CFP Board Quietly Raises Certification Fees By 17% But To What End?

EXECUTIVE SUMMARY

While the CFP Board has done a lot to justify its certification fees over recent years – from increasing the number of CFP certificants over the past 10 years by nearly 50% (despite the fact that the number of financial advisors is down over the past 10 years), to raising the status of the marks with its ongoing successful public awareness campaign – an important but little-noticed announcement was buried half way through the CFP Board’s recent monthly email update: the CFP Board will be increasing its annual certification fee from $325 per year to $355. And while this increase may seem modest, because $145 of the total certification fee is earmarked for the public awareness campaign, the reality is that this is a 17% increase on top of the $180 portion that actually goes towards operations of the CFP Board. Which raises the question: why such a large increase, and why now?

In this week’s discussion, we discuss the recently announced 17% increase in CFP Board certification fees, as well as why accountability of the CFP Board to its certificants is important, and why it is concerning that the CFP Board has given no substantive explanation for why it is pushing through such a large increase – and particularly for an organization coming off of a $1.3M surplus in 2015 and with over $20M in reserves.

Of course, fee increases aren’t unusual in the long run for any organization, as it’s essential to keep pace with rising staffing costs due to inflation. And this is still only the first increase the CFP Board has put in place since 2011… which, even then, was just tacking on the $145 surcharge to cover the public awareness campaign. It has actually been nearly 10 years since the CFP Board raised its core certification fees, relying instead on the rising number of new CFP certificants paying those fees to fund growth instead. Additionally, both the public awareness campaign and CFP Board satisfaction ratings appear to suggest the CFP Board is making some good progress.

Nonetheless, accountability is crucial, and especially since the CFP Board has been prone in recent years to taking actions without soliciting much input or holding public comment periods. In fact, while the CFP Board did put forth a recent public comment period on proposed changes to their Code of Ethics and Standards of Conduct, the reality is that their bylaws require the CFP Board to do this, and it has been over 5 years now since the CFP Board put forth a public comment period on any otherchanges to the 3 E’s (Education, Exam, and Experience) – effectively eschewing the practice ever since the CFP Board got “voted down” in negative public comments regarding increasing the number of required CFP CE credits.

Which raises the question once again of why a 17% fee increase, and why now? Especially on top of the fact that the organization is already running a substantial operating surplus of $1.3 million dollars in 2015 and has more than $20 million in net reserves available. Was there a major downturn on the CFP Board’s 2016 Form 990 that we just can’t see yet? Is the CFP Board trying to raise more revenue internally for its Center for Financial Planning initiative, even though the organization originally said it would be funded separately (especially in light of the fact that the CFP Board tried to put through a $25 fee increase last year in the form of a “voluntary donation” that certificants were going to be defaulted into)?

Unfortunately, the reality is that we just don’t know, because the CFP Board gave no substantive explanation for why it is pushing through such a large increase beyond saying that it “supports the operations of CFP Board in fulfilling its mission and strategic priorities”. And so, while it’s not necessarily a negative for an organization to raise its fees over time, the question remains: why does the CFP Board now, all of the sudden, need another $2.3 million in its operating budget for 2018? And what does it take to get some transparency and basic explanations from the CFP Board on why it is pushing through a 17% fee increase?

The fee increase will be effective for everyone who renews their CFP certification starting November 1st or later, and it also includes everyone who goes through their initial CFP certification process after November. So everybody who’s planning on taking the November exam coming up and passes the CFP exam is going to find out that once they do that and they get their CFP marks, certification fee’s will be a little more expensive than previously expected.

Now, I can’t fault any organization for periodically raising its fees. You know, it sucks from the consumer end to have to pay, but it’s an inevitable reality, especially for any sizeable organization. If you have a lot of employees who tend to want raises every year, at some point, you have to increase your prices to keep up with inflation. And in point of fact, this is actually the first change in the CFP Board Certification fees since July of 2011 when its public awareness campaign first launched. But once you consider the fact that a part of our annual certification fee is the public awareness campaign, it turns out that this fee increase is actually a much bigger deal than you might realize.

CFP Certification Fees And The Public Awareness Campaign

For those who don’t remember or who got their CFP marks since 2011, prior to the CFP Board’s public awareness campaign, the certification fee for CFP certificates was $360, payable every two years. The biannual fee structure was done that way to line up with the biannual CE certification cycle. So you need 30 hours of CFP CE credits every two years to renew and you paid a $360 certification fee every two-year renewal period. Which simply meant you affirmed your two-year CE cycle was done and then you paid your two-year recertification fee.

Now, when the CFP Board introduced their public awareness campaign, it announced two changes to the CFP certification fee at the time. The first, and kind of the big one, was that it was adding a $145 per year surcharge to the certification fee, specifically earmarked for the public awareness campaign. Now, multiplied across what at the time was about 64,000 CFP certificates, that produced about $9 million a year for the CFP Board to allocate to public awareness on top of a multi-million dollar commitment the organization made from its own reserves. The public awareness campaign was a big deal when it launched.

Now, the second change that was made at the time was to convert that biannual $360 certification fee into an annual $180 fee in steps. So they just took the $360 every two and made it $180 every one which adds up to $360 every two.

Now, paired together, that’s how we got our current $325 a year certification fee that started in July of 2011. It was $180 which was the annual certification fee, basically to cover operations of CFP Board, and then another $145 a year specifically for the public awareness campaign. So, in this context, a $30 certification fee increase is a bit more sizeable than you realize because it’s not really a $30 increase on $325.

Functionally, it’s a $30 increase on the certification fee portion, which means CFP Board is moving their fee from $180 to $210, or across their whole operating budget, that’s a 17% increase on the certification fees over what it’s been charging for the past couple of years. And multiplied across what’s now more than 78,000 CFP certificants, we’re talking about a roughly $2.3 million revenue bump for the CFP Board next year. That’s a $2.3 million increase in fees for an organization that runs its core on only about 14 million in certification fees in the first place, plus about $4 million for exam fees and CE sponsor fees.

Which raises this question, why so much of an increase now and all at once? Now, again, the increases aren’t unusual in the long run and this is the first fee increase the CFP Board has done since 2011. And again, the increase in 2011 was just adding the $145 public awareness campaign surcharge on top of the what then was $360 biannual fee or $180 a year at the time. I think it’s actually been almost 10 years since the CFP Board raised that core certification fee from $180 a year or $360 every two years.

In the meantime, it’s just been relying on the growth and the top line number of CFP certificants who pay those fees to grow the organization. So catching up for a decade’s worth of inflation adjustments is not unreasonable, but still, it’s pretty noticeable when it happens all at once like this. Especially when the CFP Board ran a $1.3 million surplus in 2015 which is the last year. Their Form 990 is publicly available.  So it’s not like they’re hurting for revenue on the operating budget right now.

Public Awareness Campaign And CFP Board Satisfaction Ratings

All this being said, I do think it’s worth recognizing the substantial progress that the CFP Board is making these days in executing on its initiatives with the certification fees that we pay. As substantial as the fee increase was for the public awareness campaign, the latest tracking study showed that even by 2015, just four years in, CFP certification had passed the CPA licenses as the designation or license that consumers most believe a financial planner should hold.

And every measure of public awareness for the CFP marks, top of mind awareness, unaided awareness, trust in CFP certification, intent to seek out a CFP certficant were all up very materially in the past several years.

Not surprisingly, then, the CFP Board did a recent satisfaction survey amongst us – the CFP certificants – and found a mere 8% said they’re dissatisfied with the effectiveness of the public awareness campaign and only 22% believe it wasn’t worth the fee increase.

That’s a pretty big deal, it was an 80% fee increase and almost 80% of advisors are still fully on board with it. So now we’re saying what the CFP Board charges for what it does, it’s getting results and most of us actually seem to be pretty satisfied with the results as I think we should be. And at the same time, it’s crucial to recognize the success the CFP Board has had in actually growing the CFP marks themselves.

Bear in mind, if you look at data from Cerulli, the number of financial advisors in total is basically flat since 2011 and down almost 10% in the past 10 years, yet the number of CFP certificants is up 25% since 2011 and almost 50% in the past 10 years. That’s phenomenal growth to achieve for the CFP Board – to be growing the ranks of the CFPs by 50% in a time when the head count of total advisors declined by 10%.

To the extent we pay CFP certification fees to CFP Board to maintain the marks and build awareness for them, the CFP Board does appear to be doing a heck of a job at executing and getting results for the fees we pay, which is why I so strongly advocate that anyone who wants to establish their career as a financial planner today and is looking forward to their career future needs to get CFP certification. It is becoming the baseline competency standard for actually being a real financial planner beyond just being licensed as an insurance agent or a registered rep salesperson.

And likewise, that’s why even if someone has often disagreed with CFP Board about its policies over the years, I advocate submitting public comment letters. Speak out, and get involved to help shape the CFP Board’s policies. The CFP marks and the CFP Board aren’t going away, so if you don’t like what the organization is doing, don’t talk about dropping the marks, get involved and be a part of the change that you want to see.

CFP Board Accountability – Why A 17% Fee Increase Now?

Now, at the same time, I’m a supporter of the CFP marks and the CFP Board, but I do think accountability is crucial, especially since the CFP Board has been prone in recent years to taking a lot of actions without soliciting much input or even holding public comment periods. Now, it did put forth a public comment period on the recent proposed change to the Code of Ethics and Standards of Conduct, but that’s because its bylaws require the organization to do so.

Aside from that change, it’s been over five years since the CFP Board put forth a public comment period on any other change to the other three E’s – the education changes, exam changes, and experience requirement changes – all of which have experienced material changes in five years.

Ever since the CFP Board proposed to increase the number of required CFP CE credits in 2012 and got basically “voted down” in negative public comments, the organization has stopped soliciting public comments and there isn’t even a way to access the prior public comments that were submitted. They’re all supposed to be public comments, but CFP Board has failed to actually make them public.

And so, in that context, where I do think there are real concerns about CFP Board’s accountability, it’s a fair question to ask, why exactly it feels the need to take a 17% increase on certification fees for 2018? Why so much of an increase? Why now, especially if the organization is already running a substantial operating surplus of $1.3 million on an $18 million operating budget in 2015, and has more than $20 million in net reserves available?

Was there some major downturn for CFP Board in 2016 that we just can’t see on the Form 990 yet because it’s not publicly available? Or is CFP Board raising revenue in advance for some new initiative that we haven’t even been told about yet and we’re being forced to pay for it before we even know what it is? Or is CFP Board trying to raise more revenue internally for its Center for Financial Planning initiative even though they said originally that the center would be funded separately from contributed income?

Especially since CFP Board tried to put through a $25 fee increase last yearby defaulting every CFP certificant into a $25 voluntary donation to the Center for Financial Planning, which they quickly eliminated 48 hours after Kitches.com published an article about it here on Nerd’s Eye View. So it may just be a coincidence, but it’s hard to believe that the CFP Board tried and failed to put through a $25 a year donation to the Center last year, and now suddenly is pushing through a $30 increase in the certification fee this year. Is the fee increase to generate revenue from the Center that they couldn’t get last year? Unfortunately, we don’t know because the CFP Board gave no substantive explanation for why it is pushing through a 17% increase in the certification fee beyond saying it supports the operations of CFP Board in fulfilling its mission and strategic priorities.

And so again, while I’m not necessarily negative on any organization that raises its fees over time especially when it’s the first increase in such a long time, the question remains: Why does the CFP Board now, all of a sudden, need another $2.3 million in its operating budget for 2018? You don’t need $2.3 million on an already profitable $18 million operating budget just to give the whole team well-deserved salary raises.

So what initiatives is this actually earmarked towards? Is this the Center of Financial Planning already experiencing some kind of mission creep by taking a portion of CFP Board operating budget even though it was never supposed to come from operating budget dollars? What does it take to get some basic transparency and explanations with CFP Board on why it’s pushing through a 17% fee increase? This isn’t just 3% or 5% adjustment we can write off as an annual cost of living tweak. For a 17% increase and a $2 million revenue grab, we should be getting a little more substantive explanation.

So what do you think? Were you aware of the CFP Board’s 17% fee increase? Should the CFP Board be more transparent about what this fee increase is going funding? Is it possible the Center for Financial Planning is already experiencing some mission creep? Please share your thoughts in the comments below!

 

Comment Letter To CFP Board On Its Proposed Fiduciary Standards Of Conduct

EXECUTIVE SUMMARY

In December of 2015, the CFP Board announced that it was beginning a process to update its Standards of Professional Conduct for all CFP certificants, the first such update since the last set of changes took effect in the middle of 2008. And on this past June 20^th, the CFP Board published proposed changes (including an expanded fiduciary duty) to its Standards of Conduct, with a public comment period that would last until August 21^st.

And so as the CFP Board’s Public Comment period closes today, I have published here in full my own comment letter to the CFP Board. And as you will see in the Comment Letter, I am overall very supportive of the CFP Board advancing the fiduciary standard of care for CFP professionals, and view this as a positive step forward for the financial planning profession.

However, the CFP Board’s proposed changes do introduce numerous new questions and concerns, from key definitions that (in my humble opinion) still need to be clarified further, to new wrinkles in what does and does not constitute a fee-only advice relationship (and whether and to what extent certain types of compensation must be disclosed), to uncertainties about how CFP professionals are expected to navigate important conflicts of interest, and how CFP professionals should interpret the 29(!) instances where the CFP Board’s new standards are based on “reasonableness”… with no explanation of how “reasonable” is determined, and a non-public CFP Board Disciplinary and Ethics Commission that doesn’t even allow CFP professionals to rely on prior case histories for precedence.

Ultimately, I am hopeful that the CFP Board will end up moving forward with its proposed changes to expand the scope of fiduciary duty for CFP certificants, but only after publishing another round of the proposal for a second comment period, given the substantive nature of both the changes themselves, and the concerns that remain.

In the meantime, I hope you find this public comment letter helpful food for thought. And if you haven’t yet, remember that you too can submit your own Public Comment letter to the CFP Board by emailingComments@CFPBoard.org – but today (August 21^st) is the last day to submit!

Comment Letter To CFP Board On Its Proposed Fiduciary Standards Of Conduct

In December of 2015, the CFP Board announced that it was beginning a process to update its Standards of Professional Conduct for all CFP certificants, the first such update since the last set of changes took effect in the middle of 2008. And on this past June 20^th, the CFP Board published proposed changes (including an expanded fiduciary duty) to its Standards of Conduct, with a public comment period that would last until August 21^st.

And so as the CFP Board’s Public Comment period closes today, I have published here in full my own comment letter to the CFP Board. And as you will see in the Comment Letter, I am overall very supportive of the CFP Board advancing the fiduciary standard of care for CFP professionals, and view this as a positive step forward for the financial planning profession.

However, the CFP Board’s proposed changes do introduce numerous new questions and concerns, from key definitions that (in my humble opinion) still need to be clarified further, to new wrinkles in what does and does not constitute a fee-only advice relationship (and whether and to what extent certain types of compensation must be disclosed), to uncertainties about how CFP professionals are expected to navigate important conflicts of interest, and how CFP professionals should interpret the 29(!) instances where the CFP Board’s new standards are based on “reasonableness”… with no explanation of how “reasonable” is determined, and a non-public CFP Board Disciplinary and Ethics Commission that doesn’t even allow CFP professionals to rely on prior case histories for precedence.

Ultimately, I am hopeful that the CFP Board will end up moving forward with its proposed changes to expand the scope of fiduciary duty for CFP certificants, but only after publishing another round of the proposal for a second comment period, given the substantive nature of both the changes themselves, and the concerns that remain.

In the meantime, I hope you find this public comment letter helpful food for thought. And if you haven’t yet, remember that you too can submit your own Public Comment letter to the CFP Board by emailingComments@CFPBoard.org – but today (August 21^st) is the last day to submit!

Narrowing The Definition Of “Family Member”

The Related Party rules under the proposed Standards of Conduct include a rebuttable presumption that any family members, or business entities that family members control, will be treated as a “Related Party” for the purposes of both compensation disclosures, and the potential determination of the CFP Professional’s status as being “Fee-Only”.

However, “Family Member” is simply defined as:

A member of the CFP® professional’s family and any business entity that the family or members of the family control.

In practice, this raises numerous questions.

First and foremost, to what depth in the “family tree” is it necessary to look to determine “member of the family” status. Parents, siblings, and children? Grandparents and grandchildren? What about aunts, uncles, nieces, and nephews? Do cousins count? Only 1^st cousins? What about 2^nd or 3^rdcousins? Do the family members of the CFP spouse’s family count, if the spouse is not themselves a CFP professional (such that the family members are “only in-laws”)?

Similarly, what constitutes “family control” of an entity? Must it be controlled by a single family member? What if multiple family members each own a minority share, but their combined ownership constitutes a majority ownership? Does “control” mean ownership of voting shares that actually control the entity? Does that mean a CFP professional could avoid “Related Party” status by owning a 99% limited partnership interest in the entity but NOT the 1% controlling general partner interest? (And does that distort the original intent of these Related Party rules, since the CFP professional would not control the entity, but would receive the bulk of the financial benefits of the entity?)

Notably, Internal Revenue Code Section 318 provides substantial guidance about where these dividing lines are drawn with respect to family members, family attribution, and constructive ownership of stock, and may serve as a guiding template for the CFP Board.

But the nature and scope of “family” and “control” must be clarified further, lest CFP professionals simply direct (without being required to fully disclose) a substantial portion of their compensation to entities in which they own 99% limited partner interests but no controlling interests to avoid the Related Party rules!

Key Point: Clarify the scope of “family member” (how much of the family tree counts?), what constitutes “control” of a business entity as a Related Party, and whether a non-controlling but majority financial interest should also be deemed a Related Party.

CFP Board Standards should clarify who a ‘family member’ is!

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Disclosing How An Advisor Is Compensated, or What An Advisor Is Compensated?

A key aspect of the fiduciary duty is to fully disclose conflicts of interest to the client (to the extent they cannot be avoided), and is articulated as such in the CFP Board’s required Duty of Loyalty to clients.

However, the actual disclosures required in Sections 10 and 11 (Introductory Information to the Prospect, and Disclosure Information to the Client) regarding compensation merely require that the advisor disclose “how the Client pays, and how the CFP professional and the CFP Professional’s Firm are compensated, for providing services and products.” Notably absent is a requirement to disclose what, exactly, the CFP professional and his/her firm will be compensated for providing services and products.

