Is It Time to Transition to a Fee-Based Practice?

For many advisors, the Department of Labor’s Conflict of Interest Rule has provided impetus to move current commission-based accounts, especially qualified ones, to managed account relationships. Of course, you cannot use the rule as a rationale for making this move, and there are many instances where commission-based or brokerage accounts make more sense for clients than fee-based ones. For example, smaller accounts and those where the client does not plan to invest his or her monies over a long period of time are cases where the cost of brokerage might be less than in a fee-based arrangement.

Still, if you are thinking about making the transition to a fee-based practice, there are many factors to consider.

A win-win. “Alignment of interests” and “same side of the table” are two phrases that exemplify how a fee-based practice can be advantageous for you and your clients. For example, let’s say your clients’ assets go up at the end of the quarter. You will collect a higher fee than when you first brought on the clients, and they will be happy since they’ve made more money. On the other hand, if clients’ assets go down at the end of the quarter, you would collect a lower fee than when you started with the clients. Your clients may not be pleased that they’ve lost money, but at least they will end up paying less in fees to you.

Objectivity. In a fee-based practice, you have the opportunity to make unbiased decisions about which investment products to use. You don’t need to consider loads and share classes, and lowest-cost investments are available for use.

Predictable revenue. Since an AUM fee is charged in a fee-based practice, an annuity-like stream of income will be produced. Compare this with a commission-based model, where uneven and many times unknown revenue streams are the norm.

Valuation. When you go fee-based, your business may actually be more attractive to prospective buyers when you’re ready to retire. Why? The predictable revenue stream.

Pricing flexibility. Once you transition, you can structure your fee schedule to reflect the level of work you provide to each client. You can also decrease or increase your fees over time.

Stronger relationships. Because of the variety of reasons listed above, you will have the potential to increase your scope of services and possibly increase referrals.

Lest you think the decision to transition to fees is all about you, clients in managed account relationships will also see a slew of benefits.

• They won’t need to make an up-front load commitment to do business with you.
• The fees and charges they pay will be more predictable; they will be charged a set AUM fee on a quarterly basis versus commissions when specific products are bought and sold.
• They will have access to institutional share class investments.
• There is greater investment flexibility. Advisors and clients have access to more investment vehicles in a fee-based account, such as stocks, bonds, and exchange-traded funds.
• During volatile markets, they may experience more cost savings than a client in a commission-based account due to the advisor’s ability to make changes to the portfolio without loads or other commissions.

Of course, there are also cons you should consider. For example:

• With smaller accounts, the AUM fee charged in a fee-based account can end up being higher than what a client would pay in a commission-based account.
• With a fee-based account, clients will be charged a fee regardless of whether they received any advice from the advisor. (So be sure you are explicit about your services, so clients know what to expect.)

In a nutshell, the focus shifts to the whole financial picture. While a commission-based approach is typically focused on specific investment products, a fee-based approach can take a more holistic approach to financial planning that may help your clients reach their goals.

If you’ve determined that a fee-based account is best for your client given his or her current financial situation and goals, let’s examine how you might transition some or all of your client accounts. In The Why and How of Switching to a Fee-Based Practice, the SEI Advisor Network has come up with steps for making the transition to a fee-based practice, which I’ve summarized below.

1) Evaluate your business. Here, you’ll want to ask yourself a few questions, including: 

• What traits define your ideal client?
• What parts of your job do you like the most? The least?
• How many clients can you and your staff support?

2) Determine the value you bring to the table versus competing advisors. Make no mistake, the client’s perception of you will be affected by your business model, so you'll need to highlight your skill set accordingly. If you are a commission-based advisor, you may be seen as a: 

• Stock, fund, or manager picker
• Product provider
• Salesperson
• Presenter

As a fee-based advisor, on the other hand, you might be viewed as a: 

• Big-picture planner
• Problem solver
• Consultant and advisor
• Listener

3) Decide how you want to manage fee-based assets. Specifically, do you want to handle these tasks yourself, or would you prefer to outsource?

4) Establish a timeline for the transition. You’ll need to think about how long it will take to move the bulk or all of your commission business to fee-based business. Keep in mind that you want to minimize the disruption to your long- and short-term cash flows.

5) Assess your staffing needs. Transitioning to fee-based accounts will inevitably add to your office's workload. Do you have the appropriate staffing to handle these additional tasks?

6) Select which clients should be transitioned first. Will you transition smaller clients first or larger? New or established? Low maintenance or high maintenance? Segmenting your book of business will help ease the transition for you and your clients.

7) Plan your communication strategy. When discussing this change to your clients, highlight the benefits noted above in both client-facing communications and in your face-to-face meetings. It might also help to discuss a potential fee schedule based upon assets invested by the household. This will help clients see the difference in costs to them associated with commission-based versus fee-based accounts.

8) Execute the transition. Put the above steps into place, monitor as you progress, and tweak the process as needed.

There’s no doubt that the industry is moving toward a regulatory environment that will demand fee transparency, fiduciary standards, and more holistic financial planning practices. Given this trend, the fee-based way of doing business makes sense, and it could be the right choice for your business and clients.

Has the DOL rule made you think of making the transition to a fee-based practice? What are the pros and cons of moving away from a commission-based model? Please share your thoughts with us below!