Choosing a Financial Planning Fee Structure – What Are the Options?

We talk with advisors a lot about fee-only vs. commission-only vs. fees-and-commission fee structures when they go to launch or transition their firm to working with Gen X and Gen Y clients.

Many advisors who are starting firms have only worked on the commission side of the industry, and aren’t quite sure about going fee-only. Others may have worked for large RIA’s that only charged their clients on an Assets Under Management basis, and are looking for alternative fee structures.

This is the first post in a multi-part series on determining the ideal fee structure for your financial planning firm. We'll start by talking through the different fee-structures that are used by fee-only advisors, and the pros and cons of each when working with Gen X and Gen Y clients.

Fee Structure Option #1: Assets Under Management (AUM)

The most popular way for advisors to charge for financial planning services is on an AUM basis. Since this article is focused on how to charge for financial planning services, it is assumed that advisors charging an AUM fee are offering both financial planning and investment management services for a single AUM-based fee.

AUM fees can be calculated a couple of different ways:

In Advance or In Arrears – Advisors can choose to deduct fees at the beginning of the quarter so they know they will be paid for the services provided. This helps to ensure payment. But it also introduces complexity should the client leave your firm and you need to rebate fees.

Changing in arrears, or at the end of the quarter, has the advisor being paid after services have been provided.

Point-in-Time or Rolling Average – Advisors can choose the way account balances are calculated for fee deductions.

For advisors charging in advance, they may simply look at the account balance on the first day of the quarter and charge an AUM fee based on that balance. Advisors charging in arrears can do the same, except they would look at account balances at the end of the quarter.

Another way to determine the account balance you will bill on is a rolling average. You will likely want to have a performance reporting software that can calculate this for you, since doing daily average balances over a quarter for all of your client accounts can be challenging.

This calculation method allows the advisor to charge based on the average balance throughout the quarter, instead of just a single point in time. During volatile market cycles, this might be seen as the more “fair” way to calculate.

Average balances are typically charged in arrears, but it's conceivable that a firm might do so in advance based on the last quarters’ average balance. Note that the popular TAMP Betterment Institutional charges in arrears using a daily average balance.

Pros and Cons of an AUM Fee Structure

Here are the pros of charging on an AUM basis:

• AUM fees are easy to calculate, and can be deducted straight from the clients investment accounts. There are IRS restrictions on deducting financial planning fees from retirement accounts; AUM fees for the most part allow advisors to deduct all of their planning and investment management fees from the investment portfolio.
• AUM is likely the highest-margin fee structure available. Since fees continue to increase as the client saves, and as the market goes up, it helps to build a stable source of revenue for the financial planning firm. There is a reason why every technology-based TAMP and major wire-house is using an AUM fee. The margins are great, and currently, clients are willing to pay the fees.

If you're considering this fee structure, familiarize yourself with the cons as well:

• While AUM is a profitable fee model today, companies like Betterment, Wealthfront, FutureAdvisor, etc. are providing investment management services for a fraction of the fees AUM advisors have historically charged. While you may also provide financial planning services -- which these competitors do not -- when your planning fees are wrapped into the investment management fee, it is difficult for the client to see the added value. The question is not if these companies are going to cause a compression of AUM fees, it’s when.
• AUM-based firms have their revenue directly tied to the market. While we expect markets to go up over time, short-term market swings (like 2008-2009) can decimate your firm’s revenue. With the reward of high margins comes the risk of short & medium term revenue drops.
• By bundling the services together, but basing the fee on managed investments, it downplays the important of financial planning services. Because financial planning and investment management services are rolled into in a single AUM fee, advisors are basically telling their client that they pay for investment management and get financial planning for free. While some advisors “give away” financial planning to capture investment management assets, this isn’t the goal of many advisors. Many want to provide financial planning services, and investment management is just a part of that service offering.
• AUM fees put financial planning services out of reach to clients that don’t have assets to manage. In order to be profitable, most firms have a minimum AUM requirement, which restricts services to folks that have had enough time to save. Ideal clients, like young doctors with high income and high levels of debt, may not meet that minimum fee. While it can be “waived” for the right client, I’m not a big fan of turning clients into loss-leaders (i.e. giving services away for free in hopes that they become profitable one day).

Fee Structure Option #2: Hourly or Time-Based

Some advisors charge clients by simply billing them for the hours they spend working for the client. While attorneys and accountants have been charging by the hour for a very long time, the hourly model was popularized in the financial advisory community by Sheryl Garrett, founder of the Garrett Planning Network.

Advisors that charge by the hour will need a time-tracking system in order to keep up with the number of hours they work for a specific client. Some choose to use software such as Rescue Time (one of our recommended 25 Technologies for Under $25 Per Month ), while others will manually track their hours in their invoicing system.

Deciding on an hourly rate is a stressful process, because there isn’t much to compare it to. Should you bill at the same rate as your recommended tax preparer or estate attorney? Maybe it should be based on other advisors that charge by the hour?