This may have simply been an unintended error of wording, but sections 10(b)(ii) and 11(a)(ii) of the final rules should be updated to clearly require the CFP professional to not merely disclose how they are compensated – e.g., “with fees” or “with commission” or “by my company” – but disclosewhat the CFP professional is compensated: i.e., disclosing to the client theactual compensation arrangements for what, exactly, the CFP professional is compensated (and not merely “how”).

Notably, if/when compensation disclosures are required that explain what, exactly, the CFP Professional and the CFP Professionals firm are paid, an additional distinction may need to be made between what the CFP Professional is paid, and what the CFP Professional’s Firm is paid, given that not all CFP Professionals are privy to the details of all revenue sources of their Firms (particularly in the case of a broker-dealer, if a broker-dealer is deemed the CFP professional’s “firm”). This may include (for firms) revenue-sharing or shelf-space agreements, 12b-1 or sub-TA fees, conference sponsorships based on sales volume, commission overrides (in the case of certain annuity and insurance products), etc. Consider whether additional clarifications are needed to specify the exact scope of compensation disclosures for the CFP profession as distinct from the CFP Professional’s Firm, especially given the breadth of some firm’s overall business models.

Key Point: Does the CFP Board expect the CFP professional to merely disclose how they are compensated (fees or commissions or both?), orwhat they are compensated (disclosure of actual compensation arrangements)? And to what extent must the CFP Professional determine the prospective compensation relationships of the CFP Professional’s Firm?

CFP Board Standards should require CFPs to dislcose both HOW they are paid, AND WHAT they are paid!

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Financial Advice Outside The Scope Of A Financial Plan

In the glossary, Financial Advice is defined as follows:

A communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the Client take or refrain from taking a particular course of action with respect to:

1. The development or implementation of a financial plan addressing goals, budgeting, risk, health considerations, educational needs, financial security, wealth, taxes, retirement, philanthropy, estate, legacy, or other relevant elements of a Client’s personal or financial circumstances;

Technically, this would suggest that any suggestion that a client take or refrain from a particular course of action not pursuant to a [comprehensive] financial plan would not be deemed advice. In other words, if the CFP professional simply gives direct advice to the client regarding budgeting, risk, wealth, taxes, retirement, etc., but not specifically pursuant to the “development or implementation of a financial plan”, it would not be financial advice subject to a fiduciary duty (unless captured in one of the other subclauses of Financial Advice regarding the investment of Financial Assets or the selection of other professionals).

Given that many forms of financial advice are given more modularly, and not necessarily as a part of a comprehensive financial plan (nor is what constitutes a “financial plan” even defined in the proposed Standards), this section should be modified to simply recognize that the subjects themselves are what trigger financial advice, not specifically the creation of a financial plan.

The most straightforward resolution would simply be to remove the words “development or implementation of a financial plan addressing”, such that the section would simply read:

A communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the Client take or refrain from taking a particular course of action with respect to:

1. The goals, budgeting, risk, health considerations, educational needs, financial security, wealth, taxes, retirement, philanthropy, estate, legacy, or other relevant elements of a Client’s personal or financial circumstances;

Notably, in the context of this change, the word “goals” should be also modified, to stipulate “financial goals” (as otherwise, even advice about a client’s “goal to lose weight” could be treated as a financial advice goal under this definition!), or alternatively the final clause could be adjusted to state “…or other relevant financial elements of a Client’s personal or financial circumstances”).

In addition, advice regarding loans, debt, and other mortgages (or more generally, “liabilities”) should be included in the list of topics which are treated as “financial advice” in this section (as the remaining subsections defining Financial Advice all pertain to a client’s Financial Assets, and not his/her Financial Liabilities).

Key Point: The delivery of financial planning advice should be treated as financial advice, regardless of whether it is actually delivered pursuant to a financial plan.

CFP Board Standards should treat advice the same, regardless of whether it is part of a plan!

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New Issues Created By Proposed Compensation Disclosure Rules

Beyond the aforementioned definitional issues regarding the Proposed Standards, a number of unique new issues arise in the CFP Board’s new approach to compensation definitions, including its “negative framing” approach to fee-only (where a “fee-only” advisor is not one who “only” receives fees, but one who does not receive any form of Sales-Related Compensation), the labels that advisors use (or may potentially use in the future) to describe their compensation methodologies.

RIA SOLICITORS AND OUTSOURCING INVESTMENT MANAGEMENT

Section 14(b) of the Proposed Standards defines Sales-Related Compensation, which is stated as:

Sales-Related Compensation is more than a de minimis economic benefit for purchasing, holding for purposes other than providing Financial Advice, or selling a Client’s Financial Assets, or for the referral of a Client to any person or entity. Sales-Related Compensation includes, for example, commissions, trailing commissions, 12(b)1 fees, spreads, charges, revenue sharing, referral fees, or similar consideration.

The fact that revenue-sharing and referral fees, along with any other kind of compensation for the referral of a Client to any person or entity, constitutes “Sales-Related Compensation”, presents substantial potential difficulties for a number of common investment arrangements that would otherwise, to an objective observer, appear to constitute a Fee-Only advisory relationship (were it not for this new compensation definition).

For instance, many financial-planning-centric CFP professionals choose to outsource their investment management implementation, rather than hiring a CFA to assist with it internally. If the advisor wants to retain operational responsibilities and “just” have a third party help with investment models and implementation, the advisor might use a Separately Managed Account. However, for advisors who want to fully outsource investment management responsibilities, it is common to use a TAMP (Turnkey Asset Management Platform), which handles both the investment management and other operational tasks of the investment portfolio, including billing.

In some cases, TAMPs will apply two tiers of fees to the advisory account – one for the TAMP’s portion of investment responsibilities, and the other for the CFP Professional’s fees. But more commonly, the TAMP will simply conduct the entire fee sweep, and then remit a portion back to the CFP professional in the form of either a revenue-sharing or solicitor fee.

The end result of this arrangement is that the CFP Professional that uses a TAMP for investments in order to focus on financial planning would be deemed to receive sales-related compensation and not be fee-only (due to the fact that the TAMP swept the fees and remitted them to the advisor), whereas if the advisor retained billing responsibility and remitted a portion of the advisor’s fee to the TAMP as an expense, he/she would be treated as fee-only. This seems to create a substantial distinction in compensation disclosure arrangements, without any actual substantive difference in what the client pays, or the nature of any conflicts of interest (particularly where the advisor retains advisory authority to hire/fire/change the TAMP manager).

Furthermore, the irony is that if the CFP professional was not independent, and instead worked for the TAMP, and was paid compensation directly by the firm for which he/she worked (even if it was a percentage of revenue), the compensation disclosure rules would (correctly) recognize that the client is paying only a fee to the CFP professional and his/her firm. Thus, an independent CFP professional who objectively chooses a third-party TAMP (for which the TAMP handles billing and shares the CFP professional’s share of the fee back to him/her) is treated as receiving sales-related compensation, yet an employee of the TAMP who only solicits for that TAMP, and receives a share of the fee revenue (a classic salesperson arrangement) would not be sales-related compensation (because as an employee, the employee’s compensation within the firm is not treated as revenue-sharing, even though it functionally is).

In other words, the CFP Board’s Proposed Standards have (perhaps unwittingly) created a substantial distinction between “first-party” revenue-sharing (CFP professional is internal to a firm), and “third-party” revenue sharing (CFP professional is external from the firm), even though the actual services rendered, fees paid by the client, and compensation paid to the CFP professional, are exactly the same… and in fact, the external advisor would be more independent and less prone to sales-related conflicts of interest!

While in theory, it might be ideal to try to “require” all advisors to structure third-party investment management agreements in certain ways – such as requiring that the advisor’s fee and the TAMP’s fee always be billed separately, or that the advisor always sweep fees and remit the TAMP’s portion to the TAMP, rather than the other way around – from a practical perspective, such changes would be substantial operational changes for many TAMPs, and not feasible to implement in a timely manner in accordance with the CFP Board’s Proposed Rules. Even though, again, the end result to the client is still that he/she is paying only fees and no actual sales-related compensation.

Accordingly, the CFP Board should consider amendments to this definition of “Sales-Related Compensation”, to more accurately reflect the underlying substance and economic reality of the arrangement for the client, and not recharacterize fees as sales-related compensation simply due to operational implementation decisions.

Reasonable safe harbors to further modify this rule might include:

– If the CFP professional receives a referral or solicitor fee from another firm, and that firm itself receives no sales-related compensation in connection with services rendered to the client, then the CFP professional’s participation in a portion of the fee-only relationship does not convert it to sales-related compensation (i.e., participating in a portion of the fees in a fee-only relationship is still a fee-only relationship);

– In order to be deemed a permissible fee-only revenue-sharing agreement, the CFP professional should retain discretion to hire or fire the third-party manager (to affirm that the CFP professional is in an independent relationship, and not operating as a captive salesperson); and

– In order to not be deemed Sales-Related Compensation for participating in the sharing of a client fee, the CFP Professional’s share of the compensation should not materially vary by the assets of the client or total assets of the relationship (to avoid sales incentives for directing client investment fees towards a particular provider)

Key Point: Treat CFP professionals who outsource to third-party managers the same as CFP professionals whose firms hire internal investment staff, if the client is actually paying the same fees either way.

CFP Board Standards should treat outsourcing and hiring internal investment staff the same!

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INTERNAL EMPLOYEE SALES-RELATED COMPENSATION IN THE FORM OF BONUSES

Continuing the prior theme, it’s also notable that all forms of “Sales-Related Compensation” implicitly assume that payments will come fromthird parties, without recognizing that for advisors who work directly for product manufacturers, “sales-related compensation” comes in the form of direct bonuses from their employer for certain levels of sales production.

In other words, when an independent advisor is paid to sell a third-party product, sales-related compensation is typically in the form of a commission. When a captive advisor is paid to sell his/her company’s ownproprietary product, sales-related compensation is typically in the form of bonuses (which firms assign based on sales targets, the profitability of products, etc.). Yet the CFP Board’s current definition of compensation would not characterize the compensation of the latter as sales-related compensation, even if the bulk of the advisor’s compensation actually was tied directly to sales (and paid in the form of employee bonuses, rather than product commissions).

Accordingly, CFP Board’s definitions for sales-related compensation need to consider the types of internal compensation bonuses paid to employees for business development and production, including common practices such as paying advisors a percentage of revenue they bring in (an indirect form of solicitor fee), and paying bonuses based on total products implemented (an indirect form of commissions). And to the extent such compensation arrangements would be deemed sales-related compensation in a third-party independent context, they should be reflected as sales-related compensation in a first-party context as well.

Otherwise, a firm could operate entirely as “fee-only” simply by manufacturing all of its own proprietary products, and rather than paying commissions to third-party advisors, simply pay its own CFP professionals a salary plus bonus (or a share of revenue) to sell its products (even though the nature of the advisor’s role is purely sales).

Key Point: Treat RIA solicitors of a fee-only firm the same as employees of a fee-only firm, given that both may be paid the exact same way (a percentage of revenue). And recognize for captive employees of firms that manufacturer proprietary product, even salary and bonus compensation can constitute sales-related compensation (even if there are no direct commissions, because the company is distributing its product directly through its own salaried salespeople).

CFP Board Standards should treat solicitors of fee-only firms the same as employees!

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ADVISORS WHO CHANGE METHODS OF COMPENSATION TO FEE-ONLY (FOR FUTURE CLIENTS)

One of the greatest challenges that may arise from the proposed definitions for fee-only and sales-related compensation is for advisors who wish to change to become fee-only, even though they previously operated as a commission-and-fee advisor who received sales-related compensation.

The reason is that, under the proposed definitions, a fee-only CFP professional cannot hold out as such if they receive any “sales-related compensation”, including trailing commissions and 12b-1 fees, even if 100% of the CFP professional’s ongoing relationships with new clients involve no new sales-related compensation. In other words, any CFP professional who wantsto operate on a fee-only basis in the future still cannot actually be fee-only unless they terminate all ongoing 12b-1 and other trailing commission payments to themselves.

Yet from a practical perspective, this is neither positive for the client, nor the advisor. To the extent the client has already purchased a commission-based product in the past, with a 12b-1 or other commission trail built into the existing pricing of the product, even if the advisor terminates the trailing commission relationship, the client will still pay the trail anyway. It will simply be collected by the product manufacturer as a “house account”, instead of being paid to the original CFP professional who sold it.

In addition, a CFP professional who terminates their commission trail relationship is required to remove themselves from being the broker-of-record or agent-of-record on the investment or insurance product, which eliminates the advisor’s ability to actually provide basic service, and answer ongoing financial planning questions, of the client.

All of which means compelling newly-fee-only CFP professionals to actually terminate their trailing commissions and 12b-1 fees results in a decrease in the ability of the advisor to service the client and address their financial planning needs, without even saving the client the cost of those trailing commissions or 12b-1 fees in the first place!

And notably, even the SEC characterizes a 12b-1 fee as a combination of a “distribution fee” (i.e., a commission, of up to 0.75%/year), and a “shareholder servicing fee” (which FINRA caps at 0.25%/year). In other words, a 12b-1 fee of up to 0.25%/year isn’t actually even “sales-related compensation” in the first place; it’s a servicing fee. (The same is true for many insurance commission trails as well, though the split between [levelized] commissions and servicing trails are not always delineated explicitly.)

Thus, given that ongoing 12b-1 and commission trails are typically for servicing anyway, and advisors who retain servicing relationships with products previously sold to clients maintain better ability to render financial planning advice on those products, a more appropriate definition of “fee-only” (or limitation on sales-related compensation” would recognize a distinction between receiving servicing 12b-1 fees and commission trails on prior transactions, from new commissions generated from new transactions (which would clearly be sales-related compensation).

Accordingly, the CFP Board should consider adding an additional exclusionary condition under Section 14(b) of its proposed rules (i.e., a new paragraph iv), which stipulates that the mere presence of 12b-1 servicing fees (in an amount no more than the FINRA-capped 0.25%), and ongoing commission trails (for servicing previously sold products), will not be treated as sales-related compensation, as long as no new sales-related compensation is introduced going forward.

Conversely, though, the CFP Board should also consider amending the rules to stipulate that if an advisor’s compensation status changes, all prospective and existing clients must be notified of the change. Otherwise, the limitations on “sales-related compensation” and the definition of “fee-only” also risks being rendered moot by an advisor who claims to be “fee-only”, then “temporarily” changes their compensation to be commission-and-fee for one client (who does a purchase of a large commission-based product), and then switches “back” to fee-only after the purchase has occurred. In other words, CFP Board needs to consider introducing some provision to clarify whether or how quickly an advisor can change their status to/from fee-only, to minimize any risk of routine “hat-switching” from one client to the next. (A notification requirement to all clients of the change in compensation methodology would likely be sufficient to reduce any advisor incentive for making regular client-by-client changes.)

Key Point: Provide clear guidance about how CFP professionals who previously received sales-related compensation, and still receive ongoing 12b-1 servicing fees and insurance commission trails for servicing, can transition to fee-only status, without being required to terminate their broker-of-record and agent-of-record affiliations that are necessary to ensure previously-sold contracts can be properly serviced by the advisor.

CFP Board Standards should give clear guidance to professionals transitioning to fee-only status!

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STANDARDIZING TERMINOLOGY IN COMPENSATION DISCLOSURES

One of the “unintended consequences” of the changes to compensation disclosures in the last update to the CFP Standards of Conduct was that, once the definition of “fee-only” became more clearly defined, advisors who wanted to market on a “similar” basis began to adopt the label “fee-based” instead.

To address this issue, the CFP Board’s new rules would require, in Section 14(a)(ii), that:

A CFP® professional who represents that his or her compensation method is “fee-based” must: a) Not use the term in a manner that suggests the CFP® professional or the CFP® Professional’s Firm is fee-only; and b) Clearly state that either the CFP® professional earns fees and commissions, or the CFP® professional is not fee-only.

While this is a reasonable way to address the concern of CFP professionals who use the label “fee-based” to imply something similar to “fee-only”, it fails to recognize the underlying challenge: that given currently favorable media coverage of the “fee-only” label, there is a substantial marketing advantage for non-fee-only advisors who can come up with a fee-only-like similar label.

Which means even if the CFP Board cracks down on “fee-based”, it’s only a matter of time before a new, alternative term arises instead. Advisors who receive fees and commissions, but want to accentuate the fee aspect of their advisory relationships, may simply instead adopt terms like “fee-oriented” or “fee-compensated” or “fee-for-service” (without acknowledging they’re also commission-compensated). Which leaves the CFP Board in the unenviable position needing to update its compensation disclosure rules every few years just to try to crack down on the latest “innovative” fee-related marketing term.

The alternative, which the CFP Board should seriously consider instead, is to standardize the terminology in compensation disclosures – a path the organization had started down previously with its 2013 “Notice To CFP Professionals” regarding compensation disclosures, with its specific disclosure types of “fee-only”, “commission-and-fee”, and “commission-only”.

In a world where those options are the only options that advisors are permitted to use – or at least, where those disclosure types must be statedfirst, before any other compensation labels – there is little risk of alternative compensation labels arising. Or at a minimum, if a CFP professional chooses in the future to call themselves “fee-oriented” or “fee-compensated” or “fee-for-service” but first must acknowledge they are commission-and-fee advisors, the risk of consumer confusion over compensation labels is greatly diminished.

Notably, though, the one caveat of this approach is that in practice, it means most advisors will end out in the “middle” category of being commission-and-fee, and that advisors will be in that category regardless of whether they receive 99% of their compensation in commissions, or 99% of their compensation in fees (even though, in practice, those are substantively different business models, with substantively different potential conflicts of interest to disclose to the client). Accordingly, to avoid rendering the “commission-and-fee” label meaningless (even as it’s used by the majority of CFP Professionals), CFP Board might consider at least adjusting to four categories: fee-only, fee-and-commission, commission-and-fee, and commission-only (where the difference between fee-and-commission versus commission-and-fee is determined based on which compensation type formed the majority of the advisor’s compensation over the prior calendar year, or some other stipulated measuring period).

Nonetheless, the fundamental point is simply this: in order to prevent the “creative” use of potentially misleading compensation labels, the CFP Board needs to standardize a fixed nomenclature of compensation models (as it has for “fee-only”, but including all the other possible categories as well), and require those labels of the first/primary explanation of compensation for the CFP professional. Anything less simply invites a never-ending oversight challenge of adapting new rules to ever-changing terms and labels in the marketplace.

