Executive Summary
Providing financial planning services takes time. A lot of time. By some industry benchmarking studies, the typical financial planner spends 15-20 hours, and sometimes more, just to gather data, analyze and produce a financial plan, and then deliver it to the client. Which means, not surprisingly, that it’s often necessary to charge clients a substantial financial planning fee to recover the time investment. Especially as financial advisors are increasingly shift to AUM fees and other fee-for-service models, rather than earning a (potentially sizable) commission for the products implemented after the plan is delivered.
Yet the reality is that with the rise of the AUM model in particular, and its recurring revenue potential, it’s actually not necessary to charge upfront for financial planning to get paid for it. Instead, as long as delivering financial planning still provides value, deepens the advisor-client relationship, and improves long-term retention, it’s entirely possible to be “paid well” for financial planning without charging for it separately at all. Because even a relatively small change in client retention rates can produce a sizable ROI for putting in the time and effort to do the financial planning in the first place.
In fact, charging separately for financial planning actually introduces the risk that clients will have “sticker shock” about the cost, and choose not to purchase it at all, which means ironically that charging for financial planning can actually reduce the number of clients who engage in it. By contrast, bundling financial planning into an AUM fee changes the client psychology, subtly encouraging clients to take advantage of the service by making it already included… knowing that clients who do engage in financial planning will be more likely to stick around for the long run anyway.
On the other hand, there is a simple appeal to the “purity” of having clients pay for financial planning at the time they receive financial planning. Nonetheless, the reality across a wide range of industries is that it’s quite common to bundle services together, in a manner that makes some clients more profitable and others less so in any particular year, as long as it averages out over time. And at least with a recurring revenue model, it’s the client’s less-time-intensive years that help to cross-subsidize the more-time-intensive ones – as opposed to a commission-based model, which the profitable clients cross-subsidize other clients instead.
Of course, it’s still impossible to offer “free” financial planning, that is paid by AUM fees over time, for clients who don’t have assets to manage in the first place; for those clients, a fee-for-service model is the only option. Yet for those who do have other means to pay, and other business models to reach them, it’s important to recognize how an advisory firm really can “give away” financial planning and still be paid well for their efforts over time!
The Labor-Intensive Cost Of Financial Planning
One of the fundamental challenges of delivering financial planning to consumers is that it’s time intensive. For most financial planners, the process involves at least two long meetings – one for data gathering and discovery, and a second to actually present “the plan” – that can take two hours each. Often there’s at least one additional follow-up meeting for implementation and initial monitoring in the first year. And then there’s the time to actually construct the financial plan itself, which one FPA study found is more than 10 hours for 50% of advisors, and more than 15 hours for 30% of them. Which means all-in, the majority of financial planners are spending at least 15 hours of time gathering data, constructing, and delivering financial plans.
<<<INSERT GRAPHIC TO SHOW THIS. I THINK I WANT TO REPEAT THE GRAPHIC FROM https://qa.kitces.com/blog/is-our-financial-planning-software-improving-our-productivity-or-destroying-it/, BUT REDO IT IN OUR COLORS. I WANT THE SLICES THAT ARE UP TO 9 HOURS TO BE ONE COLOR (E.G., THREE SHADES OF BLUE), THE 10-14 HOUR SLICE TO BE ANOTHER COLOR, AND THE 15+ HOUR SLICES TO BE A THIRD COLOR (E.G., THREE SHADES OF PURPLE?). BASICALLY, I STILL WANT TO ILLUSTRATE ALL THE PIE SLICES WITH DIFFERENT COLORS, BUT I ALSO WANT COLOR-GROUPINGS FOR THE THREE TYPES (<10 HOURS, 10-14 HOURS, AND 15+ HOURS)>>>
And given the reality that this is the time of trained professional financial planning staff, it results in a substantial cost to deliver financial planning. Even if we assume that half the effort is done by a “lead” advisor, and the other half by a paraplanner or support advisor, then given typical financial advisor compensation (assuming the lead advisor earns $75/hour, and the paraplanner is paid $30/hour), a conservative estimate of the raw cost to produce a financial plan is about $750 (and with the cost of financial planning software, and other operational overhead, can quickly exceed $1,000). Which helps to explain why the retail cost for a financial plan to consumers often starts at $1,500 and rises from there.
