I attended the Financial Advisors conference in Mumbai early this month.
One of the discussion topic was the Type of fee based model a Financial Advisor should adopt.
It was a refreshing experience. I got to understand and analyse the subject a little deeper after collecting feedback from some of the best Financial Advisors in the country today. I had to be absolutely certain that the model which we are following in our business is best suited at this time.
The speaker presented to the group of Financial Advisors the pros and cons of the different fee models.
In the article mentioned here there are advantages and dis-advantages mentioned from the Advisor's stand point.
I thought of sharing this subject from a Client's view point.
How are Financial Advisors remunerated and where is the client's best interest?
What I have mentioned here are my views after applying some of these models throughout my practise. I will share the challenges and conflict we face and how, why and which model we adopt in our practise suits the client's best interest.
Model 1: Transaction fee: Advisors can levy a transaction fee each time the client makes a transaction. It could be a fixed amount e.g. Rs 500 per transaction or a percentage on transaction value.
The challenge with client's approaching an Advisor who works on a Transaction based fee model is as follows.
The client and the Advisor are going to participate in an engagement which is very long term in nature. An advisor can be driven to make constant changes to the advice to make a transaction/remuneration happen and this in turn can be a big turn off. Moreover there is no benefit for the Advisor in working with clients who are not frequent churners or clients who are not bringing in money at frequent intervals. Additionally the advisor may get inclined to advice in certain asset classes where his remuneration is linked and ignore other asset classes, for e.g. Real Estate where he does not make a monetary benefit for his/her advice. And since each instalment of fee is not a substantial cheque there is a possibility for the Advisor to keep coming back to you for more with advice which suits him/her than the client. With the adoption of this model there could be potential conflict in the Client Advisor relationship over a period in time.
Model 2: Fixed Annual Retainer Fee
Under this method, you could charge a fixed annual retaining fee, for example Rs 10000 per year.
The reason for a successful Client Advisor relationship is the sticky nature of this business. A client tends to meet his Financial Advisor more often than any of his other Advisors like Attorney, Accountant. On an average a Financial Advisor will invest a good amount of quality time per client to deliver what has been set forth. An Advisor in some cases invests a few years in setting things in order for a client.
Considering the time constraint which the Advisor will go through if he/she has to service the client on the proposed model, he will be hitting his maximum number of clients which he/she can serve, after which there could be a significant drop in service levels, meetings or the attention to detail.
Model 3: Profit sharing fee
Advisors could charge a percentage of fee based on profits.
The work done by a Financial Advisor is fragile in nature. It is an Art and you can not get the best out of your Advisor when you set forth conditions which are deviating from the core objective in the first place. A good Advisor has to set aside all the conflicts that come with carrying out his duties and has to completely focus on Client's Goals.
This kind of an arrangement could deviate the Advisor from his core objective and focus too much on delivering the numbers. Which I feel is not what his duty should be.
There are specialists in this area who solely do the business of generating profits through a specified asset class and I feel the client should not drive their Advisors into an engagement which could potentially create a chance where the Advisor may place his interest ahead of their client's.
The last thing that a client with limited resources want is his Advisor to take a higher risk than what is allowed to give a superior performance to justify his earnings
Model 4: AUM based fee
Advisors could charge a percentage fee on the assets under advisory. (For instance, 1% on Rs 100 crore AUM would fetch you Rs 1 crore annually)
This is the model most successful Financial Advisors adopt and is followed by our company as well. This model may sound impractical when you run the numbers over your calculator however if we carefully inspect this in detail, this Fee model is the least conflicting of all models.
This model is Measurable, Transparent, and more interestingly attractive enough to the Financial Advisor to stick to his/her client and strive constantly to add value. It also gives the Advisor an opportunity to grow along with his client. An Advisor in any of the above models does not have enough scope to grow.
The fee is usually applied on a Client's managed financial assets and un-managed assets like Real Estate, Bank Deposits etc. are excluded from the AUM. Which essentially means that the cost for the client is less than 1%.
Additionally a good Financial Advisor does not cap his advice at just the managed portfolio and would give a holistic advice on other asset classes as well.
The client has the choice of bringing down the exposure in the asset class which is linked to the Advisor's remuneration till he feels certain of recouping the extra expense through the advisory service.
To Sum up
Each model come with certain implementation challenges. What clients can choose is the model which looks at creating a win-win over extended periods of time. As for a successful implementation both the Client and Advisor have to work together over many years to have a meaningful outcome of this arrangement.
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