When talking to RIA owners and especially RIA operations professionals, the topic of fees often comes up. “What is your standard rate of charge? Have you had to lower your rates over time?” are common questions that are asked from one RIA to another. The value that clients place on traditional asset management (“stock picking”) has declined significantly over time. Clients have a multitude of options for purchasing low-cost, well-diversified portfolios through a number of digital solutions or ETFs. Financial advisors who have focused their value proposition solely on their ability to build portfolios and “beat the market” have seen their fee rates decline in recent years. But most advisors who have focused on a more comprehensive value proposition, who have expanded their service offering beyond simple asset management, have maintained their fees and in some cases even managed to raise fees.
By adding additional services to their traditional asset allocation and investment management offering for liquid assets, advisors have been able to explain to clients that their AUM fee includes much more, thus keeping their fee level constant over time. Clients are now getting access to alternative investments; comprehensive financial planning is now included as part of the AUM fee charged; many firms are now offering trust and estate planning, bill payment services, insurance reviews, and in some cases, RIAs are now processing tax returns on behalf of their clients. Clearly, there has been downward pressure on rates, with customers asking: “What am I getting for the rate I'm paying you?” Advisors, in my opinion, have done a great job of articulating the full value of these fees, and thus justifying their value to their clients.
But not everything is rosy in RIA land. While these additional services have kept the average fee rate constant, these new services cost money (CFPs, CPAs, attorneys, and licensed insurance agents aren't cheap!), putting downward pressure on margins of profit. In addition to increasing labor costs, in many cases, these new service offerings require additional technological tools. These services are also more difficult to scale than asset allocation models that can be run through trading and rebalancing software. If an RIA has managed to maintain stable revenue while maintaining fee rates, but has dramatically increased the cost to serve clients, profit margins will fall and the business will be in trouble.
In the last one podcast with Michael Kitces, Mark Tibergien defined “scale” as “revenues growing faster than the firm's expenses.” Therefore, if these additional services have not retained the fees AND resulted in more clients (more revenue), these additional services will do nothing more than put the RIA out of business. As RIAs add these services, they must increase their marketing spend to ensure the market is aware of the firm's additional capabilities. Unfortunately, not every firm is able to increase labor costs and increase marketing costs at the same time, but it is necessary.
With more arrows in their service, firms can tell a broader story to attract new customers (and increase the portfolio share of existing customers). In many cases, RIAs can attract larger prospects than those clients traditionally served by RIAs. Larger, more complex clients will require help with estate planning, bill paying, access to non-traditional asset classes, etc. With these services now part of the firm's marketing efforts, more potential clients should now be attracted to it. And once they hire the RIA, with so much of their financial life being taken care of, the assets should be stickier than simple “investment only” clients.
The only reason we haven't seen rate compression is because firms have aimed to offer more services to justify those rates. Without an increase in the number of clients served and/or the average size of these clients increasing, thanks to these additional services, RIAs may find themselves in a precarious situation. Business owners should always remember that profit margins are literally the bottom line when it comes to their business. Additional services can justify fees to clients, but RIA owners must also justify those services to themselves by tracking their margins. These additional services should be advertised loudly in the firm's marketing campaigns to attract new (and hopefully larger) clients. It is the compression of margins, and not necessarily fees, that owners should be chasing.
Matt Sonnen is Chief Operating Officer at Coldstream Wealth Managementas well as the creator of the digital consulting platform COO Societywhich educates RIA owners and operations professionals on how to build more impactful and profitable enterprises. He is also the host of the popular The COO Roundtable Podcast.