The time-intensive nature of financial planning also helps to explain why it is increasingly popular for financial planners to charge standalone financial planning fees over the past decade. Because the more in-depth the financial planning becomes – as the industry evolves away from its product-sales roots – the more time-intensive it becomes, which introduces a real hard-dollar staff/labor cost for the advisory firm if the financial plan doesn’t pan out, that can’t just be made up on the next plan.
In other words, when a financial plan was commonly delivered as the lead-in to a product sale, the substantial product commission could help to cover not only the cost of the plan, but even the cost of plans to other clients that didn’t implement. For instance, if a plan was going to lead to a $250,000 rollover into an A-share mutual fund paying 4% - which results in $10,000 of compensation to the advisor – it wasn’t necessary to charge much (or at all) for the financial plan, because the time was amply compensated by the product sale. In fact, even if a few clients never implemented at all, it was still financially worthwhile to “give the plan away”, because there was enough compensation every 4 clients to still average out with profitable financial planning (averaging $2,500 of revenue per financial plan, with a cost of only $1,000 per plan).
On the other hand, as the popularity of commission-based compensation declines, and fee-based compensation and the AUM model rises, the metrics change. Now a $250,000 rollover results in a “mere” $625 fee, not paid until a few months from now (assuming a 1% AUM fee, payable quarterly to the advisor). Which substantially increases the risk to the advisory firm, as if the planning work is done and the client does not implement, it’s hard to make up the cost of the financial planning work with the next client. If the advisor delivers four financial plans but only gets one clients, now the advisor is still averaging $1,000 per plan in cost, but only $125 per client in revenue in the first few months (and only $500 in revenue per client over the first year!).
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Yet it’s crucial to recognize that from the business perspective, there’s still a substantial opportunity to “make up” the cost of delivering financial planning up front, even without charging separately for it.
The Long-Term Profitability Of AUM Clients Over Time
The interesting phenomenon of the AUM model is that, unlike earning upfront commissions (with little or nothing thereafter), it provides ongoing, recurring revenue. And in the event that clients stay on board for the long run, even clients that initially seem unprofitable (due to time-intensive financial planning or portfolio management work) can average out eventually and turn profitable eventually.
For instance, imagine an advisor who charges a 1% AUM fee, and is working with a new client who has a $250,000 portfolio. Due to the complexity of the client’s situation, the advisor spends a whopping 30 hours going through all the financial planning (and investment portfolio) meetings with the client in the first year. As the financial planning and investment implementation challenges are slowly solved, though, the time commitment falls, to an average of just 12 hours per year in years 2-5, and then eventually declines further to an average of just 8 hours/year (2-3 client meetings, plus some behind-the-scenes office work) in years 6 and beyond.
Assuming the portfolio grows at 7%/year, and the advisor’s raw time (plus support staff and overhead expenses) costs $100/hour (inflating at 3%/year for cost-of-living adjustments), the revenue, expense, and long-term profitability of this client relationship is shown below.
<<<INSERT GRAPHIC TO SHOW THIS. WANT TO SHOW A REVENUE LINE OF 1% OF $250K GROWING AT 7%, A COST LINE INCLUDING TIME/HOUR X HOURS IN EACH YEAR (INFLATING VALUE OF TIME/HOUR), AND THEN SHOW A NET PROFITABILITY LINE IN EACH YEAR, WHICH SHOULD BE NEGATIVE IN YEAR 1, GOING POSITIVE IN YEARS 2+. PROJECT OUT FOR 7 YEARS.>>>
Cumulatively over time, this is an important dynamic – even “unprofitable” clients with intense up-front work obligations do eventually become profitable over time. With a long enough time horizon – e.g., for those who stick around for a decade – the client relationship can be profitable enough to fully recover the upfront investment of time into the financial planning relationship. As long as the clients do stick around long enough.
Fortunately, though, the reality is that retention amongst advisory firms tends to be quite high; PriceMetrix data shows a financial advisor’s average client retention rate to be around 90%. Which means on average, the typical advisor loses only 1/10th of his/her clients each year, and thus the average tenure of a client really is about 10 years. Which is more than enough time to recover the cost of upfront planning!