Key Point: Standardize a series of required compensation disclosures, rather than merely defining “fee-only” and limiting “fee-based”, or the advisory community will simply keep coming up with new terms that may or may not be deemed misleading in the future. A standard nomenclature – such as fee-only, commission-and-fee, fee-and-commission, and commission-only – eliminates any room for innovating new questionable terms.

CFP Board Standards should develop a standard nomenclature of compensation disclosures!

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Limiting An Advice Engagement To A Compensated Engagement

One of the biggest practical caveats to enforcing a fiduciary duty for any professional service provider is being clear about when a professional service engagement actually begins. This helps to ensure not only that “general education” is not unwittingly treated as a fiduciary professional service, but also that “free” services (which may or may not constitute a formal professional services engagement) aren’t subject to professional standards when they shouldn’t be.

Fortunately, the flush language of the definition of “Financial Advice” in the Glossary of the proposed standards does clearly state that “…the provision of services or the furnishing or making available of marketing materials, general financial education materials, or general financial communications that a reasonable person would not view as Financial Advice, does not constitute Financial Advice.” This helps to limit any concern that a practitioner would have that general financial education will not constitute fiduciary financial advice.

However, Section 1 of the Standards still require that a fiduciary duty applies to any “Client”, where a Client is defined as “any person… to whom the CFP professional renders Professional Services pursuant to an Engagement”, and an “Engagement” is defined as “a written or oral agreement, arrangement, or understanding”. Yet at no point is there an actual requirement that such an engagement be a formal businessrelationship for compensation.

As a result, the delivery of “free financial advice” – e.g., on a pro bono basis, in an informal relationship with a friend or colleague, or even just ad hoc in a conversation with a stranger – could potentially constitute a fiduciary financial advice relationship. The conversation merely needs to start with an informal statement “Hey, let me ask your advice about something…” and if the advisor responds, an oral understanding that advice is about to be delivered exists, which attaches the advisor’s fiduciary duty.

Notably, such an (investment) advice relationship would not exist for that advisor under the Investment Advisors Act of 1940, because Section 202(a)(11) of that law stipulates that one is only an investment adviser if he/she engages in the business of advising others for compensation. Similarly, the Department of Labor’s recently introduced fiduciary rule also limits the scope of fiduciary duty to situations where the advisor “renders investment advice for a fee or other compensation…”

Accordingly, the CFP Board should adjust its definitions to clarify that “free” advice, or other non-compensated informal advice arrangements, do not (and cannot) rise to the level of being fiduciary financial advice, if the advice is not provided for consideration (i.e., for compensation). Practically speaking, this is probably best handled by adjusting the definition of a Client to be:

Client: Any person, including a natural person, business organization, or legal entity, to whom the CFP® professional renders Professional Services for compensation pursuant to an Engagement.

Key Point: A financial planning “engagement” should be limited to one where the CFP professional renders professional services for compensation, to avoid the risk that “free advice” is deemed an advice relationship.

CFP Board Standards should clarify that ‘free advice’ would not be deemed an advice relationship!

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What Does It Mean To “Manage” Conflicts Of Interest

One of the fundamental principles of a fiduciary duty is the recognition that advisors have a duty of loyalty to their clients, to act in their clients’ best interests, such that conflicts of interest must be managed, and unmanageable conflicts of interest must be avoided altogether.

Accordingly, the Investment Advisers Act of 1940 (and subsequent SEC guidance over the years) provides an extensive series of rules regarding what kinds of conflicts of interest are prohibited for investment advisers. Similarly, the Department of Labor’s new fiduciary rule (and the prior/existing rules under ERISA) prohibit a wide range of unmanageably-conflicted activities, subject to various Prohibited Transaction Exemptions if certain safe harbor stipulations are met.

When it comes to the CFP Board’s requirements, though, Section 9 of the Proposed Standards merely requires CFP professionals to disclose conflicts of interest, with a brief paragraph (out of a 17-page document) directing that “a CFP® professional must adopt and follow business practices reasonably designed to prevent Material Conflicts of Interest from compromising the CFP® professional’s ability to act in the Client’s best interests.” And while Section 1(a)(ii) does go a bit further in stating that a CFP professional should “Seek to avoid Conflicts of Interest, or fully disclose Material Conflicts of Interest to the Client, obtain the Client’s informed consent, and properly manage the conflict”, this still constitutes the entire guidance of the Proposed Standards of Conduct.

Thus, the questions arise: what, exactly, are CFP professionals expected todo to manage their conflicts of interest, what constitutes an “insufficient” business practice that fails to reasonably prevent Materials Conflicts of Interest from compromising the CFP professional, and what types of conflicts are CFP professionals actually expected to “avoid” versus merely “manage”? Will the CFP Board publish a list of prohibited transactions, akin to the Department of Labor, or create further regulations limiting CFP professionals from certain (highly conflicted) activities (as the SEC does)?

Without any guidance from the CFP Board, the risk to the CFP professional is that they will be found “guilty” of failing to manage their conflicts of interest, in a ruling from the Disciplinary and Ethics Commission that only explains what was “impermissible” behavior after the fact.

CFP professionals should not be left to wonder what will turn out, after the fact, to have been deemed an unacceptable or improperly managed conflict of interest. At a minimum, the CFP Board needs to provide additional, supplemental guidance. And the CFP Board should seriously consider whether certain especially-conflicted arrangements with clients are “so conflicted” that the Standards of Conduct should simply bar them altogether (as the Department of Labor did with its fiduciary rule).

Key Point: Provide further clarity about what it really means to “manage” conflicts of interest, and what types of conflicts the CFP Board expects CFP professionals to avoid. Don’t force CFP professionals to find out what is deemed unacceptable after the fact with an adverse DEC ruling.

CFP Board Standards should further clarify what it really means to ‘manage’ conflicts of interest!

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Navigating Conflicting Duties Of Loyalty Between CFP Professionals And Their Broker-Dealer Or Insurance Company

The first requirement of the CFP professional’s Duty of Loyalty in the proposed Standards of Conduct is that the CFP professional must “Place the interests of the Client above the interests of the CFP® professional and the CFP® Professional’s Firm”.

Yet the reality is that for a substantial number of CFP professionals, they operate as a registered representative of a broker-dealer, or an agent of an insurance company, and legally have an obligation (a bona fide agency relationship) to represent the CFP professional’s firm first and foremost, and not the client.

Clearly, it is often “good business” for firms to act in the best interests of their clients, regardless of the scope of relationship, but CFP Board’s proposed Standards of Conduct are nonetheless placing a large subset of CFP professionals in a potentially untenable conflict between the requirements of the Standards, and their legal employment agreement and relationship to the Professional’s firm.

At a minimum, the CFP Board should provide additional guidance about how, realistically, CFP professionals are expected to navigate this particular conflict of interest, and in what situations a CFP professional is expected to decline a business opportunity, or outright terminate their employment relationship, if a conflict of interest emerges where the CFP professional cannot effectively fulfill both his/her duty of loyalty to the client, and his/her agency relationship and employment agreement with the firm.

Key Point: With an explicit duty of loyalty to the client for the CFP professional, clarify how CFP professionals working at a broker-dealer or insurance company, where the CFP professional has a legal employment contract that requires him/her to operate as an agent of the company and represent the company (not the client), is expected to navigate prospective conflicts of interest.

CFP Board Standards should clarify how CFPs at BDs can navigate conflicts of interest!

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Anonymous Case Histories And Setting Precedents For Reasonableness

The final concern worth recognizing in the CFP Board’s Proposed Standards is the fact that substantial portions of the rules are based on subjective standards – beyond just the question of what is a “manageable” conflict of interest vs one to avoid – such that CFP professionals may not even know which behaviors and actions are safe and appropriate until it’s too late.

For instance, the word “reasonable” or “reasonably” is used a whopping 29 times in the Proposed Standards, pertaining to the everything from the aforementioned issue of whether a conflict of interest is Material (based on whether a “reasonable” client would have considered the information material), to whether a related party is related based on whether a “reasonable” CFP professional would interpret it that way, to requirements that CFP professionals diligently respond to “reasonable” client inquiries, follow all “reasonable” and lawful directions of the client, avoid accepting gifts that “reasonably” could be expected to compromise objectivity, and provide introductory information disclosures to prospects the CFP professional “reasonably” anticipates providing subsequent financial advice to. In addition, the entire application of the rules themselves depend on the CFP Board’s “determination” of whether Financial Advice was provided (which triggers the fiduciary obligation for CFP professionals), and CFP professionals with Material conflicts of interest will or will not be found guilty of violating their fiduciary duty based on the CFP Board’s “determination” of whether the client really gave informed consent or not.

In other words, the CFP Board’s new Standards of Conduct leave a lot of room for the Disciplinary and Ethics Commission to make a final (after-the-fact) subjective assessment of what is and isn’t reasonable in literally several dozen instances of the rules.

Of course, the reality is that it’s always the case that regulators and legislators write the rules, and the courts interpret them in the adjudication process. And using “reasonableness” as a standard actually helps to reduce the risk that a CFP professional is found guilty of something that is “reasonably” what another CFP professional would have done in the same situation. “Reasonableness” standards actually are peer-based professional standards, which is what you’d want for the evaluation of a professional.

However, when courts interpret laws and regulations, they do so in a public manner, which allows everyone else to see how the court interpreted the rule, and provides crucial guidance for everyone who follows thereafter. Because once the court interprets whether a certain action or approach is or isn’t permitted, it provides a legal precedent that everyone in the future can rely upon. Except in the case of the CFP Board’s Standards of Conduct, because the CFP Board’s disciplinary process is not public in the first place!

Which means even as the DEC adjudicates 29 instances of “reasonableness”, no one will know what the DEC decided, nor the criteria it used… which means there’s a risk that the DEC won’t even honor its own precedents, and that rulings will be inconsistent. And even if the DEC is internally consistent, CFP professionals won’t know how to apply the rules safely to themselves until they’re already in front of the DEC trying to defend themselves!

Fortunately, since 2010 the CFP Board has been providing a limited number of “Anonymous Case Histories” to provide some guidance on prior DEC rulings. However, the CFP Board’s current Anonymous Case History (ACH) database is still limited (it’s not all cases), and the database does not allow CFP professionals (or their legal counsel) any way to do even the most basic keyword searches OF the existing case histories (instead, you have to search via a limiting number of pre-selected keywords, or by certain enumerated practice standards… which won’t even be a relevant search format once the newly proposed Standards replace the prior format!).

Which means if the CFP Board is serious about moving forward with the new Conduct Standards, including the application of a fiduciary duty and a few dozen instances of “reasonableness” to determine whether the CFP professional met that duty, it’s absolutely crucial that the Commission on Standards require a concomitant expansion of the CFP Board’s Anonymous Case Histories database to include a full listing of all cases (after all, we don’t always know what will turn out to be an important precedent until after the fact!), made available in a manner that is fully indexed and able to be fully searched (not just using a small subset of pre-selected keywords and search criteria).

In addition, the CFP Board should further formalize an additional structure to provide periodic guidance to CFP professionals – akin to the Notice to CFP Professionals issued in 2013 regarding compensation disclosure, but on a more regular basis – to allow for a further fleshing out of the CFP Board’s views of what constitutes “reasonableness” in various areas, so that CFP professionals don’t have to solely rely on after-the-fact adjudication to understand how best to navigate the 29 instances where “reasonableness” is the essential criterion for determining whether the standards were met.

Key Point: With 29 instances of “reasonable” or “reasonably” in the proposed Standards, CFP professionals need further guidance on what constitutes “reasonableness” in a wide variety of situations. Establish a mechanism for providing proactive ongoing guidance, and expand the framework of Anonymous Case Histories to include all case histories, in a searchable and properly indexed archive, so CFP professionals (and the DEC itself) can have a growing body of case law that can be properly cited and reasonably relied upon for precedence. 

CFP Board Standards must clarify use of ‘reasonable’ and allow professionals to see DEC rulings!

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Thank you for providing us as CFP professionals and stakeholders the opportunity to provide public comments regarding the CFP Board’s Proposed Standards of Conduct, and I look forward to seeing how the next version of the proposed changes will address the substantive concerns raised here!

Respectfully,
– Michael Kitces

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For CFP Professionals who are interested in submitting their own comments, the official comment period closes today (August 21^st), but there’s still time!

You can submit your feedback directly through the CFP Board website here, or by emailing comments@cfpboard.org. Comments and public forum feedback will then be used to re-issue a final version of the standards of conduct (or even re-proposed if the Commission on Standards deems it necessary to have another round of feedback) later this year.

And for those who want to read through a fully annotated version of the proposed Standards of Conduct themselves, the CFP Board has made a version available on their website here, and/or you can review our prior in-depth commentary about the proposed changes here.

So what do you think? Do you favor the CFP Board’s proposed Standards of Conduct moving forward in their current form? Do you see any potential issues or loopholes? Please share your thoughts in the comments below!

 

The Challenges Of Integrating Advisory Fee Schedules And Billing During A Merger Or Acquisition

Executive Summary

There are many challenges in navigating a successful advisory firm merger or acquisition, from ensuring that the firms align on investment, financial planning, and service philosophies, to finding an agreeable valuation and terms to the transaction, and navigating the post-transaction integration process. Yet in practice one of the biggest blocking points is simply figuring out how to effectively align the advisory fee schedules and fee calculations of the two firms – for instance, when one advisory firm charges substantially more or less than the other – to the point that one of the biggest blocking points of an otherwise-well-aligned merger or acquisition is simply whether it’s feasible to integrate their billing processes (especially when the firms have differences in their underlying business model, such as an AUM firm acquiring a retainer-fee firm).

In this week’s, we discuss the major issues to consider when integrating advisory fee schedules and billing processes, from strategies to adjust when one firm has an advisory fee schedule that charges more (or less) than the other, to reconciling differences in billing timing (i.e., billing in advance versus in arrears), and the unique acquisition problems that arise when trying to acquire retainer-fee firms.

For most, though, the biggest challenge is simply reconciling differences in fee schedules between the two firms. In situations where the acquirer charges more than the firm being acquired, there’s typically a desire to lift the newly acquired clients up to the fee schedule of the existing firm – which can make the transaction a strategically positive deal for the acquirer, if it can generate more revenue from the same clients, but also increases the risk that clients will reject the new fee schedule and not transition at all (which means it may be a good idea to leave the original fee schedule in place for a year or two, to allow clients the time to adjust, and build a relationship with the new firm). On the other hand, when the acquirer charges less than the firm being acquired, it gets even messier, as if the acquirer pays “full price” for the new firm’s revenue and then immediately cuts their fee schedule, the acquirer faces a substantial loss on the transaction (unless they can bring down costs in the merger business by even more than the loss in revenue!).

Even where advisory firms reasonably align on fee schedules, though, it’s also necessary to consider whether they have the same billing timing – in particular, whether both firms consistently bill in arrears or in advance. Because differences between the two firms in their billing process can lead to substantial disruptions in cash flow for either the acquirer, or the newly acquired clients! After all, if the acquirer needs to switch the new firm from billing in advance to billing in arrears, the firm could be forced to wait up to six months without receiving any new revenue from the new clients! And if the acquirer needs to switch in the other direction – from billing in arrears to billing in advance – then the first invoice to the clients may have to be a “double-billing” of the last arrears fee and the first advance fee all at once (which increases the transition risk for the acquiring firm!). In fact, even differences in the billing calculation process – such as when one firm bills on end-of-quarter balance, and the other uses average daily balance – can create billing gaps between expected and actual revenues!

And of course, this all assumes that both the acquiring and selling firms were both charging AUM fees in the first place. In the case where the acquiring firm charges AUM fees but the acquired firm charged retainers, it can be even more challenging to transition the retainer clients onto the AUM firm’s fee schedule (especially since many retainer-based firms proactively “sell against” the disadvantages of AUM fees, which effectively chases away potential buyers who may want to convert the business to their own AUM fee schedule). In turn, this means the marketplace of potential acquirers for retainer fee firms is drastically smaller, and retainer fee firms may have more difficulty finding an acquirer that will pay them a “fair” price – particularly for firms that charge retainer fees to clients who do have assets and “could” pay AUM fees (as the situation is different when using retainer fees to serve younger clients, or other “non-AUM” types of clientele).

Ultimately, though, the key point is simply to recognize how important differences in advisory fee schedules and billing processes can be when you’re looking at a potential merger or acquisition. As a result, doing detailed due diligence on advisory fee schedules is crucial. In particular, advisors should be evaluating any differences in the level of fees charged to clients, the timing of those fees, how those fees are calculated, and whether two firms have fundamentally different approaches to billing altogether. Of course, fee schedules don’t need to be identical in order to successfully navigate a merger, but approaching a merger with a clear understanding of the potential risks and opportunities involved is crucial!

Billing In Advance Vs Arrears (and on Daily Balance vs End-Of-Quarter Values)

Now, the second area that advisors need to watch when it comes to merging advisory fee schedules is the actual billing process. Because there are two issues that can crop here, one big and one a little bit smaller. The really big one is whether you bill in advance or in arrears. In other words, when a client starts with you, is their first quarterly billing for the prior partial quarter that they were with you or is their first billing in advance for the upcoming quarter, and if they decide to terminate the next quarter, do you refund them a pro rata portion of their fees?

Now, some firms just prefer to bill in arrears and they have a philosophy, “We’re not going to bill our clients until we’ve started doing the work,” other firms I know say, “I have a strong preference for billing in advance, that way I never have any accounts receivable, and I never have to collect from clients. I just refund pro rata if someone terminates, and not many people do because I’ve got a good retention.” On an ongoing basis, most firms don’t even think about this. You just bill your clients quarterly, whether it’s in arrears or in advance. After the first billing, no one really cares unless they’re going to terminate you and then you have to figure out if you will pro rata portion the last fee back if you billed them in advance.

But in a merger or an acquisition, this matters a lot, because if you bill in arrears and you acquire a firm that bills in advance, then when you buy them, you immediately take on the liability of refunding any clients who terminate in the quarter right after you’ve billed them. Unless you immediately convert the clients to arrears billing, you also have this potential liability in the future. But if you want to convert the clients, this gets even messier.

