As originally published in Financial Advisor magazine.
We just had a big family gathering, and after a generous and noisy dinner, my dad asked me: “Why in the world do people hire you as a consultant and pay you so much money?”
It took me a second or two to recover from the shock that my own father is questioning the validity of my profession, especially after I’ve been doing it 20 years. But I realized this is a very fundamental and important question: Why do people hire “trusted advisors”? (I will use this generic term for all professionals that offer counsel— advisors, planners, consultants, attorneys, CPAs, doctors, etc.) This question is both a very healthy one to ask ourselves as well as a very good one to be prepared to answer when clients bring it up.
We all hire trusted advisors because we have decisions to make, and those decisions are often too big and too complicated to make on our own.
Should I pay for my grandkids’ college? Do I start chemotherapy or do I wait? Should I sign this restrictive partnership agreement? Should I sell some shares to my employees?
Our decisions about these complex problems are sometimes literally about life or death, wealth or poverty, and we cannot and perhaps should not make them on our own, so we need the help of an expert.
Why Pay to Have Friends?
We need experts, but why do we need to pay them all the time? Why not hire a doctor only when you are sick—or a consultant only when your company is struggling, or a financial advisor only when you bump into a money problem?
Because even though that would be efficient, it could also be disastrous. We create ongoing relationships with professionals so that they get to know us well, and that knowledge turns into insight and sometimes life-changing decisions.
I am a boxer, and in 2010 I got a concussion that caused bleeding in my brain—a potentially fatal problem that could have led to significant brain damage (perhaps it did). I realized something was wrong (it was not my first concussion) and sought the help of my doctor. Three different times on three different days I tried to get an appointment, and every time I got sent to the emergency room because my doctor was not available.
The staffs in the emergency rooms I visited, not knowing anything about me and despite my insistence that big guys hitting me on the head probably resulted in a concussion, signed me out with three different diagnostic opinions—all of them wrong. Eventually, I ended up in intensive care where a polite young doctor told me I was lucky to be alive and I should have sought the help of my doctor right away. I agreed.
So today I have a “concierge” doctor. I pay a monthly fee, and in exchange, whenever I have a health issue, I always get to see my doctor the same day. What’s more, when the issue is serious, he calls on nights and weekends. Even better, when I walk through the door, he already knows my entire history and remembers not just that I have kids but that I also still box and have very bad knees and high blood pressure.
We pay experts on an ongoing basis so that we can develop a relationship that gives them the knowledge and insight to serve us well and so that when the important decisions come, they are well prepared, equipped with the right information and available to help us.
Note, by the way, how much I emphasize my doctor’s knowledge, insight and availability, not our “friendliness.” I am not paying my doctor to be my buddy. He doesn’t box, he doesn’t approve of drinking, and he likes talking about home improvement (a topic they will discuss to punish me in hell). However, he is an expert, and he remembers and documents everything there is to know about me. That is knowledge. And that knowledge turns into insight.
How to Pay?
So if we pay for access and a relationship, what is a fair and reasonable amount? For me the answer is clear—we need to charge in a way that encourages the development of a relationship rather than sporadic and opportunistic transactions.
Fees for assets under management are an amazing pricing method that advisory firms should never, ever give up if they don’t have to. AUM fees allow advisors to build a great and consistent relationship with their clients and translate that relationship into insight tremendously beneficial to those clients.
Research suggests we evaluate relationships through different frameworks depending on whether they are “social” or “commercial.” In social relationships, we are reciprocal, attentive and cordial and do not take advantage of the other party. Commercial relationships are quite different. In these, we bargain, we haggle, we feel fully entitled to take advantage of the other party if they make a mistake.
Research also indicates that in the presence of money—either a price tag or a bill or an invoice or physical money—we tend to switch to the rules of the market, which say, “Protect yourself at all times.” In a famous study, a day care in Israel, aggravated by parents being late, started charging steep late fees. As a result, the parents became even more late, not less so. What the researchers discovered was that before the change, the parents tried not to be late out of politeness and respect for social norms. Once the price tag was there, it became a commercial transaction. They decided to just pay the fee.
The advantage of AUM fees is that they are very seamless. There are not a lot of reminders to the client that this is a commercial transaction. As a result, clients treat it as a social interaction: They are friendly, reciprocal and attentive rather than guarded and opportunistic.
The State of Industry Pricing and the Myth of Compression
When we asked in a survey, “Do you feel that your pricing is under pressure?” 47% of the firms responding said, “Little: Sporadically we have to answer questions.” Another 40% said, “Some: We need to be more competitive with our pricing.” Cerulli Associates’ results are similar. In the research firm’s interactive dashboard asking advisors about fee compression for 2018, only 30% of those responding agreed with the statement, “I feel pressure from clients to reduce fees.” Only 5% strongly agreed.
