside of the portfolio itself, or simply want professional validation of the research they’ve been doing themselves.

In recent years, this has opened up a new advisor business model: Instead of charging 1% on the investment assets being managed, charge 1% on all of the assets being advised upon.

An “Assets Under Advisement” (AUA) charge no longer has to be constrained to liquid investable assets and doesn’t require the client to liquidate or transfer the portfolio directly to the advisor’s management in order to receive advice on it.

Thus, the model opens up a large segment of consumers who aren’t self-directed, but couldn’t be effectively serviced under the AUM model!

For some clients currently on the AUM model who may not have actually wanted to turn over their portfolio – i.e., they were validators who reluctantly agreed to their AUM model because it was their “only” choice – there may be a competitive opportunity to attract AUM clients away to a more holistic AUA relationship.

But the real opportunity of the AUA (i.e., a percentage of net worth) billing model is the potential to attract that sizable swath of the pie who have the net worth, but never had the liquidity (or the inclination towards delegation) to hand over the portfolio to be managed in the first place.

Advisers vs. clients. 

In other words, the opportunity of the AUA or net worth billing model is not to compete against the AUM model, but to open up adjacent opportunities to work with clients who would have never bought into (or literally couldn’t buy into) the AUM model to begin with.

Notably, when the base of assets being advised upon expands (from “just” the managed portfolio to more of the client’s entire net worth), in practice the model may no longer specifically rely on “1%” as the benchmark fee.

Instead, to the extent that other assets come into the mix – from businesses to investment real estate to outside 401(k) plans, which increases the potential asset base – the feasible advisory fee can be a smaller percentage, while still generating the requisite revenue per client.

For instance, charging 0.5% of net worth instead of 1% of investable assets still generates the same revenue per client, if the client’s managed portfolio was, on average, “just” half of their total net worth.

Unfortunately, though, the process of billing on total net worth and assets under advisement can be messier, because there aren’t automated systems to facilitate the valuation and invoicing and billing of net-worth-based fees the way there is for portfolio-based fees under the AUM model.

Dissecting the client market

In addition, the challenge arises that clients have a financial incentive to not fully disclose all of their assets under the net worth model. As with the traditional AUM model, if the client wants the account to be managed, the advisor will obviously know about it, be able to see it, and interact with it (to manage it), and can then automate the data feeds to properly calculate the fee and bill on it.

With a net worth model, on the other hand… if clients believe they don’t “need” advice/help with that asset – for instance, an idle piece of undeveloped family land that they don’t plan to do anything with for a long time, anyway –  a temptation exists to not disclose it in order to avoid having it billed upon. Some advisors address by deliberately excluding “idle” assets (like a primary residence) from the fee, but that, in turn, further adds to the complexity of the billing process.

Similarly, some assets may be difficult to value (in order to assess a fee as a percentage of the value), such as a closely held family business. And clients may again resent being billed on increases in the value of their business, outside of the scope of their “personal” financial planning advice relationship.

The fact that advisors under a net worth model can get “paid” for charging on a client’s total net worth, including the value of a business, creates new incentives to give more holistic advice on the business (and other aspects of the client’s balance sheet) in the first place, potentially opening up new value-added services.

After all, the irony is that despite the overwhelming impact that an entrepreneur’s business can have on their long-term financial success, the CFP Board’s Topic List doesn’t even include “business consulting/advice,” outside of just doing business-related insurance products like buy-sell agreements and employee benefits!

In the past, financial advisors couldn’t effectively get paid for holistic business advice by charging on just portfolios and commission-based products… but can, with a net-worth-based AUA fee!

Further expanding the pie by billing 1% of income instead of 1% of assets

The appeal of an AUA-style model-- of billing a percentage of net-worth--is that it expands the available market of consumers… but it still is limited to only the subset of households that are at least mass affluent, with more than $100,000 of net worth outside of their primary residence on which an asset-based (net-worth-based) advisory fee can be assessed. And, while that’s a sizable portion of the total market… it still ignores the other roughly two-thirds of the pie that simply do not meet the net-worth definition of “mass-affluent” in the first place!

The advantages of an AUA fee structure

Of course, the reality is that to give financial advice and get paid for it, the client must have some financial wherewithal to pay for the advice – which is why financial advisors have typically worked with more affluent clients in the first place.