Imagine I bill in arrears and I acquire a firm that bills in advance. We’re in negotiations now, the deal closes in October, shortly after fourth quarter billing has happened at the end of September 30th. So the clients of the firm I just bought have already paid for Q4, they paid it in advance, which means if I want to bill them in arrears, my next billing isn’t going to happen for five months, until the end of Q1, March 31st, when I can bill them in arrears for the first billing as the acquired firm.

If I bought the firm in October, I don’t get any revenue at the end of the fourth quarter. There’s no Q4 billing in arrears because the firm already billed Q4 before they sold it to me. That seller has that money gone with it. And if I don’t bill in advance, I can’t bill them for Q1 at the end of the year. Instead, I have to wait three months into Q1. So you have to be cognizant of whether there were gaps between the firms billing in advance and in arrears.

And unfortunately, it’s not much better going the other direction. If the acquiring firm bills in advance and the firm being acquired bills in arrears, then the only way to true-up clients is that as the acquirer, you have to double-bill them. So in my earlier example, if you buy a firm in October that bills in arrears when you bill in advance, and at the end of Q4, on December 31st, you’re going to bill Q4 in arrears, because the clients haven’t paid for that yet, and you’re going to bill Q1 in advance because that’s what you do on an ongoing basis. And so the clients are going to get hit with two bills to get them on track the first time you do billing with them as the acquirer.

Now, it’s worth noting that you’re not cheating them or anything here. You’re not like literally double-charging them. They’re paying the Q4 fees because services were rendered in Q4, and you’re billing them in advance for Q1 because that’s what you do with all of all your clients, and if they terminate you you partially refund. But it does mean you have to be prepared to communicate that to transition them from arrears into an advance, there has to be a double-billing that occurs. You have to go two-quarters of fees to get an arrears closed out and an advance set up going forward. And so that’s a real risk, a real transition risk if you’re an acquirer, and you have to convince clients to stick around when the first thing you’re going to do is bill them for two-quarters when they’re still getting to know you. Now, it can be done. I know firms that have done it and they were able to get through it, and they were able to have retention. But at a minimum, it’s a really sensitive issue.

The other piece that goes along with these sort of mundane billing processes is you need to be aware of whether there’s alignment in how the fees are calculated. Specifically, when you do that billing, whether it’s in advance or in arrears, do you calculate based on end of quarter balance, or do you calculate based on average daily balance? Now, in theory, on average, these things average out, but not always. If your clients are net savers, end of quarter balances tend to be higher than average daily balances within the quarter because clients keep contributing lifting up the balance so that the end of quarter tends to be the highest one because it’s got all the contributions.

But if you’re mostly working with retirees, it may be the other way around. Average daily balances tend to be higher than end of quarter balances because at the end of the quarter all the withdrawals have occurred. And then, of course, in any particular quarter, you can get big gaps if the market moved sharply in the last couple of weeks in either direction and the end of quarter balance is very different than the average daily balance. In general, this adjustment tends to be more administrative (particularly in the quarter where the transition is occurring), but you need to know that the billing process is going to change. First, because you have to communicate it, second, because you probably need to reflect it in an updated advisory agreement, but you also need to consider whether there’s a risk that it may distort revenue in the first billing period after you acquire.

The Acquisition Problem With Retainer Fees In Lieu Of AUM Fees

Before I wrap up, there’s actually one other important dynamic I want to note here as well, and it’s the unique challenges that crop up when you’re trying to merge advisory firms where their fee schedule isn’t AUM fees in the first place, it’s retainer fees. Now, we know from industry research that the overall majority of advisory firms are still AUM-centric. And in fact, that the larger the advisory firm, the more affluent their clients, the more likely they are to charge AUM fees. Which means, on average, most buyers of retainer firms are still going to be AUM firms. And AUM firms acquire other firms to get more AUM. That’s what they do.

But what that means is that when an AUM acquires a retainer firm of clients who actually have assets, there’s usually a plan to convert those retainer clients over to an AUM fee structure. Except, unfortunately, that’s often very difficult because the firms that use retainer fees, particularly for affluent clients, tend to aggressively sell against AUM fees to convince their clients that the retainer model is superior, which means you effectively poison the well for most of your acquirers.

And this is one of the major drawbacks to pivoting from AUM to retainer fees that I find very rarely ever comes up in conversation (although I know a number of advisors who switched to retainer fees years ago and now want to retire and can’t find anyone to buy their firm because most firms charging retainer fees are relatively small, don’t have great margins, and don’t have the size and scale and cash flow to buy…while the AUM firms who’ve got dollars to buy, don’t want to buy retainer fee firms where the clients have been told that the AUM model is bad).

An often overlooked downside to the retainer model is finding a buyer in an AUM-centric world!

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This isn’t necessarily an issue for those who are doing retainer fees for younger clients who don’t have assets, because the truth is, no AUM buyer is going to be acquiring a practice of clients who don’t have assets (or if they do, they’re going to acquire because they want to actually do the retainer model the way the retainer model is being executed). But if you’re a firm that works with affluent clients who have assets and simply charges retainer fees, this gets a lot harder to find prospective buyers because the AUM buyers want to convert but are afraid of the risk, and there aren’t very many non-AUM buyers. You risk drastically reducing the appeal for the bulk of prospective buyers.

And in fact, even other retainer firms often have trouble acquiring those who do complexity-based retainer fees because different firms characterize complexity differently. And so, even two firms doing annual retainer fees for affluent clients might charge very differently for some of those clients. Which means if you’re the acquirer, this is a really messy, one-client-at-a-time process of figuring out what each acquired client would be charged under the new firm’s model, and whether it’s more or less than what the old firm was charging.

Indirectly, this is actually one of the reasons why the AUM model happens to work so well because, by its nature, it’s actually a really systematized billing model. At worse, you have to change a few rates or break points on your AUM fee schedule, but there’s a standard fee structure for all clients. And that’s often not the case with retainer firms. And so, it can make the billing process much harder to reconcile for an acquiring firm. Sometimes so difficult that it may narrow the number of buyers, which means you have to spend more time trying to sell your firm and have fewer bidders competing and hopefully bidding up your price, which is not good news if you hope to be a seller some day. So do understand that most firms tend to get acquired by those who have comparable billing styles or business models, and make sure you know that you’re going to have buyers if you’re making business model decisions.

One reason the AUM model works so well is that it is actually a systematized billing model!

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But anyway, the bottom line is just to recognize how important it is when you’re looking at a potential merger or an acquisition to do this kind of detailed due diligence on the advisory fee schedules and the billing processes. Do the firms have the same fee schedule? If not, who’s higher and lower all the way up and down the spectrum? Do they both bill in arrears or in advance, or is there a gap? Do they both bill on quarter and/or average daily balance or is there another gap? And if the firm charges retainer fees or separate planning fees (or a blended AUM plus retainer), are those fee structures and the way the fees are set consistent across the firms? Because, if they’re not, those kind of manually assigned retainer fees and planning fees are often the hardest parts to line up.

So be aware of that, and particularly if you’re thinking about moving away from AUM fees and towards the emerging range of “non-traditional” fee structures, as you may limit the potential market for buyers. It doesn’t necessarily mean it’s a bad thing to do if you think you can grow the business well enough in that direction. You may grow up on more than enough to make up for the fact that you’ve got a smaller market, but it’s really hard to find firms that will want to acquire you because of all these challenges in integrating fee schedules and billing if you use a substantially different fee model than everybody else.

I hope that’s helpful as some food for thought.

So what do you think? Are differences in fee schedules a potential problem when looking at mergers and acquisitions? Have you been in a similar situation? How did you manage the transition from one fee schedule to another? Please share your thoughts in the comments below!

Financial Advisor Fees Comparison – All-In Costs For The Typical Financial Advisor?

Executive Summary

While the standard rule-of-thumb is that financial advisors charge 1% AUM fees, the reality is that as with most of the investment management industry, financial advisor fee schedules have graduated rates and breakpoints that reduce AUM fees for larger account sizes, such that the median advisory fee for high-net-worth clients is actually closer to 0.50% than 1%.

Yet at the same time, the total all-in cost to manage a portfolio is typically more than “just” the advisor’s AUM fee, given the underlying product costs of ETFs and mutual funds that most financial advisors still use, not to mention transaction costs, and various platform fees. Accordingly, a recent financial advisor fee study from Bob Veres’ Inside Information reveals that the true all-in cost for financial advisors averages about 1.65%, not “just” 1%!

On the other hand, with growing competitive pressures, financial advisors are increasingly compelled to do more to justify their fees than just assemble and oversee a diversified asset allocated portfolio. Instead, the standard investment management fee is increasingly a financial planning fee as well, and the typical advisor allocates nearly half of their bundled AUM fee to financial planning services (or otherwise charges separately for financial planning).

The end result is that comparing the cost of financial advice requires looking at more than “just” a single advisory fee. Instead, costs vary by the size of the client’s accounts, the nature of the advisor’s services, and the way portfolios are implemented, such that advisory fees must really be broken into their component parts: investment management fees, financial planning fees, product fees, and platform fee.

From this perspective, the reality is that the portion of a financial advisor’s fees allocable to investment management is actually not that different from robo-advisors now, suggesting there may not be much investment management fee compression on the horizon. At the same time, though, financial advisors themselves appear to be trying to defend their own fees by driving down their all-in costs, putting pressure on product manufacturers and platforms to reduce their own costs. Yet throughout it all, the Veres research concerningly suggests that even as financial advisors increasingly shift more of their advisory fee value proposition to financial planning and wealth management services, advisors are still struggling to demonstrate why financial planning services should command a pricing premium in the marketplace.

How Much Do Financial Advisors Charge As Portfolios Grow?

One of the biggest criticisms of the AUM business model is that when financial advisor fees are 1% (or some other percentage) of the portfolio, that the advisor will get paid twice as much money to manage a $2M portfolio than a $1M portfolio. Despite the reality that it won’t likely take twice as much time and effort and work to serve the $2M client compared to the $1M client. To some extent, there may be a little more complexity involved for the more affluent client, and it may be a little harder to market and get the $2M client, and there may be some greater liability exposure (given the larger dollar amounts involved if something goes wrong), but not necessarily at a 2:1 ratio for the client with double the account size.

Yet traditionally, the AUM business has long been a “volume-based” business, where larger portfolios reach “breakpoints” where the marginal fees get lower as the dollar amounts get bigger. For instance, the advisor who charges 1% on the first $1M, but “only” 0.50% on the next $1M, such that the with double the assets does pay 50% more (in recognition of the costs to market, additional service complexity, and the liability exposure), but not double.

However, this means that the “typical financial advisor fee” of 1% is somewhat misleading, as while it may be true that the average financial advisory fee is 1% for a particular portfolio size, the fact that fees tend to decline as account balances grow (and may be higher for smaller accounts) means the commonly cited 1% fee fails to convey the true sense of the typical graduated fee schedule of a financial advisor.

Fortunately, though, recent research by Bob Veres’ Inside Information, in a survey of nearly 1,000 advisors, shines a fresh light on how financial advisors typically set their AUM fee schedules, not just at the mid-point, but up and down the scale for both smaller and larger account balances.  And as Veres’ research finds, the median advisory fee up to $1M of assets under management really is 1%. However, many advisors charge more than 1% (especially on “smaller” account balances), and often substantially less for larger dollar amounts, with most advisors incrementing fees by 0.25% at a time (e.g., 1.25%, 1.00%, 0.75%, and 0.50%), as shown in the chart below.

More generally, though, Veres’ research affirms that the median AUM fee really does decline as assets rise. At the lower end of the spectrum, the typical financial advisory fee is 1% all the way up to $1M (although notably, a substantial number of advisors charge more than 1%, particularly for clients with portfolios of less than $250k, where the median fee is almost 1.25%). However, the median fee drops to 0.85% for those with portfolios over $

1M. And as the dollar amounts rise further, the median investment management fee declines further, to 0.75% over $2M, 0.65% over $3M, and 0.50% for over $5M (with more than 10% of advisors charging just 0.25% or less).

The typical financial advisor reduces AUM fees for clients with larger account sizes!

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Notably, because these are the stated advisory fees at specific breakpoints, the blended fees of financial advisors at these dollar amounts would still be slightly higher. For instance, the median advisory fee at $2M might be 0.85%, but if the advisor really charged 1.25% on the first $250k, 1% on the next $750k, and 0.85% on the next $1M after that, the blended fee on a $2M portfolio would actually be 0.96% at $2M.

Nonetheless, the point remains: as portfolio account balances grow, advisory fees decline, and the “typical” 1% AUM fee is really just a typical (marginal) fee for portfolios around a size of $1M. Those who work with smaller clients tend to charge more, and those who work with larger clients tend to charge less.

How Much Do Financial Advisors Cost In All-In Fees?

The caveat to this analysis, though, is that it doesn’t actually include the underlying expense ratios of the investment vehicles being purchased by financial advisors on behalf of their clients.

Of course, for those who purchase individual stocks and bonds, there are no underlying wrapper fees for the underlying investments. However, the recent FPA 2017 Trends In Investments Survey of Financial Advisors finds that the overwhelming majority of financial advisors use at least some mutual funds or ETFs in their client portfolios (at 88% and 80%, respectively), which would entail additional costs beyond just the advisory fee itself.

Fortunately, though, the Veres study did survey not only advisors’ own AUM fee schedules, but also the expense ratios of the underlying investments they used to construct their portfolios. And as the results reveal, the underlying expense ratios add a non-trivial total all-in cost to the typical financial advisory fee, with the bulk of blended expense ratios coming in between 0.20% and 0.75% (and a median of 0.50%).

Of course, when it comes to ETFs, as well as the advisors who trade individual stocks and bonds, there are also underlying transaction costs to consider. Fortunately, given the size of typical advisor portfolios, and the ever-declining ticket charges for stock and ETF trades, the cumulative impact is fairly modest. Still, while most advisors estimated their trading costs at just 0.05%/year or so, with almost 15% at 0.02% or less, there were another 18% of advisors with trading costs of 0.10%/year, almost 10% up to 0.20%/year, and 6% that trade more actively (or have smaller typical client account sizes where fixed ticket charges consume a larger portion of the account) and estimate cumulative transaction costs even higher than 0.20%/year.

In addition, the reality is that a number of financial advisors work with advisory platforms that separately charge a platform fee, which in some cases covers both technology and platform services and also an all-in wrap fee on trading costs (and/or access to a No-Transaction-Fee [NTF] platform with a platform wrapper cost). Amongst the more-than-20% of advisors who reported paying such fees (either directly or charged to their clients), the median fee was 0.20%/year.

Accordingly, once all of these various underlying costs are packaged together, it turns out that the all-in costs for financial advisors – even and including fee-only advisors, which comprised the majority of Veres’ data set – including the total cost of AUM fees, plus underlying expense ratios, plus trading and/or platform fees, are a good bit higher than the commonly reported 1% fee.

For instance, the median all-in cost of a financial advisor serving under-$250k portfolios was actually 1.85%, dropping to 1.75% for portfolios up to $500k, 1.65% up to $1M, and 1.5% for portfolios over $1M, dropping to $1.4% over $2M, 1.3% over $3M, and 1.2% over $5M.

The typical advisor’s all-in costs are more than 1.5%/year, even for millionaires!

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Notably, though, the decline in all-in costs as assets rise moves remarkably in-line with the advisor’s underlying fee schedule, suggesting that the advisor’s “underlying” investments and platform fee are actually remarkably stable across the spectrum.

For instance, the median all-in cost for “small” clients was 1.85% versus an AUM fee of 1% (although the median fee was “almost” 1.25% in Veres’ data) for a difference of 0.60% – 0.85%, larger clients over $1M face an all-in cost of 1.5% versus an AUM fee of 0.85% (a difference of 0.65%), and even for $5M+ the typical total all-in cost was 1.2% versus a median AUM fee of 0.5% (a difference of 0.70%). Which means the total cost of underlying – trading fees, expense ratios, and the rest – is relatively static, at around 0.60% to 0.70% for advisors across the spectrum!

On the one hand, it’s somewhat surprising that as client account sizes grow, advisors reduce their fees, but platform fees and underlying expense ratios do not decrease. On the other hand, it is perhaps not so surprising given that most mutual funds and ETFs don’t actually have expense ratio breakpoints based on the amount invested, especially as an increasing number of low-cost no-load and institutional-class shares are available to RIAs (and soon, “clean shares” for broker-dealers) regardless of asset size.

It’s also notable that at least some advisor platforms do indirectly “rebate” back a portion of platform and underlying fees, in the form of better payouts (for broker-dealers), soft dollar concessions (for RIAs), and other indirect financial benefits (e.g., discounted or free software, higher tier service teams, access to conferences, etc.) that reduces the advisor’s costs and allows the advisor to reduce their AUM fees. Which means indirectly, platforms fees likely do get at least a little cheaper as account sizes rise (or at least, as the overall size of the advisory firm rises). It’s simply expressed as a full platform charge, with a portion of the cost rebated to the advisor, which in turn allows the advisor to pass through the discount by reducing their own AUM fee successfully.

Financial Advisor Fee Schedules: Investment Management Fees Or Financial Planning Fees?

One of the other notable trends of financial advisory fees in recent years is that financial advisors have been compelled to do more and more to justify their fees, resulting in a deepening in the amount of financial planning services provided to clients for that same AUM fee, and a concomitant decline in the profit margins of advisory firms.

To clarify how financial advisors position their AUM fees, the Veres study also surveyed how advisors allocate their own AUM fees between investment management and non-investment-management (i.e., financial planning, wealth management, and other) services.

Not surprisingly, barely 5% of financial advisors reported that their entire AUM fee is really just an investment management fee for the portfolio, and 80% of advisors who reported that at least 90% of their AUM fee was “only” for investment management stated it was simply because they were charging a separate financial planning fee anyway.

For most advisors who do bundle together financial planning and investment management, though, the Veres study found that most commonly advisors claim their AUM fee is an even split between investment management services, and non-investment services that are simply paid for via an AUM fee. In other words, the typical 1% AUM fee is really more of a 0.50% investment management fee, plus a 0.50% financial planning fee.

Perhaps most striking, though, is that there’s almost no common consensus or industry standard about how much of an advisor’s AUM fee should really be an investment management fee versus not, despite the common use of a wide range of labels like “financial advisor”, “financial planner”, “wealth manager”, etc.