One pitfall of this method: advisors billing by the hour tend to undercharge for their services. Sheryl Garrett once told me that you should just set a price, and see how it feels.

You always want to be just a little uncomfortable when you tell someone your pricing, so when it becomes comfortable to tell a prospective client your hourly rate, you should raise it.

I experienced this when I launched my firm. I would charge $2,700 for a financial plan ($180/hr for 15 hours of work). For the first 15 to 20 plans I did, I felt uncomfortable giving this quote.

After a while, I began to realize that I was giving such incredible value that $2,700 was a really good deal. I remember quoting a $2,700 plan and thinking “I hope they don’t sign on… The work isn’t worth the money” and I was shocked at myself. I immediately raised by fees to $200/hour -- and made myself a little uncomfortable again.

Another way to calculate your hourly rate is to work backwards. How much money do you want to make per year? How many hours do you want to work per week -- or per month, or per year?

Doing some quick division will give you a great starting place for your hourly fee.

Pros and Cons of a Time-Based Fee Structure

There are several advantages to setting up your fee structure based on hourly work (or some other period of measured time):

• Working hourly allows advisors to work with clients no matter their assets. This can really open up the number of prospective clients for your firm.
• You can help clients with small projects and large ones. Many advisors only provide comprehensive financial planning services, which is a really expensive and time consuming process. By charging hourly, you can help clients craft an investment plan or just chat about their student loans, without them having to go through the comprehensive planning process.
• An infrequently discussed benefit is that it provides immediate revenue. When you charge hourly, you get paid by your client immediately. With other fee structures, you might have to wait until the next quarter ends to get paid. While creating on-going revenue sources is nice, having money in the bank quickly is a huge help for an advisor starting a firm. Whether it’s $180 for one hours work or $2,700 for a comprehensive plan, that check is really helpful.

Here are the downsides of charging based on your time:

• Hourly advisors tend to work with a lot more clients that those operating under other fee structures. When you are willing to work for just a few hours with a client, you end up needing to work a lot of hours to get to your goal income level.
• Clients tend to come to hourly advisors in crisis mode. Before they call you, they may think “Is this an $180/hour question?” Many times, they answer “no” when the answer was obviously “yes.” By the time they pull the trigger and make the call, it might be past a time when you could do planning and instead your helping them through crisis mode. (Admittedly, I do this with my accountant. I hate paying in 15 minute increments, and end up waiting -- sometimes too long -- before finally biting the bullet and calling.)
• It’s difficult to get paid what you're worth. A client may call and ask a question, and you can respond quickly with an answer. While it may only take you 10 minutes to answer, think about what all went into having the knowledge to answer that question: degree programs, CFP® education, conferences, hours spent reading up on the latest laws… all of that is very expensive and very valuable. Charging the client for a 10 minute answer doesn’t reflect the true value to the client, nor the cost for you to obtain that knowledge.
• When the economy drops, the clients can quickly dry up. During the most recent market crash, a lot of hourly advisors realized that one of the first cuts made to the budget for a year or two was seeing their financial planner. This can really put a squeeze on the bottom line. Hourly revenue tends to be very cyclical, so it is something to be aware of during good economic times, since you need to be prepared for the bad times.

Fee Structure Option #3: Project-Based

 Many advisors choose to charge a project fee to their clients. Instead of calculating the fee based on number of hours spent working with the client, advisors will instead charge based on the value of the project they are providing.

As an example, consider Sophia Bera, a founding member of XYPN. She offers a service called a “Quick Start Session.” This service includes a 90 minute call focusing on 1 to 2 pressing topics that the client wants to discuss. She charges $499.

Another option is to package together common client requests. For instance, you might charge $500 for a student loan analysis and recommendation session, while charging $1,000 for a cash-flow and budgeting session.

Remember that project based fees don’t need to be about the time spent working with the client – it should reflect the value of the service being provided.

Pros and Cons of a Project-Based Fee Structure

Here are the pros to charging based on packaged services or projects:

• Project-based fees allow the advisor to charge an amount that reflects the value of the service being provided, not just the number of hours being spent on the client case.
• You can work with clients that aren’t quite ready for the “full package” of financial planning services that you offer. I have found that many clients come to a financial planner with a primary issue that is really stressing them out. It might be that they want to understand the programs to pay back student loans, or want to buy a house but don’t know if they should use a fixed or variable mortgage. It is really hard to explain all the benefits of comprehensive financial planning until you have helped them solve their immediate issue. By helping them with their big stressor, advisors can showcase their abilities and the value of financial planning. Advisors essentially get paid to market their services. Michael Kitces wrote a great article that goes in-depth on this topic, which you can read here. Not only are you marketing to the client, you are also giving them a great experience that they will tell their friends about, leading to more referrals.
• Project-based fees (like hourly fees) make financial planning accessible to folks that just have a few questions. I was amazed at the number of clients that were happy to pay $500 for a retirement projection, and not want any additional services.