But the fundamental problem with the traditional approach – in essence, various forms of balance-sheet-based billing (on either “just” investable assets, or a broader slice of the client’s entire net worth being advised upon)--is that it completely ignores the fact that many consumers could simply pay for financial advice directly from their income instead!

The quintessential example would the young doctor, or lawyer, who has finished school and begun their professional career, and may be earning a substantial $250,000 annual income… but also has a 6-figure student loan debt, and won’t have any portfolio to manage – or even a positive net worth – for a long time to come.

But with a healthy, six-figure income, such an individual could easily pay 1% of their income to receive financial planning advice about that student loan; budgeting their now-substantial income; planning for a future wedding and merging household finances with a future spouse; saving for a house; negotiating a mortgage; starting college savings plans; buying life insurance when children arrive and navigating all the other life changes that may impact their finances in the coming decade. Not to mention advice about their career, including employee benefits decisions, handling salary negotiations, choosing whether to work for a large firm or go independent, etc.

Of course, many clients who have high income also have a substantial net worth. But the fact that some individuals have a healthy income but not substantial net worth yet – known in the industry as “HENRY” clients, short for “High Earner, Not Rich Yet” – suggests that an additional portion of the prospective client pie may become unlocked by simply allowing them to pay for advice from their income (because they do have the financial wherewithal to pay), instead of assets they haven’t accumulated yet.

In other words, rather than simply taking on such high-income-low-asset individuals as “accommodation” clients, the opportunity of the 1%-of-income model is to proactively charge them for real (and profitable) advice. For example, the 1% fee generates revenue of $2,500 per client, or $200 an hour, as long as the advisor “only” spends 12 hours per year (an average of 1 hour per month) interacting with the client and providing ongoing advice.

Tiering income-based advice fees: From HENRY to EWAN

An important caveat to the proverbial “advisors charge 1% fees” is that, in practice, not all advisors charge 1% to all clients.

At least some fee variability exists from one advisor to the next, based on the depth and breadth of services (e.g., some advisors charge less than 1% for investment-only services; others charge more for comprehensive wealth management services). Fees, themselves, are also typically tiered based on the client’s available assets to manage in the first place, with a median fee of 1.3%, to a 1% fee on a $1M portfolio, scaling down to a fee of 0.6% on a $5M+ portfolio.

Tracking average AUM  fees by investable assets.

Similarly, percentage-of-income fees would likely scale as well, with higher fee percentages on lower incomes, and lower fee percentages at higher income levels.

For instance, an advisor’s income-based fee might start at 2% per year for lower income clients, reaching 1% of income for higher income individuals, and dropping below 1% for the highest income individuals.

Given a median household income of just over $60,000/year in the US, a 2%-of-income advisory fee would generate a minimum revenue per client of $1,200 per year, enough to support several 1-hour interactions (in-person meetings, or phone calls, or video chats) per year to provide clients with ongoing advice.

The fee is similar to the revenue-per-client, an advisor would generate with a $100,000 asset minimum.

As income rises from there, the client becomes even more economically viable for the advisor to service more deeply.

At $100,000 per year of income, the advisory fee would be $2,000. And, the advisor could add subsequent breakpoints – such as dropping the fee to 1.5% of income above $100,000 per year, and 1% on income above $250,000 per year (although the blended fee, at that point, would already be $4,250 per year from the lower income tiers). The fee structure would be akin the fee breakpoints typically applied to AUM fee schedules as assets rise.

Or alternatively, the advisor might just have a 1%-of-income fee with a minimum income of $400,000 per year and focus on working with more affluent HENRYs (just as some advisors work with more affluent higher-asset households).

But even with “just” an average fee of $2,000 per client, working with 100 clients, there’s a potential for $200,000 a year in revenue for what, otherwise, would be an extremely low-cost-to-service clientele. The advisor wouldn’t even necessarily need the (relatively expensive) software tools to manage portfolios today.

The impact of tiered, income-based fee structure.

The advisor would predominantly just be paid for their time to actually give the advice – at what still amounts to a very healthy hourly rate and an above-average take-home income for the typical advisor!