As noted earlier, in part this may be because a subset of those advisors in the Veres study are simply charging separately for financial planning, which increases the percentage-of-AUM-fee-for-just-investment-management allocation (since the planning is covered by the planning fee). Nonetheless, the fact that 90% of advisors still claim their AUM fees are no-more-than-90% allocable to investment management services suggests the majority of advisors package at least some non-investment value-adds into their investment management fee. Yet how much is packaged in and bundled together varies tremendously!

Most financial advisors do more than just investment management for their AUM fees!

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More broadly, though, this ambiguity about whether or how much value financial advisors provide, beyond investment management, for a single AUM fee, is not unique to the Veres study. For instance, last year’s 2016 Fidelity RIA Benchmarking Study found that there is virtually no relationship between an advisor’s fees for a $1M client, and the breadth of services the advisor actually offers to that client! In theory, as the breadth of services to the client rises, the advisory fee should rise as well to support those additional value-adds. Instead, though, the Fidelity study found that the median advisory fee of 1% remains throughout, regardless of whether the advisor just offers wealth management, or bundles together 5 or even 9 other supporting services!

The Future Of Financial Advisor Fee Compression: Investment Management, Financial Planning, Products, And Platforms

Overall, what the Veres study suggests is that the typical all-in AUM fee to work with a financial advisor is actually broken up into several component parts. For a total-cost AUM fee of 1.65% for a portfolio up to $1M, this includes an advisory fee of 1% (which in turn is split between financial planning and investment management), plus another 0.65% of underlying expenses (which is split between the underlying investment products and platform). Which means a financial advisor’s all-in costs really need to be considered across all four domains: investment management, financial planning, products, and platform fees.

Notably, how the underlying costs come together may vary significantly from one advisor to the next. Some may use lower-cost ETFs, but have slightly higher trading fees (given ETF ticket charges) from their platforms. Others may use mutual funds that have no transaction costs, but indirectly pay a 0.25% platform fee (in the form of 12b-1 fees paid to the platform). Some may use more expensive mutual funds, but trim their own advisory fees. Others may manage individual stocks and bonds, but charge more for their investment management services. A TAMP may combine together the platform and product fees.

Overall, though, the Veres data reveals that the breadth of all-in costs is even wider than the breadth of AUM fees, suggesting that financial advisors are finding more consumer sensitivity to their advisory fees, and less sensitivity to the underlying platform and product costs. On the other hand, the rising trend of financial advisors using ETFs to actively manage portfolios suggests that advisors are trying to combat any sensitivity to their advisory fees by squeezing the costs out of their underlying portfolios instead (i.e., by using lower-cost ETFs instead of actively managed mutual funds, and taking over the investment management fee of the mutual fund manager themselves).

Consumers are more sensitive to advisory fees, forcing advisors to squeeze costs of their providers!

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In turn, we can consider the potential implications of fee compression by looking across each of the core domains: investment management, financial planning, and what is typically a combination of products and platform fees.

When it comes to investment management fees, the fact that the typical financial advisor already allocates only half of their advisory fee to investment management (albeit with a wide variance), suggests that there may actually not be much fee compression looming for financial advisors. After all, if the advisor’s typical AUM fee is 1% but only half of that – or 0.50% – is for investment management, then the fee isn’t that far off from many of the recently launched robo-advisors, including TD Ameritrade Essential Portfolios (0.30% AUM fee), Fidelity Go (0.35% AUM fee), and Merrill Lynch Guided Edge (0.45% AUM fee). At worst, the fee compression risk for pure investment management services may “only” be 20 basis points anyway. And for larger clients – where the fee schedule is falling to 0.50% anyway, and the investment management portion would be only 0.25% – financial advisors have already converged on “robo” pricing.

On the other hand, with the financial planning portion of fees, there appears to be little fee compression at all. In fact, as the Fidelity benchmarking study shows, consumers (and advisors) appear to be struggling greatly to assign a clear value to financial planning services at all. Not to say that financial planning services aren’t valuable, but that there’s no clear consensus on how to value them effectively, such that firms provide a wildly different range of supporting financial planning services for substantially similar fees. Until consumers can more clearly identify and understand the differences in financial planning services between advisors, and then “comparison shop” those prices, it’s difficult for financial planning fee compression to take hold.

By contrast, fee compression for the combination of platforms and the underlying product expenses appears to be most ripe for disruption. And arguably, the ongoing shift of financial advisors towards lower cost product solutions suggests that this trend is already well underway, such that even as advisory firms continue to grow, the asset management industry in the aggregate saw a decline in both revenues and profits in 2016. And the trend may only accelerate if increasingly sophisticated rebalancing and model management software begins to create “Indexing 2.0” solutions that make it feasible to eliminate the ETF and mutual fund fee layer altogether. Similarly, the trend of financial advisors from broker-dealers to RIAs suggests that the total cost layer of broker-dealer platforms is also under pressure. And TAMPs that can’t get their all-in pricing below the 0.65% platform-plus-product fee will likely also face growing pressure.

Notably, though, these trends also help to reveal the growing pressure for fiduciary regulation of financial advisors – because as the investment management and product/platform fees continue to shrink, and the relative contribution of financial planning services grow, the core of what a financial advisor “does” to earn their fees is changing. Despite the fact that our financial advisor regulation is based primarily on the underlying investment products and services (and not fee-for-service financial planning advice).

Nonetheless, the point remains that financial advisor fee compression is at best a more nuanced story than is commonly told in the media today. To the extent financial advisors are feeling fee pressure, it appears to be resulting in a shift in the advisor value proposition to earn their 1% fee, and a drive to bring down the underlying costs of products and platforms to defend the advisor’s fee by trimming (other) components of the all-in cost instead. Though at the same time, the data suggests that consumers are less sensitive to all-in costs than “just” the advisor’s fee… raising the question of whether analyzing all-in costs for financial advice may become the next battleground issue for financial advisors that seek to differentiate their costs and value.

In the meantime, for any financial advisors who want to access a copy of Veres’ White Paper on Advisory Fees and survey results, you can sign up here to order a copy.

So what do you think? Do you think financial advisors’ investment management fees are pretty much in line with robo advisors already? Is fee compression more nuanced than typically believed? Please share your thoughts in the comments below!

CFP Board Commission On Standards Expands CFP Fiduciary Duties… But Can It Enforce Them?

Executive Summary

After a nearly 18-month process of working to update its Standards of Professional Conduct, the CFP Board’s Commission on Standards has released newly proposed Conduct Standards for CFP professionals, expanding the breadth of when CFP professionals will be subject to a fiduciary duty, and the depth of the disclosures that must be provided to prospects and clients.

In fact, the new CFP Board Standards of Conduct would require all CFP professionals to provide a written “Introductory Information” document to prospects before becoming clients, and a more in-depth Terms of Engagement written agreement upon becoming a client. In addition, the new rules also refine the compensation definitions for CFP professionals to more clearly define fee-only, limit the use of the term fee-based, and updates the 6-step “EGADIM” financial planning process to a new 7-step process instead.

Overall, the new Standards of Conduct appear to be a positive step to advance financial planning as a profession, more clearly recognizing the importance of a fiduciary duty, the need to manage conflicts of interest, and formalizing how CFP professionals define their scope of engagement with the client.

Ironically, though, the CFP Board’s greatest challenge in issuing its new Standards of Conduct is that the organization still only has limited means to actually enforce them, as the CFP Board can only make public admonishments or choose to suspend or revoke the CFP marks, but cannot actually fine practitioners or limit their ability to practice. And because the CFP Board is not a government-sanctioned regulator, it is still limited in its ability to even gather information to investigate complaints in the first place, especially in instances where the complaint is not from a client but instead comes from a third party (e.g., a fellow CFP professional who identifies an instance of wrong-doing).

In addition, the CFP Board’s new Standards of Conduct rely heavily on evaluating whether the CFP professional’s actions were “reasonable” compared to common practices of other CFP certificants… which is an appropriate peer-based standard for professional conduct, but difficult to assess when the CFP Board’s disciplinary proceedings themselves are private, which means CFP professionals lack access to “case law” and disciplinary precedents that can help guide what is and is not recognized as “acceptable” behavior of professionals. At least until/unless the CFP Board greatly expands the depth and accessibility/indexing of its Anonymous Case Histories database.

Nonetheless, for those who want to see financial planning continue to advance towards becoming a recognized profession, the CFP Board’s refinement of its Standards of Conduct do appear to be a positive step forward. And fortunately, the organization is engaging in a public comment process to gather feedback from CFP certificants to help further refine the proposed rules before becoming final… which means there’s still time, through August 21^st, to submit your own public comments for feedback!

CFP Board Commission On Standards Proposes Revised CFP Code Of Ethics And Standards Of Conduct

Back in December of 2015, the CFP Board first announced that it was beginning a process to update its Standards of Professional Conduct, by bringing together a new 12-person “Commission on Standards” (ultimately expanded to 14 individuals), including diverse representation across large and small firms, broker-dealers and RIAs, NAPFA and insurance companies, and even a consumer advocate and former regulator.

The purpose of the new group was to update the CFP Board’s existing Standards of Professional Conduct, which is (currently) broken into four key sections:

– Code of Ethics and Professional Responsibility: The 7 core ethical principles to which all CFP certificants should aspire, including Integrity, Objectivity, Competence, Fairness, Confidentiality, Professionalism, and Diligence

– Rules of Conduct: The specific rules by which the conduct of CFP professionals will be evaluated, including a CFP certificant’s obligations to define the client relationship, disclose conflicts to the client, protect client information, and the overall duty of conduct of the CFP certificant to the client, to employers, and to the CFP Board itself.

– Financial Planning Practice Standards: The standards that the CFP certificant should follow that define what financial planning “is” and how the 6-step financial planning process itself should be delivered.

– Terminology: The definitions of key terms used in the Standards of Professional Conduct, from what constitutes a “financial planning engagement” to what it means to be a “fiduciary” and the definition of “fee-only” and what is considered “compensation” to be disclosed.

The update process would be the first change to the CFP Board’s Standards of Professional Conduct since mid-2007, which at the time was highly controversial, and stretched out for years, but culminated in the first application of a fiduciary duty for CFP professionals.

Under the newly proposed Code of Ethics and Standards of Conduct, which the CFP Board published for public comment last Tuesday, June 20^th, the four sections above will be consolidated into two sections – a Code of Ethics, and a Standards of Conduct (which will incorporate the prior Rules of Conduct, Practice Standards, and key Terminology).

The full text of the Proposed Code of Ethics and Standards of Conduct can be viewed here on the CFP Board’s website.

Expanding The Fiduciary Definition Of “Doing” Financial Planning

Under the CFP Board’s current Rules of Conduct for CFP professionals, certificants owe to their clients a fiduciary duty of care when providing financial planning or material elements of financial planning. Accordingly, the reality is that the overwhelming majority of CFPs are already subject to a fiduciary duty when providing financial planning services to clients.

However, the CFP Board’s standard has been criticized as allowing for a “loophole”, in that it’s not based on simply being a CFP professional, but instead tries to identify when people are doing financial planning (or material elements thereof). Which at best isn’t always clear, and at worst allows a subset of CFP professionals to aggressively sell nothing but their own products – knowingly not serving as a fiduciary, despite holding out as a CFP certificant – because a single product recommendation was not deemed to be “doing financial planning”.

New CFP Board Fiduciary Duty When Providing Financial Advice

In its new CFP Code of Ethics and Standards of Conduct, the CFP Board takes a stronger position that CFP certificants should be held to a fiduciary standard when delivering their services. Accordingly, the very first section of its new Standards of Conduct states:

A CFP Professional must at all times act as a fiduciary when providing Financial Advice to a client, and therefore, act in the best interest of the Client.

Notably, under this new rule, the scope of fiduciary obligation is not limited to just when providing “financial planning” or “material elements of financial planning”. Instead, the fiduciary duty will apply anytime a CFP professional is “providing financial advice”, which itself is defined very broadly, as:

Financial Advice (according to CFP Board)

A) Communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the Client take or refrain from taking a particular course of action with respect to:

1. The development or implementation of a financial plan addressing goals, budgeting, risk, health considerations, educational needs, financial security, wealth, taxes, retirement, philanthropy, estate, legacy, or other relevant elements of a Client’s personal or financial circumstances;
2. The value of or the advisability of investing in, purchasing, holding, or selling Financial Assets;
3. Investment policies or strategies, portfolio composition, the management of Financial Assets, or other financial matters;
4. The selection and retention of other persons to provide financial or Professional Services to the Client; or

B) The exercise of discretionary authority over the Financial Assets of a Client.

In this definition, the mere suggestion that a client take or refrain from taking any particular course of action is deemed “financial advice”. Notably, the CFP Board does clarify that marketing materials, general financial education materials, or general financial communication “that a reasonable person would not view as Financial Advice” does not constitute Financial Advice. Nonetheless, most classic recommendations – from delivering a comprehensive financial plan, to merely suggesting “this product is right [or not right] for your situation”, would be captured under this definition of Financial Advice, and subjected to a fiduciary duty.

In other words, the expansion of the CFP Board’s application of the fiduciary duty to providing any kind of “financial advice”, and not just delivering “financial planning or material elements of financial planning”, eliminates the current gap where product salespeople could sell a product as a CFP certificant and claim they’re not subject to the fiduciary duty because it wasn’t “financial planning”. Although the fiduciary duty is still not defined by merely being a CFP or holding out as a CFP certificant, this new and far-broader scope of applying the fiduciary duty when “delivering financial advice” still accomplishes a substantively similar result, as even a focused, single-product recommendation, would still constitute “financial advice” under the new rules.

The CFP Board’s new fiduciary rule would even apply to single product recommendations!

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On the other hand, the CFP Board’s new definition of Financial Advice to which a fiduciary duty applies may actually have gone too far, as the new rules have no actual requirement that the client have agreed to engage the CFP professional in order for the fiduciary standard to occur. By contrast, for the fiduciary duty to apply to an RIA under the Investment Advisers Act, the investment adviser must give investment advice for compensation, and the Department of Labor similarly only applies a fiduciary duty to investment advice given to a retirement investor for compensation. The “compensation” requirement helps to ensure that free advice is not subject to a fiduciary duty, and also helps to ensure that suggestions that may be given in the course of soliciting a prospect are not deemed as fiduciary financial advice even if the advisor is never hired. The CFP Board may need to consider adding a similar stipulation to their current rules, to make it clear that the CFP professional’s obligation to deliver fiduciary financial advice only applies if the client ultimately actually engages the professional for advice for which at least some type of compensation is paid!

New Fiduciary Duties Of A CFP Professional

Of course, if CFP certificants are going to be held to a fiduciary duty, it’s still necessary to define exactly what that means. Most financial advisors, thanks to the recent discussions about the Department of Labor’s fiduciary rule, are familiar with the classic requirement that fiduciaries must act in the best interests of their clients, but in reality a fiduciary duty can (and should be) broader than just this Duty of Loyalty to the client.

In its new rules, the CFP Board defines the obligations of the CFP professional as a fiduciary to include:

CFP Professional’s Fiduciary Duty

A) Duty of Loyalty. A CFP® professional must:

1. Place the interests of the Client above the interests of the CFP® professional and the CFP® Professional’s Firm;
2. Seek to avoid Conflicts of Interest, or fully disclose Material Conflicts of Interest to the Client, obtain the Client’s informed consent, and properly manage the conflict; and
3. Act without regard to the financial or other interests of the CFP® professional, the CFP® Professional’s Firm, or any individual or entity other than the Client, which means that a CFP® professional acting under a Conflict of Interest continues to have a duty to act in the best interest of the Client and place the Client’s interest above the CFP® professional’s.

B) Duty of Care. A CFP® professional must act with the care, skill, prudence, and diligence that a prudent professional would exercise in light of the Client’s goals, risk tolerance, objectives, and financial and personal circumstances.

C) Duty to Follow Client Instructions. A CFP® professional must comply with all objectives, policies, restrictions, and other terms of the Engagement and all reasonable and lawful directions of the Client.

In other words, the CFP Board is, in fact, applying the two core duties of a fiduciary standard: the Duty of Loyalty (to act in the interests of the client), and the Duty of Care (to act with the care, skill, prudence, and diligence of a professional). In addition, the CFP Board still affirms that a CFP professional must follow their clients’ instructions as well. (Which means a CFP professional still has an obligation to follow the clients’ instructions if the client wants to make their own bad financial decision against the advisor’s advice!)

Notably, in the past, the CFP Board’s existing Rules of Conduct for CFP professionals also stated that the CFP certificant – when acting as a fiduciary while providing financial planning or material elements of financial planning – owes to the client a duty of care, and must place the interest of the client ahead of his/her own. However, the new rules go much further in clearly and concretely defining the fiduciary duties of loyalty and care.

Managing Fiduciary Conflicts Of Interest As A CFP Professional

One of the core issues of a fiduciary duty, and the obligation to place the interests of the client above that of the advisor or his/her firm, is how to handle the inevitable conflicts of interest that may arise.

The CFP Board’s new Duty of Loyalty specifically requires that CFP professionals seek to avoid conflicts of interest, or fully disclose any Material conflicts of interest (where “material” is defined as “information that a reasonable client would have considered important in making a decision”).

In addition, a further expansion of the CFP professional’s duties with respect to conflicts of interest, in Section 9 of the new Standards, would obligate the CFP professional to obtain “informed consent” after disclosing any Material conflicts of interest (though informed consent can be handled in conversation in a prospect/client meeting, as written consent is not required).

Furthermore, CFP professionals are expected to “adopt and follow business practices reasonably designed to prevent Material Conflicts of Interest from compromising the CFP professional’s ability to act in the Client’s best interests.” Notably, this is very similar to the “policies and procedures” requirement that the Department of Labor imposes on Financial Institutions engaging in fiduciary advice with respect to retirement accounts – although the DoL fiduciary rule requires the firm to adopt policies and procedures, while the CFP Board’s standards require the individual CFP certificant to adopt those business practices (recognizing that the CFP Board has no jurisdiction over firms, only certificants, and that CFP certificants must comply even if their firms, which may have non-CFPs as well, do not adopt firm-wide policies and procedures).