When our firm asked advisors if they had changed their fees in the last two years, only 37% of firms had. Now the punchline: Of those firms that said yes, only 10% lowered them! Thirty-five percent increased their fees and 55% increased the fees for some clients and lowered them for some. For me, this does not reflect price compression—quite the opposite.
It is still not clear, even to industry insiders, what “advice” means. The components of “advice” are also not agreed on. Advisory firms describe their relationships with clients similarly but provide dramatically different services. Imagine if cars did not have a make, model or year but were simply “cars.” Shopping for one would leave consumers puzzled. Some would cost $500,000, others only $10,000.
Without agreed upon definitions, a consumer with $2 million in investable assets may be paying an advisory fee of anywhere from 65 to 95 basis points for the same service (or one that is described in a similar way to something with a different price). The fee is not a function of the components of the service. The “2016 Fidelity RIA Benchmarking Study” showed that there is no correlation between the number of services provided and the prices paid by clients. Rather, advisors (and perhaps clients) mostly judge pricing based on the size of the household relationship.
This lack of consistency in pricing and lack of correlation between pricing and service components are interpreted by some industry observers as evidence the market is inefficient. Again, I disagree. While I can’t break my visit to the doctor into components such as diagnosis, evaluation of alternatives, prescription, education, etc. (my insurance company can and does), I don’t feel that I need to or care to. All I want to know is that I can go to the doctor with something that hurts and shortly walk out with the pain gone.
Are We Earning Unreasonable Fees?
The lack of standardized definitions of advice and wealth management may make it more difficult for the market to find the Adam Smith point of equilibrium, but it does not mean that the market is misfunctioning. First of all, pricing information is widely available. It is a matter of public disclosure through the ADV Part II brochures, and there are also many surveys one can easily find. In a recent pricing project, we identified 10 different pricing benchmarks from diverse sources.
Clients are not oblivious to this information and not unsophisticated in using it. In a survey of the advisors we work with, we asked if clients ask about fees. The prevailing answer was “often, but not always.” Clients do inform themselves. However, when we ask the question, “Do clients negotiate fees?” 84% of the firms said, it “happens, but rarely.”
Asking about fees is not the same as negotiating. Unfortunately, when the advisors themselves feel insecure in their professional competency or their ability to add value to the client (or both) they tend to react by discounting. Some years ago, I had a younger associate who was invited to present at a conference. He was not very experienced and shared with me that he doubted whether he had enough expertise on the topic. After some anxious thinking, he decided to cut his speaking fee in half. I think that’s just plain wrong. If you don’t have much to say, don’t accept the speaking engagement. But don’t lower the price. If you can’t cook, the answer is not to open a cheap restaurant!
Unfortunately, that’s what often happens. Advisors who are not very sure they can provide good advice decide that lowering the price is the way to alleviate the problem. Of course, then they feel price compression every time a client asks.
Do Clients Care about Fees?
No one says, “I need surgery. Who is the cheapest surgeon in town?” No one wants to do “three for the price of two” root canals. When the stakes are high, clients equate price with quality; in all professional services, clients would rather work with a premier provider who has the necessary skills and experience than take a risk with someone who offers a 20%-off coupon. This relationship between price and quality continues to protect pricing for premier providers even in very competitive professional services such as accounting and law.
In a survey conducted by State Street Global Advisors in 2017, clients ranked fees as the fourth most important factor they evaluate when choosing an advisor, and only 12% of clients ranked that factor as important. Put that next to “trustworthiness,” which 69% of clients considered most important, and the advisor’s understanding of client needs, named by 20%.
But the key thing here is to be a “premier” provider, engaging in the kind of work that has critical outcomes for the client. Patients will in fact price shop for elective surgeries. Taxpayers with basic two-page tax returns will definitely compare the price for accountants. There are a lot of 1-800-LAW-HELP services that explicitly compete on price. So the fundamental question to advisors is: Will you position yourself as the equivalent of the heart surgeon or be the financial-planning equivalent of laser hair removal?
Data shows that larger firms working with larger clients are already charging a lot more for their services and are more likely to increase prices than lower them. When we compare the pricing reported by “super ensemble” firms (the largest firms) to the overall industry pricing as reported by surveys, we see a “premium” of 5 to 10 basis points in the fee charged by larger firms at every level of client over the industry average. In our studies, large firms are also more likely to increase their fees than the average firm.
Pricing is a critical decision. It determines profoundly the economics of the client-advisor relationship. It also sets the tone for the nature of the relationship. It creates a methodology not just for how money is collected but also for how information flows and how much knowledge and insight is retained and delivered. Pricing unfortunately is also a one-way street. If you were to ask attorneys and accountants, they would probably tell you that they wish they could get away from the hourly bills. Airlines would probably tell you that they wish they didn’t have to constantly offer “discounts.”
The advisory industry has to be very mindful and careful in determining its own way of pricing. There is nothing wrong with consumers asking “Why do I hire you, and how much do I pay?” That is the most fundamental (and very healthy) question. If you feel threatened by it, forget discounts. You shouldn’t be an advisor.