And the cons to using this type of fee structure:

• Advisors providing project-based services will find they end up working with a lot of clients in order to generate revenue. While you will likely generate more money per hour than charging hourly, you will still have to work with a lot of clients if you charge $500/project.
• It can be really frustrating when you see blaring needs that your client has, but since they have only engaged you for a project, you can’t address it. You might notice that a client doesn’t have life insurance, but you are focusing on student loans so insurance analysis isn’t possible. As someone who sees the value in comprehensive financial planning, it is difficult to only focus on 1 to 2 topics and basically ignore the rest. The service is certainly still valuable, but it can be frustrating.

Fee Structure Option #4: Retainer or Subscription-Based

When the market crashed a few years ago, many advisors saw their revenues drop by 40% (or more) in a just a few quarters. Not only did the market drop (so AUM revenues went down), hourly and project-based fees dried up and new clients quit calling.

Advisors began to realize how dependent their revenues were on the market, and started looking for a way to stabilize their income.

Retainer fee structures have been around a while. Bert Whitehead, founder of Alliance of Comprehensive Planners (previously Alliance of Cambridge Advisors), pushed his network of advisors to charge annual-based retainers almost two decades ago.

It's taken a while for the fee structure to catch on, but its popularity is certainly growing. There are many different ways to calculate and bill a subscription based service, but there are two primary ways fees are calculated:

Retainer Based on Variables – Many advisors charge a flat fee to the client based on variables they believe are relevant. These variables might be a percentage of net worth and income, household net worth, some measure of complexity, or other important measure.

These fees are then typically charged quarterly, but we are seeing a surge in monthly subscription fees.

Note that in order to avoid tripping over the custody rules, you can’t accept fees more than 6 months in advance. This means you must take installment payments through the year, whether semi-annually, quarterly, or monthly.

(If you prefer to get the full year fees upfront, you will have to pay for an independent audit of your firm each year, which will cost you upwards of $10,000!)

Flat Fee – For advisors with a clearly defined niche market, they can simply charge the same fee to every client. This takes the guess work out of determining complexity, and they simply quote their typical fee.

For instance, if you only work with dentists starting a practice then you know exactly how much work goes into that type of client and you can charge a flat fee.

Pros and Cons of a Retainers and Subscription-Based Fee Structure

As with all other fee structures, this method comes with advantages and things to watch out for. Here are the upsides:

• Clients are accustomed to paying all of their bills on a monthly basis, so paying their financial planner a monthly fee just makes sense to them. This makes financial planning services seem like just another bill they have to pay, which is very different from how planning has been perceived in the past.
• Charging a subscription fee gives greater transparency to the client regarding how much they are paying for financial planning services.
• If you charge a subscription fee for planning separate from an AUM fee for investment management services, it shows the client that they are paying for two distinctly separate services – financial planning and investment management. There is a perception that value and price are correlated (i.e. “you get what you pay for”) so having the client pay separately for the two services forces them to value the services separately.
• Depending on how you calculate fees, charging a subscription based fee opens the door to working with a lot more clients than the traditional AUM model. Many advisors charging a monthly fee charge between $100 and $200/month. I pay more than that for my CrossFit Membership, Verizon bill, Charter Cable, and more. It’s hard to say I can’t “afford” a financial planner when it’s $100/month!
• Billing a subscription based fee provides the advisor with a stable source of revenue. Since fees aren’t tied to market swings, advisors will have a dependable base of revenue each month/quarter.
• By providing financial planning services on a subscription basis, you can offer investment management services as an add-on service and charge an AUM fee. This allows you to operate without account minimums, because you are profitable on the financial planning fees. This combination is becoming extremely popular, as it allows you to work with clients that have smaller account balances, or simply want to self-manage their investments.

And the downsides:

• With additional pricing transparency comes a more difficult sale. When you clearly lay out your pricing, it forces clients to understand and realize exactly how much they are paying for services. If you are comparing you to a commission salesman or AUM-centric advisor, your fees will appear higher, even though they might be the same and you are providing a much higher level of service than a salesman.

What Option Should Financial Advisors Choose?

When trying to decide which billing method to choose, I encourage you to take a step back and ask yourself “who is my ideal client?” When you know who you want to work with, then ask yourself “how does my ideal client want to pay me?”

If you work primarily with clients that have high asset levels, AUM might make the most sense. If you work with a lot of clients looking to just get a few questions answered, then hourly or project based might make sense. If you work with Gen X and/or Gen Y clients, then a subscription based services is likely ideal.

Most firms will end up using multiple options within their firm. In fact, some will use all four fee structures in some way! As long as you have clearly defined service offerings, and explain how you charge for each service, I don’t see any issues with offering multiple service offerings.

Our next post in this series will focus on the monthly subscription model, outlining ways to calculate the fees, integrate investment management & one-time services, and more.