The upshot of this shift to a percentage-of-income advisory fee, and especially one that is tiered (to make it more economically feasible to service clients further down the income spectrum), is that it shifts the income-based model even further down the income spectrum, from the HENRY (High Earner, Net Rich Yet) to the EWAN (Earner Wanting Advice Now)!

While a $1,200-per-year (or $100 a month) advice fee might seem high to a middle-income household… the reality is that even middle-income households can easily make a financial mistake that costs 2% of income. Thus, paying a 2%-of-income advisory fee to help make better decisions about the other 98% is still a net positive.

Such households will already pay a similar $1,200 commission for “just” rolling over a modest $24,000 IRA (into a 5%-commission A-share mutual fund).  For their money, the consumer often receives no more than a single implementation meeting to complete the transaction (without any ongoing advice). And, the fee can be broken down to a simple monthly subscription fee (e.g., $100 per month) that can be billed automatically to their credit card or bank account.


Ultimately, the key point is that while a shift from the AUM model to the AUA model (charging a percentage of assets under advisement, or a fee based on a percentage of the client’s entire household net worth) does begin to expand the reach of financial planning advice, it still remains largely concentrated among the top one-third of households who are at least “mass affluent” with more than $100,000 of net worth outside of their primary residence.

How an AUA model expands the client pool.

However, a shift from charging 1% of assets under management, or net-worth, or assets-under-advisement, to charging 1% of income, fundamentally opens a wider portion of the marketplace, to not only the HENRYs, but also the EWANs, who simply want to pay for at least some advice, directly from their income.

Of course, the caveat to all of these models is that advisors must actually have the training and experience to actually provide value for their advice fees.

Especially in a world where advisors charge clients a percentage of income rather than of a portfolio… placing the focus solely and entirely on whether the advisor’s advice is really worth the fee being charged.

On the other hand, the fact that the advisor would be paid primarily, or solely, for his/her advice and time creates the potential for significant operational leverage and efficiencies to make even middle-income clients profitable… and in the process, expand the true reach of financial planning advice!

Michael Kitces is a Partner and the Director of Research for Pinnacle Advisory Group, co-founder of the XY Planning Network and AdvicePay, and publisher of the financial planning industry blog Nerd’s Eye View. You can follow him on Twitter at @MichaelKitces.

To read the original article on Nerd’s Eye View, click here


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Top Executive: Michael Kitces




Brian Murphy

Brian Murphy

February 16, 2019 — 8:42 PM
Clever-er by a 1/2! Seems like the goal of the work behind these industry gurus is NOT to serve a bigger client base, but to a) serve a larger client base while b) continuing to justify similar compensation to themselves. So we jump through a bunch of hand-waving and impracticalities to arrive at "a new model" that opens up the market to a broader population. Did it ever occur to any of these gurus that fees (whether charged on managed assets only, or including illiquid assets) have to come out of liquid taxable funds? That, in and of itself, throws the biggest monkey-wrench into this mental exercise...the "take" by investment advisors has to come out of liquid assets - regardless of how you wish to bill. If you wish to broaden the market - the only answer is the most obvious; move from Asset based fees to a pure subscription model. Unfortunately for the industry of today, the only way to do that is through increased use of technology, and means a "winner take all" market.
brooke

brooke

February 16, 2019 — 9:48 PM
Brian, Surely the Kitces fee model in question is fledgling in many respects but not for lack of his explication and a basis in his experience. It doesn't seem fair to label an act of guru hand-waving. Meanwhile, I am curious what you mean by "pure subscription model"? And an 'increase (of) the use of technology'? And who do you imagine is the 'winner that takes all'? It seems like if we've learned anything in the in-process RIA take down of Wall Street it's that each RIA is a snowflake and that investors like it that way. Technology has yet to talk an investor off a ledge, right? Do you see evidence that suggests otherwise? Cheers, Brooke
Steven Draper

Steven Draper

February 15, 2019 — 4:15 PM
The statement: “Unfortunately, though, the process of billing on total net worth and assets under advisement can be messier, because there aren’t automated systems to facilitate the valuation and invoicing and billing of net-worth-based fees the way there is for portfolio-based fees under the AUM model.” Understandable, but there is a new technology solution - <a href="http://www.eton-solutions.com" rel="nofollow">www.eton-solutions.com</a> - for the valuation and invoicing and billing of net-worth-based fees. It also uses special Assets-Not-Held at a custodian accounts to allow the holding, pricing and reporting of non-investable assets. These two approaches combined help facilitate true net worth based servicing.
Brian Murphy