<<<INSERT GRAPHIC TO SHOW THIS. NOW I WANT TO SHOW THE CUMULATIVE PROFITABILITY OVER TIME. ANNUAL PROFITS FROM PRIOR CHART, ADDED UP, GOING OUT 15 YEARS, TO ILLUSTRATE HOW CUMULATIVELY PROFITABLE THE CLIENT IS. THEN ADD A MARKER AT THE 10-YEAR THRESHOLD ON THE LINE TO NOTE “HIGHLY PROFITABLE AT AVERAGE TENURE!”>>>
Financial Planning And Client Retention Rates
Of course, for advisory firms that expect to have profitable long-term clients on an AUM model anyway, it may be appealing to skip the financial planning altogether, and just spend that time getting more AUM clients instead. After all, if the advisor didn’t do any financial planning, and could reduce the number of hours spend in the early years (e.g., to just 10 hours for initial and ongoing meetings in year 1, and 4 hours/year thereafter for monitoring plus one annual portfolio review meeting), the client relationship would be even more profitable.
Of course, in theory a “lesser” amount of service might merit a lesser fee, but the recent 2016 RIA Benchmarking study from Fidelity showed that advisors charge remarkably similar fees, with a median of 1%, regardless of the depth of services! Which means doing less really can just make the client relationship more profitable!
<<<INSERT NEW CHART HERE. A REPEAT OF THE PRIOR CUMULATIVELY PROFITABILITY CHART, BUT NOW I WANT TO SHOW THE PRIOR NUMBER WITH FINANCIAL PLANNING, AND A NEW “INVESTMENT-ONLY” SCENARIO WITH THE HOURS-OF-SERVICE NOTED ABOVE. WANT TO ILLUSTRATE THE TWO PROFITABILITY LINES SIDE-BY-SIDE. THE INVESTMENT-ONLY LINE SHOULD KICK ASS. ? >>>
However, this assumes that the investment-only client and the full-financial-planning client will have the same retention rate over time, which isn’t necessarily true. As even though the data suggests clients don’t appear to discriminate very well between fewer or more bundled financial planning services when picking an advisor, the difference in service can still show up in retention later. And although there isn’t much good data on this, there is some indication this is the case.
For instance, the aforementioned PriceMetrix data showing 90% retention rates is drawn heavily from brokerage firms, which historically were investment-only (or at least, investment-primary) in their service model. By contrast, the latest Investment News Financial Performance Study from 2016 showed that the typical mid-to-large-sized RIA – which tends to be more financial planning centric – had an average retention rate of closer to 97%. And while that 7% difference in retention may seem small, going from a 10% attrition rate down to a 3% attrition rate extends the average tenure of the client from 10 years to more than 30 years! Writ large across the whole practice, this is a massive impact.
As an example, let’s assume for a moment that two advisory firms each charge 1% for comparable clients. Each is growing at a healthy pace of 10 clients per year. The financial-planning-centric firm spends far more time, and thus has “less profitable” clients, but also has a higher retention rate. After 10 years, when each firm has brought on 100 clients, it converts to a “lifestyle” practice with no more new clients. And as the results show, the ongoing impact of retention produces a substantial dispersion over time, as the investment-only firm is more quickly profitable early on, but begins to lose ground over time due to the difference in retention rates.
<<<INSERT GRAPHIC TO SHOW THIS. THIS WILL BE THE KEY GRAPHIC OF THE SERIES. GOING TO RUN FOR 20 YEARS TOTAL. THE FIRST 10 YEARS, WE ADD 10 CLIENTS/YEAR, USING THE AFOREMENTIONED METRICS ABOUT HOURS SPENT AND CLIENT RETENTION. (NOTE THAT MEANS YOU’LL HAVE TO TRACK CLIENT COHORTS, UNTIL THEY ALL GET INTO THE ‘LONG-TERM’ COHORT WITH STABLE HOURS.) FOR ATTRITION, ASSUME THE INVESTMENT-ONLY FIRM LOSES 1 CLIENT PER 10 EVERY YEAR. ASSUME THE FP FIRM LOSES 1 CLIENT PER 10 EVERY 3 YEARS. SHOW THE CUMULATIVE PROFITABILITY LINES OVER TIME. THE FP FIRM SHOULD BE LOSING EARLY ON, BUT END OUT WAY AHEAD BY THE END. IF NECESSARY, WE CAN TWEAK ASSUMPTIONS ABOUT GROWTH RATES OR OTHER FACTORS, TO HELP ILLUSTRATE THE POINT.>>>
As the illustration shows, even the firm that doesn’t charge separately for financial planning ends out drastically more profitable in the long run. The reason is that, to the extent the financial planning work increases client retention, that impact alone is more than enough to recover the entire “cost” of financial planning, and then some!