On the other hand, organizations like the Institute for the Fiduciary Standard have already pointed out that the CFP Board has a history of encouraging CFP professionals to disclose conflicts of interest, but not necessarily urging them to actually avoid or eliminate those conflicts. By contrast, the Department of Labor’s recent fiduciary rule goes into far greater depth about what constitutes an unacceptable (i.e., not realistically manageable) conflict of interest, and outright bans many (as does ERISA’s fiduciary duty). For the CFP Board, though, the new standards have little guidance on whether CFP professionals are actually expected to avoid any conflicts of interest at all, as the focus of the new standards is simply on disclosing material conflicts of interest (and gaining “informed consent” from the client).

In fact, because the CFP Board allows for material conflicts of interest – as long as there is informed consent – there is arguably no requirement that CFP professionals actually avoid any conflict of interest at all, nor necessarily even manage them. After all, while the new rules do suggest that CFP professionals should adopt business practices to prevent material conflicts of interest from compromising their duty of loyalty, the rules also fully permit those material conflicts of interest anyway, as long as the CFP professional can demonstrate that it was disclosed and that the client agreed to the recommendation anyway (i.e., gave informed consent).

The CFP Board’s new fiduciary rule doesn’t limit conflicts of interest if the client consents!

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Doing Financial Planning And The CFP Board Practice Standards

In addition to the new rules placing on CFP professionals an obligation to act as fiduciaries to clients, including both a Duty of Loyalty and a Duty of Care, the new Practice Standards further emphasize that when providing financial advice, the CFP professional is expected to actually do the financial planning process.

In fact, the new Practice Standards presume that whenever a CFP professional provides financial advice, there should be a financial planning process that integrates together the relevant elements of the Client’s personal and/or financial circumstances to make a recommendation. Or viewed another way… not only are CFP professionals no longer allowed to escape fiduciary duty by providing narrow product recommendations – in an attempt to avoid providing “financial planning” or “material elements of financial planning” – but under the new rules, any (product or other) recommendation or “suggestion to take or refrain from a particular course of action” is presumed to be “financial planning” and necessitates following the full financial planning process, unless the CFP professional can prove that it wasn’t necessary to do so (or that the client refused the comprehensive advice, or limited the scope of engagement to make comprehensive advice unnecessary).

However, it’s important to recognize that “doing” financial planning when giving financial advice still doesn’t necessarily mean every client must be provided a comprehensive financial plan. Under the new conduct standards, “financial planning” itself is defined as:

“Financial Planning: A collaborative process that helps maximize a Client’s potential for meeting life goals through Financial Advice that integrates relevant elements of the Client’s personal and financial circumstances.”

The key term here is “relevant elements” of the client’s personal and financial circumstances. Thus, just as a doctor doesn’t need to conduct a full-body physical exam with blood analysis just to set a broken arm, neither would a CFP professional be required to do a comprehensive financial plan just to help a client set up a 529 college savings plan. Nonetheless, a full evaluation of the relevant circumstances – from the ages of children and time horizon to college, to the risk tolerance of the parents, their tax situation, and available savings and other resources for college – would still be necessary to deliver appropriate financial (planning) advice.

EGADIM 6-Step Process Becomes A 7-Step Financial Planning Process

Perhaps more notable, though, is that the financial planning process itself is changed and updated under the new conduct standards.

In the past, the standard financial planning process was known by the acronym EGADIM: Establish client/planner relationship, Gather data, Analyze the client situation, Develop plan recommendations, Implement the plan, and Monitor the plan. And each of those parts of the 6-step process had 1-3 levels of detailed practice standards about how they should be delivered.

Now, under the new rules, financial planning will entail a 7-step process of:

1) Understand the Client’s Personal and Financial Circumstances (including gathering quantitative and qualitative information, analyzing the information, and identifying any pertinent gaps in the information);

2) Identify and Select Goals (including a discussion on how the selection of one goal may impact other goals)

3) Analyze the Current Course of Action and Potential Recommendations (evaluating based the advantages and disadvantages of the current course of action, and the advantages and disadvantages of potential recommendations)

4) Develop Financial Planning Recommendations (including not only what the client should do, but the timing and priority of recommendations, and whether recommendations are independent or must be implemented jointly)

5) Present Financial Planning Recommendations (and discuss how those recommendations were determined)

6) Implement Recommendations (including which products or services will be used, and who has the responsibility to implement)

7) Monitoring Progress and Updating (including clarifying the scope of the engagement, and which actions, products, or services, will be the CFP professionals’ responsibility to monitor and provide subsequent recommendations)

Unfortunately, the new 7-step process isn’t as conducive to an acronym as EGADIM was, though a new option might be CGADPIM (Circumstances, Goals, Analyze, Develop, Present, Implement, Monitor). In practice, the primary difference under the new rules is that the prior requirement to “establish the scope of the engagement” is not considered part of the financial planning process itself (though it will still be separately required, as discussed below), the “gather client data” phase is now broken out into two standalone steps of the process (first to gather information about the client’s Circumstances, then to identify the client’s Goals), and the CFP Board has similarly separated the prior “Develop and Present Recommendations” of EGADIM into separate “Develop” and “Present” process steps.

The CFP Board Standards of Conduct would change the 6-step EGADIM planning process to 7 steps!

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Another key distinction of the new 7-step process, though, is that the last two steps – to Implement, and to Monitor – are explicitly defined as optional, and are only an obligation for the CFP professional if the client’s Scope of Engagement specifically dictates that the CFP professional will be responsible for implementation and/or monitoring (although notably, the presumption is that the CFP professional will have such responsibilities, unless they are specifically excluded in the Scope of Engagement).

In other words, if the CFP professional defines the scope of the agreement as only leading up to presenting recommendations (the CGADP part of the new financial planning process), but leaves it up to the client to proceed with implementation and monitoring, that is permitted under the new rules… recognizing that some clients prefer to only engage in more “modular” advice and a “second opinion” from a CFP professional, but may not wish to implement with that CFP professional.

Introductory Information And Financial Planning Terms (And Scope) Of Engagement

Currently, the CFP Board’s Rules of Conduct when a CFP Professional is engaged by a client to provide financial planning (or material elements of financial planning) include an obligation to provide information to clients (prior to entering into an agreement), including the responsibilities of each party, the compensation that the CFP professional (or any legal affiliates) will or could receive, and, upon being formally engaged by the client for services, the CFP professional was/is expected to enter into a formal written agreement, specifying the (financial planning) services to be provided.

Under the new rules, these disclosure and engagement requirements would be expanded further, into a series of (at least) two written documents: the first is “Introductory Information” to be provided to a prospect (before becoming a client), and the second is a “Terms of Engagement” agreement provided to a client (at the time the client engages the advisor).

The Introductory Information must include:

Introductory Information

1) Description of the CFP professional’s available services and category of financial products;

2) Description of how the client pays, and how the CFP Professional and the Professional’s Firm are compensated for providing services and products;

3) Brief summary of any of the following Conflicts of Interest (if applicable): offering proprietary products; receipt of third-party payments for recommending products; material limitations on the universe of available products; and the receipt of additional compensation when the Client increases the amounts of assets under management; and

4) A link to (or URL for) relevant webpages of any government authorities, SROs, or professional organizations, where the CFP professional’s public disciplinary history or personal/business bankruptcies are displayed (e.g., the SEC’s IAPD, FINRA BrokerCheck, and the CFP Board’s own website).

New CFP Board rules would require all CFP professionals to provide standardized disclosures upfront!

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The new rules state that for RIAs, the delivering of Form ADV Part 2 will satisfy the Introductory Information requirement. Broker-dealers, though, would need to create and distribute their own Introductory Information guidance. (The CFP Board has indicated that it will be creating an Introductory Information template for advisors and brokers to use.) The Introductory Information is expected to be delivered to a prospect at the time of initial consultation, or “as soon as practicable thereafter”, and it may be delivered in writing, electronically, or orally (if appropriate given a [presumably limited] scope of services).

In addition, when a CFP professional is actually engaged to give financial advice, the CFP professional must further provide a written Terms of Engagement agreement, including:

Terms Of Engagement Financial Planning Agreement

– Scope of Engagement (and any limitations), period for which services will be provided, and client responsibilities

– Further disclosures, to the extent not already provided, including:

– More detailed description of costs to the client, including:

– How the client pays, and how the CFP Professional and the Professional’s Firm are compensated for providing services and products;

– Additional types of costs that the Client may incur, including product management fees,

– Identification of any Related Party that will receive compensation for providing services or offering products

– Full disclosure of all Material Conflicts of Interest

– Link to relevant webpages of any government authorities, SROs, or professional organizations, where the CFP professional’s public disciplinary history or personal/business bankruptcies are displayed

– Any other information that would be Material to the client’s decision to engage (or continue to engage) the CFP professional or his/her firm

As mentioned earlier, the CFP Board’s current Standards of Professional Conduct already require that CFP certificants enter into a written agreement with clients that defines the scope of the engagement. But with an expanded fiduciary duty for CFP professionals, it seems likely that financial advisors may become more proactive about clearly defining the scope of what they will, and won’t, do as a part of the client engagement. Especially since the CFP Board’s new 7-step process makes it optional for the CFP to follow through on the implementation and/or monitoring phases of the process, but only if the scope of engagement explicitly excludes those steps of the process.

In addition, the mere delivery of a “comprehensive” financial plan, under a more “comprehensive” fiduciary duty, creates potential new liability exposures for financial advisors. If the advisor’s agreement says the financial plan is “comprehensive”, what, exactly, does that cover? Is it everything in the CFP Board’s current topic list? Does that mean CFP professionals could get themselves into trouble for offering a “comprehensive” financial plan, but failing to review a will or a trust, or an automobile or renter’s insurance policy? Under the new standard in the future, CFP professionals may want to become far more proactive about stating exactly what they will cover in a plan – to more concretely define the scope of engagement – rather than just stating that it will be “comprehensive”.

Will offering comprehensive plans create fiduciary risk for CFPs under the new conduct standards?

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The new standards of conduct also require that the CFP professional disclose to the client any Material change of information that occurs between the Introductory Information and when the actual Terms of Engagement are signed, along with any Material changes that occur after the engagement begins but during the scope of the (ongoing) engagement. Ongoing updates must be provided at least annually, except for public disciplinary actions or bankruptcy information, which must be disclosed to the client within 90 days (along with a link to the relevant regulatory disclosure websites).

Cleaning Up Fee-Only Definitions And Sales-Related Compensation

One of the most challenging issues for the CFP Board in recent years has been its “compensation definitions” – specifically pertaining to when and how a CFP professional can call themselves “fee-only”, which had led to both a lawsuit against the CFP Board by Jeff and Kim Camarda, the resignation of (now-former) CFP Board chair Alan Goldfarb (who was later publicly admonished), and a series of ongoing debacles for the CFP Board as it kept trying to update its flawed interpretation of the original “fee-only” compensation definition.

The problem was that under the prior rules, “fee-only” was defined as occurring “if, and only if, all of the certificant’s compensation from all of his or her client work comes exclusively from the clients in the form of fixed, flat, hourly, percentage, or performance-based fees.” And the certificant’s “compensation” was in turn defined as “any non-trivial economic benefit, whether monetary or non-monetary, that a certificant or related party receives or is entitled to receive for providing professional activities.”

The primary problem in this context was that the CFP Board interpreted these rules to mean that if a related party could receive non-fee compensation, the CFP certificant couldn’t call themselves “fee-only”, even if the CFP professional could prove that 100% of their clients paid 100% in fees (and no commissions) for any/all client work. In other words, the CFP Board imputed the possibility of a commission to taint the CFP professional’s status as fee-only, regardless of whether the client ever actually paid a commission to anyone, ever. Such that even being able to prove that all your clients only paid fees wasn’t a legitimate defense to claiming that you were fee-only!

Under the new Standards of Conduct, the overall structure of “fee-only” is substantively similar, but updated in ways that should help to resolve many of the prior problems and misinterpretations of the definition. Now, fee-only is defined as:

Fee-Only. A CFP professional may represent his or her compensation method as “fee-only” only if:

1. The CFP professional and the Professional’s Firm receive no Sales-Related Compensation; and
2. Related Parties receive no Sales-Related Compensation in connection with any Professional Services the CFP professional or the CFP Professional’s Firm provides to Clients.

In turn, “Sales-Related Compensation” is defined as:

Sales-Related Compensation. Sales-Related Compensation is more than a de minimis economic benefit for purchasing, holding for purposes other than providing Financial Advice, or selling a Client’s Financial Assets, or for the referral of a Client to any person or entity. Sales-Related Compensation includes, for example, commissions, trailing commissions, 12(b)1 fees, spreads, charges, revenue sharing, referral fees, or similar consideration.

Sales-Related Compensation does not include:

1. Soft dollars (any research or other benefits received in connection with Client brokerage that qualifies for the “safe harbor” of Section 28(e) of the Securities Exchange Act of 1934);
2. Reasonable and customary fees for custodial or similar administrative services if the fee or amount of the fee is not determined based on the amount or value of Client transactions; or
3. The receipt by a Related Party solicitor of a fee for soliciting clients for the CFP® professional or the CFP® Professional’s Firm.

Not surprisingly, “sales-related compensation” is defined as any type of compensation that is paid for any type of purchase or sale related to a client’s financial assets, or for a referral (that might subsequently lead to such outcomes). Thus, for instance, selling an investment or insurance product for a commission would be sales-related compensation, as would referring a client to an insurance agent or broker (or anyone else) who pays the CFP professional for referring the lead. Although under the current rules, using an outsourced investment provider – i.e., a TAMP – might also be deemed a “referral” fee, to the extent that many TAMPs collect the AUM fees and then remit a portion of the CFP professional as a solicitor/referrer fee, which would no longer be allowed, even if the cost is the same to the client as the CFP professional who hires his/her own internal CFA to run the portfolio. Will the CFP Board be compelled to refine its “sales-related compensation” rules to allow for level AUM fees as a part of standard solicitor agreements?

More generally, though, it’s notable that the new “fee-only” rules are not actually defined by whether the CFP professional receives various types of AUM, hourly, or retainer fees; instead, it is defined by not receiving any type of Sales-Related Compensation (such that client fees are all that is left). As a result, the new “fee-only” definition might more aptly be explained as being a “no-commission” (and no-referral-fee) advisor instead.

A key distinction of the new rules, though, is that for a CFP professional to be fee-only, neither the CFP professional nor his/her firm can receive any sales-related compensation, but a related party can receive sales-related compensation as long as it is not “in connection with” the services being provided to the client by the CFP professional or his/her firm. This shift is important, as otherwise, any connection between the CFP professional and any related party to his/her firm could run afoul of the fee-only rules; for instance, if a fee-only RIA was bought by a bank or holding company, which separately had another division that happened to offer mortgages (for a commission), the RIA would lose its fee-only status, even if no clients ever actually did business with the related subsidiary. Under the new rules, external related parties could still co-exist in a manner that doesn’t eliminate the CFP professional’s fee-only status, as long as no clients actually do business with that related party (so no clients ever actually pay a commission to a related party), and the CFP professional’s own firm doesn’t directly accept any type of sales-related compensation.

Notably, under these new definitions, Jeff and Kim Camarda – who had a “fee-only” RIA but referred clients internally to a co-owned insurance subsidiary that earned commissions – would still not have been permitted to call themselves “fee-only” (as clients really were paying commissions to a related party in connection with the Camardas’ financial advice). However, the strange case of former CFP Board chair Alan Goldfarb, who was deemed to violate the fee-only rules because his RIA-parent-company accounting firm also owned a broker-dealer even though it was never stated that a single client of Goldfarb’s ever actually paid a commission to that entity, would have been (appropriately) still allowed to call himself “fee-only”.

On the other hand, it’s not entirely clear whether the CFP Board considered how CFP professionals might shift towards fee-only compensation in the future. For instance, what happens if a CFP professional who currently earns commissions and trails decides to stop doing any commission-based business, and operate solely on a fee-only basis in the future… but doesn’t want to walk away from his/her existing trails for prior business? Under a strict interpretation of the current “sales-related compensation” rules, even old sales-related compensation that has no relationship to current clients would still run afoul of the rules, even though the CFP professional really does work solely on a fee-only basis now. In addition, receiving “old” trails typically still requires the CFP professional to maintain a broker-dealer registration (to remain as Broker of Record), and/or a state Insurance license (and appointment to one or several insurance companies) to remain Agent of Record… which means the CFP professional would still be affiliated with a firm that receives sales-related compensation (which also runs afoul of the rules). Does the CFP Board need to add a further clause that clarifies how CFP professionals who are transitioning to fee-only can keep old commission trails for prior sales, and “old” affiliations to broker-dealers or insurance companies to receive those trails, and still be permitted to hold out as fee-only going forward, as long as no new clients will ever again compensate the advisor via commissions or other sales-related compensation?

CFP Board Cautions Against Marketing “Fee-Based” Compensation

In addition to tightening the CFP Board’s compensation of “fee-only”, the new rules also explicitly caution CFP professionals against the use of the term “fee-based”, which was originally a label for investment wrap accounts where trading costs were “fee-based” rather than a per-trade commission, but in recent years has occasionally been used by brokers to imply they are offering “fee-only” advice (relying on consumers to not understand the difference between fee-based and fee-only).

To limit this, the new CFP Board conduct standards would require that anyone who holds out as “fee-based” to clearly state that the CFP professional either “earns fees and commissions”, or that “the CFP professional is not fee-only”, and that the term should not otherwise be used in a manner that suggests the CFP professional is fee-only. (Recognizing that the term is enshrined in SEC regulations as a part of fee-based wrap accounts, and can’t realistically be eliminated from the investment lexicon altogether.)

CFP Board has proposed to limit the ‘fee-based’ label unless clearly stated to NOT be fee-only!

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The caveat, however, is that while the CFP Board is explicitly cracking down on the use of “fee-based” as a marketing label, the organization is backing away from its prior “Notice to CFP Professionals” guidance from 2013, which grouped all financial advisor compensation into being either “fee-only”, “commission-only”, or “commission and fee”. Which seems concerning, as while grouping CFP professionals into “just” three buckets has limited value – when most are in the middle and operate with some blend of commissions and fees – it’s still better than not requiring consistent definitions at all. Otherwise, what’s to stop CFP professionals from just coming up with another label for being (partially) fee-compensated, that isn’t fee-only, but sounds similar… which is precisely why “fee-based” has been increasingly adopted in recent years anyway.

