Much Ado About Nothing Charging Fees in Financial Planning
by Andrew Rickard, CFP
The media has made much of the trend towards fee-based financial planning, regularly devoting column inches to how and why advisors should integrate fees into their practices. But will it ever become the industry norm?
According to Advisor's Edge magazine's first annual Dollars & Sense Survey¹, 17 per cent of all Canadian financial advisors now receive fee-based compensation. Taken out of context, that figure might lead one to believe that a significant number of industry participants had given up their securities and insurance licenses and are now charging hourly rates. But dig a little deeper into the study and you'll also discover that 86 per cent of advisors still receive commissions, and that only seven per cent of those surveyed actually placed themselves in the "fee only" category².
I'm inclined to believe that the high percentage of fee based business doesn't really represent some sort of paradigm shift in the financial planning industry - where one in every ten planners now charges by the hour for estate planning work - but simply a change in how many investment advisors are being compensated.
Commissions Unbundled
Traditional commission structures for investment products have been picked apart and are now being renamed "fees." Rather than putting clients into a mutual fund with 2.3 per cent management expense ratio (MER) and collecting a commission directly from the fund company, fee-based advisor now suggests that a client purchase a no-load fund with a 1.3 per cent MER instead. He or she then bills the consumer for the difference in the form of a one per cent fee charged to total assets under management, and there is your "fee-based" transaction.
One wonders what has propelled the move away from commission income. It's certainly not public demand. In the most recent FPSC Consumer Survey, only 37 per cent of respondents who were working with an advisor indicated that they would rather pay a separate fee, while 54 per cent³ said they'd prefer to have the costs of preparing the plan built into the products and services&sup4;. Clearly it is financial planners, and not clients, who are anxious to make the change.
Motivation for Change
The largest group of advisors (48 per cent) told Investment Executive that the main reason they made the switch to fees was to avoid conflicts of interest. They felt clients would be better served if the advisor's paycheque was tied to investment returns. This may sound like noble self-sacrifice, until one realizes that this principled position can also be quite a comfortable one.
Unlike their purely commission-driven counterparts, advisors who use a fee-based model can look forward to a more predictable stream of income. Once he or she has accumulated an adequately sized book of business, the fee-based advisor can focus on serving existing accounts rather than trying to find new clients. And not only does it free up more of the advisor's time, it also seems to be a profitable business model. In fact, more than 80 per cent of those surveyed by Investment Executive said their incomes rose after three years of fee-based planning, and half the entire group said it jumped at least 20 per cent.
Insurance Conundrum
While there may be plenty of good reasons for an advisor to integrate fees into his or her investment business, what is one to do if the client requires life insurance? In the 1999 FPSC survey, 77 per cent&sup5; of consumers said they relied on their planner not only to design, but also to implement the financial plan. If a client does take out insurance with the advisor's help, a commission will be paid - for unlike the investment business, the insurance industry has yet to unbundle its costs.
This places the advisor in a difficult position. He or she cannot simply hand over the commission to the client because the practice of rebating is forbidden by law in all provinces except Alberta. Is the advisor supposed to perform insurance-related planning as a philanthropic endeavor, giving away the business to another (commissioned) advisor?
Motivating people to consider their own mortality and take out life insurance is a thankless task - one that would not be performed very often if it were not the accompanying up-front compensation. Fees may work when one gives tax and investment advice, but it seems unlikely that most consumers would ever be willing to pay planners a fee to tell them they need insurance.
Until human nature changes, perhaps in the case of insurance the payment of a commission remains the most realistic form of advisor compensation. If that's the case, I suspect we're a long way from ever seeing financial planning become a purely fee-based business.
¹conducted in October, 2002
²Presumably the remaining five per cent of the advisor spectrum consists of salaried advisors who do not receive commissions directly or charge fees. Whether their compensation is at all tied to commissions they may generate for their employers is open to speculation.
³ A 7 per cent increase over the results of previous survey conducted in 1999.
&sup4; The other 10 per cent didn't know what they wanted.
&sup5; Because question wording was changed in the most recent FPSC survey there is no equivalent data for 2003. There was, however, a significant increase from 1999 to 2003 in the percentage of Canadians using the financial professional to implement the plan only and keep it on track (7% to 24%).
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