Brian Murphy

February 16, 2019 — 10:38 PM
Any solution that solves a problem by adding additional barriers to overcome is not well thought out, regardless of who it comes from. I have nothing against Mr. Kitces (or anyone else) and from what I understand he'd be considered something of a guru in this business - so that's where "guru hand-waving" came from. Nothing more. AUA is not a viable solution for a number of reasons as mentioned both within the article and in my prior response. That said, I'm perfectly comfortable with other's pursuing short-sighted solutions meant to keep the game as it's currently being played intact. It just leaves the table open for real innovation when it comes along. The facts are that only 20% of the U.S. household population has more than $100k in savings...40% have nothing and 40% have up to $100k. So on that front I agree - today's solutions aren't viable for the majority. The way you reach these people is not through human advisors - human advisors don't "scale". You reach them via subscription technology that handles everything that needs to be handled. Wealthfront and Betterment started down this path - but their businesses are poorly thought out; hence they end up creating services that a) compete headon with one another and b) can easily be replicated by any incumbent and c) "rides" on existing business models - just at lower cost. There is no reason from the client side of the equation for any sort of AUM fee. It's a completely contrived model created by the industry to make human advisors economically viable. Technology will change the prevailing business model from AUM to SaaS. The "winner take all" solution has not been launched yet - but I'm working on it. I would suspect others are too, but to date I haven't seen what I believe to be the compelling technology/business model mix that stands a chance of winning. It's a completely open table as I noted previously because when the winner emerges, the industry will be dramatically different within a decade. Sure, human advisors will remain (and perhaps thrive) - but they will have to find a niche. Given $290 billion was spent on investment fees in 2017 I believe, there is ample incentive. To the point that each RIA is a snowflake - perhaps, but I'd again challenge you on that front. Each community bookstore was a "snowflake" before Amazon launched...and each corner drugstore was a "snowflake" before Walmart moved in. Again, no malice intended towards anyone. I just find much of what passes for "innovation" in this industry is mental gymnastics meant to keep the status quo of human advisors/asset based pricing in place - whether those advisors are brokers, RIAs, or robos. Peace. Brian
Alvin Gentry

Alvin Gentry

February 17, 2019 — 8:17 PM
Murphy idea sounds a lot like what Joe Duran is doing at United Capital
Brian Murphy

Brian Murphy

February 18, 2019 — 5:02 AM
@Alvin - To some extent, though not focused on the "life-coaching" side of the game.
Jamie McLaughlin

Jamie McLaughlin

February 18, 2019 — 2:46 PM
There is widespread evidence that clients now value many non-investment service (NIS) components at least as much as the investment components where their performance expectations have been muted by low single digit returns. While firms have been slow to use this latent demand to modify their pricing strategies for NIS-related services, they’ve expanded their service offerings embedding increased fixed costs for their staff complements. This “arms race” is unsustainable and, unless corrected, will systematically erode their margins. Michael may be a little early, but there's no question we are moving from an asset-based fee model to a negotiated fee-for-service model that corresponds to the true cost of the services rendered plus some reasonable markup. The challenge, however, will be for firms to demonstrate their value. No small feat.
David Garcia

David Garcia

February 18, 2019 — 3:24 PM
find enormous value in the services my CFP/RIA provides. That said, the thought that someone considers it reasonable to even suggest charging me based on my net worth or income scares the crap out of me. A 2%/20% is a better value proposition, as bad as that is. If a percent of AUM is not working for the advisor they may need to do what everyone else does without sufficient income: get a second job until a single full-time job can provide an adequate living. We all need to be careful of overestimating our own importance or the value we provide to our employer or customers. A happy client but disturbed observer.
Realist

Realist

February 20, 2019 — 3:33 PM
Charging an advisory fee based on income is the most ridiculous gimmick I've seen yet. As income rises, more money is devoted to CPA's, estate attorneys and insurance companies. It shouldn't be allocated to a financial planner. If anything, a financial planner should be paid a flat fee annually based on the amount of anticipated work. I appreciate what Kitces is trying to do to help the industry, but he is largely out of touch with the reality of what most advisors experience on a daily basis.

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