In other words, if the CFP Board states: “All CFP professionals must disclose that their compensation is fee-only, commission-and-fee, or commission-only, and should provide further compensation disclosure details as appropriate” then at least CFP professionals will disclose their compensation consistently. But with the CFP Board’s current approach, a CFP professional who receives at least some fees might have to stop using “fee-based”, but could just use similar words like “fee-oriented” or “fee-compensated” or “fee-for-service” financial advice, which would still focus on and imply fees (and fee-only) without stating that the actual compensation includes commissions as well (as using the term “fee and commission” is now only required when attached to fee-based).

Enforcement Of The New CFP Board Standards Of Conduct?

Notwithstanding its expansion in the scope of fiduciary duties that would apply to CFP professionals, it’s important to recognize that the CFP Board’s ability to enforce its standards is still somewhat limited.

At most, the CFP Board’s Disciplinary and Ethics Commission (DEC) can only privately censure or publicly admonish a CFP certificant, and/or in more extreme cases to suspend or revoke the CFP marks from that individual. However, that doesn’t mean the CFP Board can actually limit someone’s ability to be a practicing financial advisor, who offers (and is paid for giving) financial advice to the public. Nor can the organization fine or otherwise financially punish a CFP certificant, beyond the financial consequences that might occur to the CFP certificant’s business if he/she is either publicly admonished, or has his/her marks suspended or revoked (which is also part of the public record).

Although the real challenge for the CFP Board is that because it is not an actual government-sanctioned regulator, its ability to collect the information necessary to adjudicate its disciplinary hearings is a significant challenge. Because broker-dealers and advisory firms have in some cases refused to provide the necessary information to the CFP Board regarding a CFP certificant and his/her clients when a client is filed, as the firm fears that actual government regulators (e.g., the SEC and/or FINRA) might discipline them for a breach of client privacy by sharing information with the CFP Board in the first place! In fact, back in 2011 the CFP Board had to seek out a “No-Action” letter from the SEC to affirm that it was permissible for firms to share “background documents” without violating Reg S-P, and continued pushback from firms led the CFP Board to request a follow-up No-Action letter request in 2014 to further expand the scope of what firms even could share with the CFP Board.

Of course, in situations where a client files a complaint with the CFP Board, the client has authorization to release his/her own information to the CFP Board to evaluate the complaint. But the limitations of the CFP Board’s ability to even investigate complaints against CFP certificants, especially in the case of third-party complaints (i.e., where it is not the client who submits the complaint, and his/her information to document it), raise serious concerns about its ability to effectively enforce its new standards. It’s not a coincidence that the overwhelming majority of current CFP Board disciplinary actions are based almost entirely on public information (from bankruptcy filings and DUI convictions, to CFP certificants who are disciplined after the SEC or FINRA already found them publicly guilty), and/or pertain to situations that wouldn’t require client-specific information anyway (e.g., whether the advisor misrepresented his/her compensation in marketing materials).

In other words, the “good” news of the new CFP Conduct Standards is that CFP professionals will be required to meet a fiduciary standard of care when providing any kind of financial advice to clients… but what happens if they don’t? To what extent can the CFP Board enforce against those who don’t effectively comply with the rules, and then simply refuse to provide information – under the guise of Reg S-P – when a complaint is filed? Will the CFP Board have to rely on consumers to file their own complaints, just to get the information necessary to investigate such complaints? And is the CFP Board prepared to enforce against the non-trivial number of CFP certificants who have been acting as non-fiduciaries for years or decades already by using their CFP marks to sell products (which now will be subject to a fiduciary obligation for the first time)? Especially since the CFP Board doesn’t require CFP professionals to state in writing that they’re fiduciaries to their clients, which means the CFP Board’s fiduciary duty still won’t necessarily be grounds for a client to actually sue the financial advisor for breach of fiduciary duty (as the CFP certificant would simply be failing to adhere to the CFP Board’s requirement that he/she act as a fiduciary, and not an actual fiduciary commitment to the client!).

CFP Board Anonymous Case Histories And Case Law Precedents

On the other hand, one of the greatest challenges for the CFP Board may not be the consequences if it can’t investigate claims against CFP professionals, but what happens if it does see an uptick in the number of complaints and enforcement actions under the new CFP Conduct Standards.

The problem is that ultimately, a large swath of the newly proposed Conduct Standards contain potentially subjective labels to determine whether the rules have actually been followed, or not. For instance, the word “reasonable” or “reasonably” is used a whopping 26 times in the new Conduct Standards, pertaining to everything from whether a conflict of interest in Material (based on whether a “reasonable” client would have considered the information important), to whether a related party is related based on whether a “reasonable” CFP professional would interpret it that way, to requirements that CFP professionals diligently respond to “reasonable” client inquiries, follow all “reasonable” and lawful directions of the client, avoid accepting gifts that “reasonably” could be expected to compromise objectivity, and provide introductory information disclosures to prospects the CFP professional “reasonably” anticipates providing subsequent financial advice to. In addition, the entire application of the rules themselves depend on the CFP Board’s “determination” of whether Financial Advice was provided (which triggers the fiduciary obligation for CFP professionals), and CFP professionals with Material conflicts of interest will or will not be found guilty of violating their fiduciary duty based on the CFP Board’s “determination” of whether the client really gave informed consent or not.

In other words, the CFP Board’s new Standards of Conduct leave a lot of room for the Disciplinary and Ethics Commission (DEC) to make determinations of what is and isn’t reasonable in literally several dozen instances of the rules, as well as determining how they will determine when Financial Advice is given and what does and doesn’t really constitute informed consent.

New CFP Standards of Conduct use ‘reasonableness’ 26 times to determine what is ‘appropriate’!

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To be fair, the reality is that it’s always the case that regulators and legislators write the rules, and the courts interpret them in the adjudication process. So the idea that the CFP Board’s DEC will have to make interpretations of all these new rules isn’t unique or that out of the ordinary. And frankly, using “reasonableness” as a standard actually helps to reduce the risk that a CFP professional is found guilty of something that is “reasonably” what another CFP professional would have done in the same situation. “Reasonableness” standards actually are peer-based professional standards, which is what you’d want for the evaluation of a professional.

However, when courts interpret laws and regulations, they do so in a public manner, which allows everyone else to see how the court interpreted the rule, and provides crucial guidance for everyone who follows. Because once the court interprets whether a certain action or approach is or isn’t permitted, it provides a legal precedent that everyone thereafter can rely upon. In point of fact, many of the key rules that apply to RIA fiduciaries today, including the fact that a fiduciary duty applies to RIAs in the first place, didn’t actually come from regulators – it came from how the courts interpreted those regulations (which in the case of an RIA’s fiduciary duty, stemmed from the 1963 Supreme Court case of SEC v Capital Gains Research Bureau).

The problem, though, is that the CFP Board’s disciplinary process is not public. Which means even as the DEC adjudicates 26 instances of “reasonableness”, no one will know what the DEC decided, nor the criteria it used… which means there’s a risk that the DEC won’t even honor its own precedents, and that rulings will be inconsistent, and even if the DEC is internally consistent, CFP professionals won’t know how to apply the rules safely to themselves until they’re already in front of the DEC trying to defend themselves!

Notably, this concern – of the lack of disciplinary precedence in CFP Board DEC hearings – was a concern after the last round of practice standard updates in 2008, and did ultimately lead to the start of the CFP Board releasing “Anonymous Case Histories” in 2010 that provide information on the CFP Board’s prior rulings. (The case histories are anonymous, as making them public, especially in situations where there was not a public letter of admonition or a public suspension or revocation, would itself be a potential breach of the CFP professional’s privacy.)

However, the CFP Board’s current Anonymous Case History (ACH) database is still limited (it’s not all cases, but merely a collection of them that the CFP Board has chosen to share), and the database does not allow CFP professionals (or their legal counsel) any way to do even the most basic keyword searches OF the existing case histories (instead, you have to search via a limiting number of pre-selected keywords, or by certain enumerated practice standards… which, notably, will just be even more confusing in the future, as the current proposal would completely re-work the existing practice standard numbering system!).

Which means if the CFP Board is serious about formulating a more expanded Conduct Standards, including the application of a fiduciary duty and a few dozen instances of “reasonableness” to determine whether the CFP professional met that duty, the CFP Board absolutely must expand its Anonymous Case Histories database to include a full listing of all cases (after all, we don’t always know what will turn out to be an important precedent until after the fact!), made available in a manner that is fully indexed and able to be fully searched (not just using a small subset of pre-selected keywords and search criteria). Especially since, with the CFP Board’s unilateral update to its Terms and Conditions of Certification last year, CFP professionals cannot even take the CFP Board to court if they dispute the organization’s findings, and instead are bound to mandatory arbitration (which itself is also non-public!).

Overall Implications Of The CFP Board’s New Fiduciary Standard

Overall, for CFP certificants (including yours truly) who have called for years for the CFP Board to lift its fiduciary standard for its professionals, there’s a lot to be liked in the newly proposed Standards of Conduct. The CFP Board literally leads off the standards with the application of the fiduciary duty to CFP professionals (it’s the first section of the new Standards of Conduct!), and expands the scope of the CFP Board’s standards to cover not just delivering financial planning or material elements of financial planning, but any advice by a CFP professional (for which it is presumed that delivering that advice should entail doing financial planning!).

In addition, the CFP Board has made a substantial step forward on its disclosure requirements for conflicts of interest, particularly regarding the creation of its “Introductory Information” requirement for upfront disclosures to prospects, and its expanded and more detailed requirements for setting the Terms of Engagement for client agreements. (For anyone who still believes the CFP Board is beholden to its large-firm broker-dealers, this should definitively settle the issue – as broker-dealers compliance departments will most definitely not be happy that the CFP Board as a “non-regulator” is imposing disclosure requirements on their CFP brokers! In fact, there’s a non-trivial risk for the CFP Board that some large brokerage or insurance firms may decide to back away from the CFP Board’s expansion of its fiduciary duty, just as State Farm did back in 2009 when the CFP Board first introduced its fiduciary standard.)

On the other hand, it is still notable that despite increasing the disclosure requirements associated with its expanded fiduciary duty for CFP professionals, the CFP Board isn’t actually requiring CFP professionals to change very much from what they do today. Material conflicts of interest must be disclosed, but obtaining informed consent appears to be a legitimate resolution to any actual conflict of interest. And debating whether a conflicted recommendation that the client agreed to with informed consent was still a fiduciary breach or not would quickly come back to a determination of whether the CFP professional’s advice met various standards of “reasonableness” – which, as of now, aren’t entirely clear standards, and if the CFP Board can’t effectively expand its Anonymous Case Histories, may not get much clearer in the future even as the DEC interprets what is “reasonable”, either.

In the meantime, though, to the extent that the CFP Board’s newly expanded fiduciary standard – both the duty of loyalty, and the expanded duty of care – does create at least some new level of accountability for CFP professionals, the real challenge may be the CFP Board’s own ability to enforce and even investigate complaints if and when they do occur. As the saying goes, the CFP Board needs to make sure its mouth isn’t writing checks that its body can’t cash, by promulgating standards of conduct it may struggle to effectively enforce. Whether and how the CFP Board will expand and reinvest into its own disciplinary process and capabilities remains to be seen.

But overall, the CFP Board’s newly proposed Standards of Conduct really do appear to be a good faith effort to step up and improve upon the gaps of the prior/existing standards of professional conduct. The scope of what constitutes “doing” financial planning for the purposes of the fiduciary duty is expanded (and if anything, the CFP Board may have gone too far by not limiting the scope of fiduciary duty to an established financial advice relationship for compensation), the fee-only compensation definition is improved (although the CFP Board may be starting a problematic game of whack-a-mole by just punishing “fee-based” instead of more formally establishing a standardized series of compensation definitions), and although the CFP Board didn’t crack down on material conflicts of interest to the extent of the Department of Labor’s fiduciary rule, it did still move the ball further down the field by more fully highlighting prospective conflicts and increasing the disclosure requirements for both RIAs and especially broker-dealers and insurance firms.

For the time being, though, it’s also important to recognize that these are only proposed standards, and not final. The CFP Board is engaging in a series of eight Public Forums in late July across the country to gather feedback directly from CFP professionals (register for one in your area directly on their website here), and is accepting public comment periods for a 60-day period (ending August 21^st), which you can submit either through the CFP Board website here, or by emailing comments@cfpboard.org. Comments and public forum feedback will then be used to re-issue a final version of the standards of conduct (or even re-proposed if the Commission on Standards deems it necessary to have another round of feedback) later this year.

And for those who want to read through a fully annotated version of the proposed Standards of Conduct themselves, the CFP Board has made a version available on their website here.

DOL Rule Forces Independent Advisors To Differentiate & Adapt

In the latest Schwab Independent Advisor Outlook study, a growing number of financial advisors report feeling compelled to do more for clients, without being able to increase their fees to pay for it. A whopping 44% of advisors state they have already begun to provide more services to clients without charging for them, and 40% of advisors are spending more time on each client without increasing fees. Notably, the study does not find that advisors are cutting their fees to compete with robo-advisors and the like; instead, advisory firms are responding to competitive pressures by trying to do more to justify their existing fees in the first place (at the risk of compromising their profit margins over time).

In fact, the pressure to do more and offer a wider range of services for clients was the dominant theme of the study’s future outlook as well, as advisors themselves are increasingly suggesting that the key to differentiation in the future – especially as DoL fiduciary forces more and more competitors into the AUM model – will be offering clients a broader range of services beyond just the portfolio, from tax planning, to philanthropic advice, and health-care planning. In the meantime, as the DoL fiduciary standard itself becomes universal, only 20% of the RIAs in Schwab’s study stated that they anticipate trying to differentiate through a commitment to more stringent standards for advice. Nonetheless, 79% of advisors reported feeling confident about the future of the industry, and expect more opportunities in the next 10 years, particularly as financial planning itself continues to mature.

Why Actively Managed Mutual Fund Performance Is About To Improve

Executive Summary

This week is the first that financial advisors must operate under the Department of Labor’s fiduciary rule, subject to Impartial Conduct Standards which require that they must give best interests advice, for reasonable compensation, and make no misleading statements. While much has been said about the impact this will have for advisors and their clients, there’s also a not-well-discussed secondary shift that will be triggered by the DoL fiduciary rule, which will impact actively managed mutual funds and their performance in the coming years – in a “surprisingly” positive way.

This week I will be covering how the DoL fiduciary rule will likely end out causing an improvement in the return performance of actively managed mutual funds, thanks to the rise of clean shares and a shift in how brokers are compensated for recommending such funds!

Most predictions about the likely impact of the Department of Labor’s fiduciary rule is that it will lead to a (continued) decline in the use of actively managed mutual funds, and support the ongoing rise of passive ETFs, thanks to the fiduciary rule’s focus on low cost. But the truth is, that there actually is no requirement in the DoL fiduciary rule that financial advisors eschew actively managed funds and switch to lower cost passive funds. The only real requirement is that if an advisor is going to use an actively managed fund, that there needs to be a clear reason and justification for paying that active manager’s fee. And if you can make the case for the active manager, there’s nothing wrong with using the actively managed fund.

There is, however, a requirement to use the lowest cost share class if multiple share classes of the same fund are available. This is why we’ve seen the launch of T shares and clean shares – which either pay a uniform 2.5% upfront commission and 0.25% trails, or eliminate commissions entirely with the broker-dealer then wrapping a levelized commission around the whole fund or account. And this matters, because mutual funds currently have to report their performance net of commissions and broker compensation. But as broker-dealers shift to being compensated by levelized commissions outside of the funds (even if the consumer still pays a 1% fee via the broker-dealer equivalent to the 1% trail in a C share), the mutual fund itself will no longer have to count the broker’s compensation against their own performance!

And this is important because a lot of mutual fund managers have not been underperforming by the amount of the manager’s fee, but instead, they’ve been underperforming because of the drag of the broker’s commission compensation. Which means, “suddenly”, we’re going to start seeing the average actively managed mutual fund begin to improve on its performance… starting this week, with the rollout of the DoL fiduciary rule (and the rapidly rising adoption of clean shares in particular). Not because mutual fund managers are necessarily managing any differently or better, but simply because they’re no longer paying broker compensation out of their own performance track records! Ironically, this may even handicap RIA performance reporting relative to brokers, given that brokers typically point to mutual fund performance (which will not include the broker-dealer’s level commission payout) instead of account performance, whereas advisors in an RIA that want to market GIPS-compliant performance track records will still have to follow specific rules requiring a full accounting for fees.

In the end, this shift may still result in a roughly-similar total cost to consumers – whether it’s a 1% AUM fee, a 1% commission, or a 1% broker-dealer payout wrapped around clean shares – but the net result nonetheless is that with a shift to clean shares, reported performance for actively managed mutual funds is going to start looking better. Which means in a few years, we may suddenly be talking about how much better actively managed mutual funds are doing again. But it won’t be because “the pendulum swinging from passive to active”… or because that’s when the Fed started accelerating their rate increases… or whatever else happens economically from here. It will be because DoL fiduciary reconfigured how brokers get paid, reducing the need for 12b-1 fees, reducing the expense ratio of actively managed mutual funds, and improving the reported performance of the mutual fund itself!

DoL Fiduciary Doesn’t Kill Mutual Funds, Just Share Classes

I know most predictions about the impact of the DoL fiduciary rule is that it would lead to a declining use of actively managed mutual funds and support for the ongoing rise of passive ETFs thanks to the fiduciary rule’s focus on low cost. But the truth is, there’s really no requirement in the DoL fiduciary rule that advisors have to assume actively managed funds and switch to lower cost passive funds. The only real requirement is that if an advisor is going to use an actively managed fund, there needs to be a reason and a justification for paying the active manager’s fee. And if you can make the case for the active manager (i.e. they have reasonable performance), there’s nothing wrong with using an actively managed fund.

Secondarily, though, there is a requirement under the DoL fiduciary rule that if there are multiple share classes of the exact same fund, you better use the lowest cost version available to you. And to further ensure that advisors aren’t even tempted towards a small subset of higher cost funds that might pay them better, financial institutions have a requirement under DoL fiduciary to make compensation uniform across an entire category of investment products. Which means, while there may be cost differences between passive and active funds, the advisor or broker must be getting the same compensation for all of them regardless of which one is used. And this requirement that compensation must be uniform across mutual fund share classes is indirectly why I recently predicted that I think we’re going to see a total collapse in the number of mutual fund share classes in the next year or so.

