Convert your practise to fee-based

By Marc Lamontagne | June 1, 2009 | Last updated on June 1, 2009
7 min read

In our rapidly evolving industry, with stiff competition from the banks and ever-increasing demands from clients (not to mention decreases in revenue brought on by the extended bear market), many fi nancial advisors have decided it makes good sense now to transition their practices to the fee model.

Even though advisors understand the rationales, there are perceived obstacles that need to be overcome— the largest being a lack of confi dence that clients will agree to pay for advice they, up to now, regarded as being free.

Compared to most professionals, we have fairly unique relationships with our clients that are based on advice and trust. And, because of this trust, clients are prepared to pay for value. People are conditioned to see the value of services other professionals provide every day: They have no problem paying to get their cars fi xed, or their teeth cleaned. So, be prepared to hear your clients say yes when you lay out your transition-to-fees proposal, because in the end you do a lot more than the other professionals they deal with.

Have a Plan The same way you produce a fi nancial plan for your clients, you should produce a business plan to guide the transition over to the fee model (see “Planning Ahead?” below).

There are two parts to planning a transition. First, take care of structural issues such as what bespoke services you’ll provide, your fee schedule, and how quickly you expect to transition your practice. On that last point, according to the 2009 Fee Advisor Survey by To Fee or Not to Fee, 50% of advisors going through this process will transition only one or two clients a month, and may never get to 100% fees.

A U.S. fi nancial services research firm, Cerulli Associates, first identifi ed this migration process (a very slow and steady transition). They opined it could take up to three years for a fi nancial advisor to reach just 40% of revenue in fees.

But at this point, the benefi ts of the fee model would begin to be appreciated by the advisor, pushing him or her to convert the rest of the practice in far less time. On the other hand, more experienced and successful advisors are more likely to have a formal transition plan, moving on average six to 10 clients a month, and reaching 50% of fees within 12 months.

The second part of the transition plan centres on the communication plan—how and when you will approach your clients. Face-to-face meetings work best, as opposed to e-mails or other types of written correspondence.

To smooth the process, you’ll want to develop and rehearse a script that outlines the reasons for the change and the advantages it brings the client. You’ll also want to prepare a handout package that includes your fee schedule, a letter that mirrors your script, and most importantly, third-party articles that talk about the benefits of dealing with a feemodel advisor.

How Do I Set My Fee? The three main obstacles advisors face at the beginning of the transition are how to set their fee levels, where to start the transition with existing clients, and determining whether they’ll face a decline in income. Advisors can get answers by doing a segmentation and profitability analysis of their books of business. A profitability analysis allows an advisor to test-drive various fee levels and types of fees—such as whether to separate planning and portfolio management fees. Essentially, this tool lets an advisor look at each client as a stand-alone business (see “Determining Factors,” below ).

Other fee-setting influencers include an advisor’s knowledge and years of experience, an estimate of the hours worked to provide each service being paid for, and an understanding of what the market will bear.

Managing Your Clients When making these transitions, the natural tendency is to start with toptier clients, because they’re the most likely to benefit from the change. But if you start with your high-end clients, and are not as rehearsed with your presentation script as you should be, you may stumble out of the gate. Likewise, if you start with your low-end clients (who are the least likely to convert), you may end up discouraged and scrap the process.

So, start with your middle clients, or the low end of your target market, so it won’t be a tragedy if you mess up a bit. Talk to the clients you’re most comfortable with and listen to their objections. Use your experience to build your confidence as you work your way up to the A-list.

Once you arrive at the top, start talking with the middle to the bottom tiers. Due to the fact that your practice has gained you confidence, many of your lower-end clients may convert just through your sheer enthusiasm with the new business model. Remember, you are converting clients, not a block of business. Approach each as an individual, one client at a time.

Present the Benefits In the client meeting, explain what brought you to move to this new model— perhaps it was the inherent conflict of interest and lack of transparency in the commission-based model. Talk about the trends in the industry, how there is a shift toward fees. Tell the clients why this model gets them more of your attention.

You can also discuss the costs and time involved with running your practice. Your clients understand you’re operating a business and are allowed to make a profit.

For instance, you may adopt a tiered basis-point fee schedule, under which you charge clients more on the first tier of assets, but less on the next tier, and so on. You’ll certainly be able to justify this change by explaining that up to this point you have been underpaid for smaller clients and potentially overpaid for larger clients.

It’s important to emphasize this is a win-win arrangement, because you may have fewer clients and can spend more time with each. Mention the structured process, your service standards, or enhanced tiered services. Your clients should see they are getting something, otherwise, why should they bother?

Even if the new fee structure ends up costing the client more, you want that client to focus on the idea of fee for value. While raising the subject of cost in the middle of a bear market might be difficult, there’s no reason to delay implementation with new clients. As for existing clients, it’s best to judge each as an individual and wait a bit if you think it’s prudent.

Another area to look at is the potential cost savings. Fee advisors have much more control over pricing compared to their asset-based and commission- based colleagues. This often leads them to use lower-cost products, such as index funds and ETFs. So, combine a transparent compensation system that eliminates any product bias with lower cost to the client, throw in the potential tax deductibility, and the transition is pretty much a slam dunk!

Overcoming Objections It is, of course, human nature for clients to question your reasons for a change to a fee business, so be prepared for this.

Review the benefits in your mind as many times as necessary. It’s crucial that you are convinced you’re doing the right thing. Talk to other advisors who are doing the same thing to get comfortable with the planned change. By the time you start talking to your clients about converting, it should seem second nature to you.

Ultimately you must believe what you’re doing is the right thing for both you and the client. There will be some clients who won’t take you up on your offer. Don’t force the issue. If they don’t want to switch right away, it may be they just need time to adjust to your new way of doing business. You can try again in six months.

You also need to be prepared for more work during the transition period: Meet clients to explain the new concept and sign a new engagement letter; move the assets to a fee-based account; perhaps introduce new services. One-third of advisors going through a transition will also make additional changes to their practices, such as changing custodians.

Will My Income Decrease? Contrary to popular lore, a large percentage of advisors don’t experience a drop in revenue during these transitions. This may be due to a slow migration or because the adoption of the fee model has turned formerly unprofitable clients into profitable ones (see “Recovery Time,” below).

Any percentage drop in income, and the time needed to recover, will depend on the current structure of your business and the execution of your transition plan. I’ve seen financial advisors take from a few months to three years to convert to 100% fees. A reasonable goal is to be back to your starting income within two years or fewer.

I’ve yet to see a case where income never recovered. Nevertheless, advisors still look at converting to the fee model with uncertainty because of this possible temporary drop in income. In your case, though, you’ll have the advantage of planning for it ahead of time.

Marc Lamontagne, CFP, R.F.P., FMA, is a fee-based financial planner with Ryan Lamontagne Inc. in Ottawa and author of To Fee or Not to Fee.

Marc Lamontagne