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Practical Implications Of Profiting From Offering Free Financial Planning
<<<INSERT IMAGE WITH AMAZON LINK FOR ANDERSON’S BOOK TO THE RIGHT OF THIS PARAGRAPH>>>The idea that a service can be offered profitably, even if not charged for directly, is not new. As detailed in Chris Anderson’s book “Free”, the use of various “freemium” models has existed for a long time. From Gilette that famously made its money by selling cheap or giving away razors for free, and charging for the blades. To Google’s engine for growth being heavily driven off its “free” apps like Gmail and Google Maps (linked to advertising where it gets paid).
In the context of financial planning, the challenge of charging separately for financial planning is that it makes the cost highly salient. Clients are acutely aware they’re paying, which makes them ask about the value they’ll get, which unfortunately is hard for most advisors to articulate. And thus, advisors who charge separately often get clients who “opt out” of financial planning altogether, which ironically means they value the financial planning even less (because they never experienced it at all!). Maybe they would have liked it, but they aren’t certain enough to pay up front. Yet if they don’t, then they may not retain as well over time, either!
By contrast, a “freemium” model that includes financial planning bundled to AUM fees makes the cost less salient, and it shifts the default. Now, it’s “you’re already paying for planning because it’s included in your fee. Are you sure you don’t want to use it?” The good news of this approach is that it’s much more likely to engage people, by not having a separate cost barrier. The bad news is that as the advisor, you’ll also get more people who “kick the tires” and don’t take the planning seriously. As ironically, the one upshot to charging separately for financial planning is that while the upfront cost may turn a lot of people away, it does at least ensure those who pay tend to be more serious!
Nonetheless, to the extent that the planning services are engaged – even if just partially – and it improves long-term retention, the key point is to recognize that the planning is profitable and is paid for. It’s just paid over time, “earned” in the form of client retention in the long run, rather than a separate up front payment. Though advisory firms must be cautious to recognize this, too. It means your financial planning staff aren’t a “cost” to be managed down; it’s an investment in client retention that needs to be nurtured!
Of course, I realize that some people may view it as a negative to say that costly financial planning upfront will be made up for with long-term profitability from AUM fees. And that clients should pay at the time for what they’re getting at the time… which means paying more in the early years, and less in the later years, to align with where the time is spent. And in point of fact, some firms are even experimenting with cutting AUM fees for long-term clients, in recognition that often those “well-behaved” long-term clients really are easier to service in the long run!
But the problem, again, is that larger upfront fees can still discourage utilization of financial planning altogether. Creating the ironic risk that the advisor actually sacrifices long-term profitability by trying to focus too much on short-term profitability. Because firms which price their services to be profitable in every year can cause “sticker shock” and actually be at a competitive disadvantage to firms that smooth the fees out over time. (Of course, this presumes the client has a portfolio to manage and against which AUM fees can be assessed in the first place; if the client doesn’t have assets to manage, clearly standalone financial planning fees will be the only viable option to pay for financial planning services.)
But at a minimum, the key point is just to recognize that as a business, it’s not necessary to maximize profit in each and every year of the business, as long as the business is profitable over the long run. Or viewed another way, there’s nothing wrong with running a business where a particular client is a little more profitable in some years and less in others, as long as it averages out over time. (Which is still much better than the commission model, where profitable clients subsidized unprofitable ones; in this case, it’s the profitable years of a particular client that helps to subsidize the more time-intensive less-profitable years, which is arguably much fairer for any particular client.)
[Tweet "Commissions use profitable clients to subsidize those who don’t do business; AUM fees reduce this risk!"]
As a starting point, though, consider your own advisory firm. Do the clients who engage in financial planning retain more/longer than those who don’t? Is the gap large enough that it’s worthwhile to lower the price of your financial planning, or even give it away for “free”, just to make it easier for more clients to actually do financial planning it, where the business profits in the long run anyway?
So what do you think? Do you use a weekly team meeting structure? When do you meet? How do you handle your weekly agenda? Please share your own experiences and thoughts in the comments below!
Hi Michael,
Nice article! But I guess someone forgot to insert the graphs.
Luiz