Because, the truth is, the primary reason there are so many mutual fund share classes (e.g., some companies have more than a dozen different share classes) is basically because they have a dozen different arrangements to pay brokers to sell their products. And when compensation has to be uniform, the mutual fund share classes you need become uniform as well, and that’s why we’re seeing the launch of T shares and clean shares. So T shares, for those of you who aren’t familiar, will have a uniform commission paying 2.5% upfront and 25 basis point trails every year thereafter no matter what fund company it is and clean shares are just like what they sound, completely clean. No commissions, no 12B-1 fees at all.

DoL fiduciary doesn’t kill actively managed mutual funds, just reduces the number of share classes!

 

Now, obviously, even with clean shares, the broker still has to get paid, but that’ll happen by simply wrapping a levelized commission (such as 1% a year) around the whole brokerage account by the broker-dealer themselves, and the end result is actually that broker-dealers are going to start looking more and more like RIAs that buy institutional class shares and wrap their 1% AUM fee around it to manage it.

In fact, in the DoL guidance, when they confirmed that fiduciary rule was going to go forward on June 9th, even pointed out that they might look at issuing new rules with another streamlined exemption similar to the level fee fiduciary exemptions, specifically for brokerage firms using clean shares and this AUM style of perfectly level commissions. Which means, simply put, there’s going to be a lot of dollars flowing into clean shares in the coming years.

How DoL Fiduciary Will Lead To Better Mutual Fund Performance

So here’s why this all matters from the perspective of the performance of actively managed mutual funds. As the entire brokerage industry shifts from A shares to lower commission T shares (and particularly from C shares to clean shares), the cost structure of mutual funds themselves begins to change. Now, this isn’t necessarily about the difference to the end consumer. You can pay a 1% trail on a C share or you can pay a 1% fee to a broker who uses a clean share. Either way, the consumer pays 1%. But the flow of payments is different. Instead of the consumer as mutual fund shareholder paying 1% out of the fund, the consumer is going to pay 1% directly to the brokerage firm who will remit a portion to the broker because the mutual fund itself is a clean share which means the cost of compensating brokers will no longer be paid from mutual fund assets, which means the mutual fund no longer has to count broker compensation against their own performance.

Just think about that for a moment. What happens when every mutual fund currently paying 1% trail to a broker suddenly no longer has to carry that 1% fee as part of the fund’s expense ratio? Think about what that does to performance. When you drop the expense ratio of all of those mutual funds by an entire 100 basis points per year indefinitely. This is a profound shift. We all know that one of the primary blocking points that keeps actively managed mutual funds from outperforming is their cost, right? There are actually a decent number of mutual fund managers who do outperform their benchmarks on a gross basis, just not net of fees. SPIVA actually did a study recently and found that in some of the less efficient international categories, the majority of fund managers actually outperform gross of fees.

Now, obviously, it’s kind of a moot point if a mutual fund outperforms gross of fees but not net of fees because the consumer only gets the net return, but the problem is that a lot of mutual funds have not actually been underperforming by the amount of the manager’s fee. They’ve been underperforming because of the drag of the broker’s commission (the original commission plus 12B-1 fees). Those aren’t investment management costs. Those are marketing costs borne by shareholders thanks to the 12B-1 rules that allow expenses for marketing to be paid from mutual fund assets, and therefore count against mutual fund performance.

But again, with the shift to both lower commission T shares (and especially the clean shares), the cost will still be paid by the consumer, but not out of mutual fund assets in a manner that gets held against their performance. Which means, suddenly, I think you’re going to see actively managed mutual fund performance is going to start improving starting now… starting this week. Not necessarily because they’re managing any differently, but simply because they’re no longer paying broker compensation out of their performance.

DoL fiduciary will improve mutual fund performance by reducing drag from broker compensation!

The Beginning Of The End Of The 12b-1 Fee

When I look back over the years, I find it somewhat ironic that asset managers haven’t tried to fix this for themselves earlier, given that their performance is often getting buried by the cost of the broker and not their actual management fees. Because, if you go back to the roots of mutual funds, it didn’t always work this way. For the first almost 50 years of mutual funds, they only covered management fee costs, not broker costs for commissions. It changed in 1980 when we passed the rule 12B-1 that allowed, for the first time, for expenses to market and distribute mutual funds (including and especially the compensation of brokers) to come directly from the mutual fund assets, and therefore the fund’s expense ratio, and therefore the fund’s performance.

Arguably, back then, it didn’t matter as much. The fund industry was reeling from the bad performance in the 1970s, trying to get growth going, and they found if they paid 12B-1 fees to the rising number of independent broker-dealers, then registered reps would sell their funds and bring in assets to the fund. And, since people just weren’t as performance sensitive back then, it wasn’t as big of a deal. Remember the time? We launched the 12B-1 fee…in frankly, probably just coincidentally, what was the eve of the great bull market of the 1980s and the 1990s. So most people were pretty happy with their results, and they didn’t even have good tools to analyze mutual fund performance to compare to a benchmark anyway. So no one cared about relative performance to benchmarks that much. And even if they did, they didn’t know how to measure it.

But now, we have the internet, and both consumers and advisors themselves have a huge number of solutions at their fingertips, including Morningstar itself to show them exactly how their mutual funds are performing net of fees relative to a benchmark and passive alternatives. And, as we know, the results haven’t been very good, especially as average investment manager improves, which paradoxically reduces the amount of alpha available on the table – as folks like Larry Swedroe or Andy Berkin have been writing about.

So, now we’re in a world where investors are more performance sensitive because they’re more easily able to measure investment performance against benchmarks, and their fund managers are still allowing the marketing expenses of the fund company paid to brokers to be applied against their performance records.

At least until this week, when DoL fiduciary takes effect and we see the rise of clean shares. And I suspect that once more mutual fund managers realize this (that if they switch to clean shares, they can get broker compensation out of their performance records) they’re going to push for it, because it makes their performance look better. And this may actually be the beginning of the end of the 12B-1 fee altogether.

A Handicap For RIA Performance Against Brokers?

Now, ironically, one final thing that’s worth pointing out in this phenomenon where brokers’ costs of buying clean shares will no longer be counted against mutual fund performance itself, is that is kind of unique broker-dealers Because, if you’re an RIA,  your advisory fees absolutely get counted directly against client performance. In particular, if you’re an RIA that wants to market a GIPS-compliant performance track record, there are very specific rules about how to construct those performance composites and their associative fees to ensure that net performance is reported properly. And if the RIA has firm reports on performance, it’s always reporting net of fees.

So, I suspect that in broker-dealers using clean shares will primarily point to the performance of their mutual funds. Not necessarily performance of the account, because the account is net of the brokers fee, but the mutual funds will not be. Which means, mutual fund will get reported gross of broker compensation but RIA performance will get reported net of AUM fees. Which ironically, means now the fee drag pressure is on RIAs more whereas, in the past, it was on broker-dealers, because that’s just the reality of how we’ve tended to construct the comparisons. We look at RIA firm performance against mutual fund share class performance in broker-dealers.

We’ll see how this plays out. Perhaps the industry and consumers themselves will coalesce around some kind of a reporting process that tracks advisor aggregate performance whether at broker-dealer or RIA and it looks like net results, net of all cost and regardless of whether they’re applied at the advisor level, the broker-dealer level, or the fund level. Maybe Morningstar itself will get into the fray at some point? I think this is…frankly, how performance should be tracked, right? Net of all fees. But that’s not always practical with the available technology and reporting processes today, and DoL fiduciary and the rise of clean shares is certainly rearranging a lot of common industry practices.

But the bottom line is just to recognize that with the rise of clean shares, there is a fundamental shift in how brokers are getting compensated now, even if it doesn’t change the total cost to consumers. Because, again, for the consumer, I can pay a 1% commission trail or I can pay 1% AUM fee. It’s still the same 1%, though it dramatically changes the expense ratio of the mutual fund, and therefore the performance of mutual funds themselves who will no longer be saddling their performance records with broker compensation.

Which means that in a few years, I think we’re going to end up talking about how suddenly actively managed mutual funds started doing better in Q3 of 2017. And it won’t be because the pendulum swinging from passive to active… or because that’s when the Fed started accelerating their rate increases… or whatever else happens from here. It will be because the DoL fiduciary reconfigured how brokers get paid, reducing the need for 12B-1 fees, and reducing the expense ratio of actively managed mutual funds and improving their reported performance.

And with major broker-dealers and wirehouses now rationalizing which funds to keep on their platforms and eliminating a lot of higher cost and lower performing funds, I think a lot of the weakest funds actually will die from the lack of flows in the coming years. These funds probably should’ve gone away in the first place, but that means the surviving funds going forward, on average, are going to be even better, right? The higher quality crop with the lower expenses, with the better average performance of actively managed funds in the future.

So watch out for this trend. I think you’re going to see a lot coming out about it in the next year or two as we suddenly say, “Wow. Mutual funds suddenly seem to be performing better and this is why.”

I hope that helps and provides a little food for thought about what I think is important but not well discussed secondary shift that’s underway thanks to the DoL fiduciary rule. THave a great day, everyone!

Investment Wholesaling And Segmenting The Four Types Of Financial Advisors

Historically, different financial advisors operated different business models depending on their industry channel – RIAs managed investment portfolios, while wirehouses sold proprietary products and securities from their inventory, and independent broker-dealers sold third-party investment products. Accordingly, asset managers and product manufacturers aligned their investment wholesalers to those channels, with one for wirehouses, another for independent broker-dealers, and a third for the independent RIA community. The challenge, though, is that as the advisor value proposition evolves, along with industry business models, and the regulatory environment, the “traditional” industry channels are breaking down as a way to segment financial advisors!

In this post it will discuss from the investment wholesaler perspective, the four different types of financial advisors that have emerged, how they differ based on client approach and value proposition, and how wholesalers can best add value to these different types of advisors!

The key issue is to recognize that financial advisors tend to have fundamentally different ways in which we frame our own value proposition, and approach client situations, that are no longer necessarily defined by industry channel. And this matters, because when companies with their own wholesalers are trying to reach advisors, the ways in which an advisor approaches their clients and define their own value proposition heavily impacts what that advisor will and will not see as valuable from their wholesalers!

For instance, some advisors taking a very financial planning-centric approach to clients, while others are more investment-centric. And when it comes to delivering value to clients, some are more advice-centric, and others are more product-centric. Thee various combinations result in four categories of financial advisors: (1) fee-for-service financial planners; (2) investment managers; (3) needs-based sellers; and, (4) asset gatherers.

From the perspective of the wholesaler, it is crucial to recognize that each of these segments receives different value from a wholesaler, and demands different types of products and services. Because if an advisor is an asset gatherer, they are going to want to see a product that can easily help them gather assets… but if they are needs-based sellers, they will want planning strategies and sales ideas… and if they are an investment manager, they will want products that they can manage to demonstrate their own expertise (without outsourcing to other active managers!)… and if an advisor is a fee-for-service financial planner, they will want solutions that help them simplify investment management to free up time to service clients and focus on planning. Thus, investment managers (which might be an RIA or a Rep-As-PM at a broker-dealer) tend to use stocks, bonds, and ETFs, but asset gatherers (which might be RIA or at a broker-dealer) are more likely to use multiple TAMPs and SMA, and fee-for-service financial planners (usually RIAs) will typically just use one TAMP for all of their assets and be uninterested in individual investment products at all!

The bottom line, though, is simply to recognize that the whole advisory industry is in the midst of reorienting itself, and trying to segment financial advisors by wirehouse, broker-dealer, and RIA industry channel no longer works. Advisors are reinventing their value propositions and where they focus, while DoL fiduciary further forces firms to re-draw their lines and tech innovation accelerates these trends. Which means, if wholesalers want to reach financial advisors and add value to them, wholesalers need to pay attention to the four different types of financial advisors!

Tor a lot of big national asset managers, there’s a set of wholesalers for RIAs, there’s another set of wholesalers for independent broker-dealers, there’s maybe another set of wholesalers just to call on the wirehouses, and maybe there’s a separate national account or key accounts team that focuses on wholesaling to firms that centralize their investment offerings. Because, if I’m a registered rep at broker-dealer but I use the home office to design portfolios, it doesn’t really make any sense for the wholesaler to spend time with me as the rep. You’ve got to send someone from national accounts wholesaling to the home office if you want to get onto that platform.

But beyond just the different industry channels, I think we also have fundamentally different ways that we as advisors are now framing our own value propositions in approaching client situations. And it matters because so many investment firms now, I find, with their wholesalers, they’re trying to reach us as advisors, whether it’s firms looking to serve advisors outsourcing investment manager responsibilities, other tech firms and platforms serving us, and especially financial services product manufacturers trying to distribute products through us to our clients, the ways we approach our clients and define our value proposition really impacts what we do and don’t see as valuable from wholesalers. But when the wholesalers don’t recognize that, we get all these awkward mismatches that just don’t line up anymore with traditional industry channels.

Financial Planning Oriented vs Investment Oriented & Product-Centric Vs Advice-Centric

I’ll give you an example of this. Some financial advisors have a client approach that is very investment oriented. They approach clients as, “I’m here to help you invest your money.” So, the advisor might manage it themselves or maybe they buy mutual funds or maybe they outsource it to someone else, but they focus on portfolios.

By contrast, other advisors are very financial planning oriented in the approach. They lead with financial planning. Every client starts with a financial plan. They might produce the plan themselves, they might delegate it, they may use a third party firm or home office to help create it, but they view the financial planning as the primary approach and focus, and only secondarily do they then plug in investment products because at some point, even if you’re giving advice, the money’s got to land somewhere.

Now, a second way to think about advisors, is what we get paid for. Some of us get paid for our products and some of us get paid for our advice itself. So, an advice-centric financial advisor views their primary product value proposition usually as themselves. They see it as, “It’s my knowledge. It’s my expertise. The client pays me for my personal value.” That’s an advice-centric value proposition.

Now, for other advisors, they’re more product-centric. The primary value that they bring to the table is the quality of the products they provide. So, the job is to implement a financial services product, and the better products I have as a product-centric advisor, the more things I could sell, and the more things I can implement with clients. But the value isn’t me per se, the value is my ability to bring valuable products to the table, for my clients.

Four Types Of Financial Advisor Value Propositions

Here’s why this segmentation matters. Bear with me a moment. Think about this as like a two-dimensional grid. So, on the left side we’ve got financial planning-centric advisors, on the right side we have investment-centric advisors. And then across the top we have the advice-centric advisors, and across the bottom we have the product-centric advisors. So, we now kind of got this two-by-two grid where people line up in different categories.

The upper left would be financial planning oriented advisors that are advice-centric. This is the domain of those who offer a primarily fee for service financial planning. They focus on financial planning advice, the value is the person who gives the advice. It’s the advisor. So, this would include advisors that charge hourly, project, and retainer financial planning fees. I think it even includes a subset of advisors that maybe charge for assets under management, but in the end, the portfolio is not meant to be the value. It’s usually a very simple portfolio. Because the client isn’t really paying for the portfolio, they’re paying for financial planning advice, and maybe it just might be easier to bill a portfolio if they have assets anyways.

So, when we look at financial planning-centric advisors, we have a different grouping than the rest. And the interesting phenomenon is that I find they often span channels. Now, planning fee for service advisors tend to be independent RIAs or at least dual-registered, because I can’t actually get paid a fee under a broker-dealer form and I’ve got to have an RIA or a hybrid registration.

But here’s why it matters from the perspective of investment wholesalers that come at us. When we’re financial planning-centric, we tend to outsource our investments. For instance, these are the RIAs that use TAMPs, because the advisor’s value proposition isn’t focused on the investments, it’s focused on the financial planning. They’re often quite comfortable to delegate the non-essential investment process to a TAMP. And many advisors that are planning centric, they just kind of pick one TAMP for everything. Pnce you find a reasonable solution to plug in after you do the real planning stuff for clients, why bother with more?

Now, the upper right corner is different. These are the investment oriented advisors that are still advisor-centric. So, these are typically the advisors that view their primary value proposition as their ability to implement quality investments for clients. Now, the key distinction here is the investment oriented advisor who is advice-centric doesn’t want to use products to implement. They don’t want to use actively managed funds, they don’t want to use separately managed accounts, they don’t want to use TAMPS. Their investment ideas, their strategies, their ability to pick the right investments, that’s their value as the advisor.

Again, this matters from the perspective of wholesalers who typically approach us, and particularly because this isn’t specific to a channel. There are RIAs who are investment oriented and advice-centric. They created the RIA to build portfolios for the clients, but there are also registered reps and broker-dealers who did the same thing. It’s even got a label now. It’s called Rep-as-PM, which is short for rep as portfolio manager, because as the name implies, it’s the rep who’s trying to create the value for clients by being the portfolio manager.

Which is important because if you’re a wholesaler and I’m an investment oriented advice-centric advisor and you come at me with actively managed funds, SMAs, and a TAMP, you’re wasting your time. Whether I’m an RIA or a Rep-as-PM or at a broker-dealer, I’m not investing with your solutions because I’m going to do it myself, because that’s my value.

And I think this is actually where ETFs are shining right now. For a lot of investment-oriented advisors, we don’t necessarily have time to do individual stock analysis. Though some may have a stock picking process or they grew large enough to hire an investment team to help, it’s certainly not all advisors.

For a lot of advisors that are in this investment oriented category, ETFs are just an easier building block to manage than individual stocks. And so, the investment oriented advisor often then ends up using ETFs. But here’s a key point to it. It’s not that the investment oriented advisor is buying ETFs because they’re going passive. They’re actively managing the ETFs.

But because the advisor says their value proposition is actively managing the ETFs, this is why even with all the growth of ETFs, I’m incredibly negative about actively managed ETFs. Because I think the investment product manufacturers have missed that the advisors who are using ETFs and managing them in their portfolios, it’s because the advisor wants to be the one adding value. I don’t want to hire some other active manager because then the client’s going to say, “What do I need you for? I could have bought the active fund directly.” The advisor says, “This is my value,” so they’re not going to adopt actively managed ETFs they’re not going to adopt actively managed mutual funds, they’re not going to adopt SMAs, and they’re not going to adopt TAMPs, because they build the portfolios themselves. But again, this isn’t specific to industry channels. This can be Rep-as-PM at a broker-dealer, or this can be a particular subset of independent RIAs that say investments are their value proposition.

The lower right corner is the third group. These are the investment oriented folks, because we’re still on the right, but product-centric because we’re across the bottom now of our little two-by-two grid. For these advisors, they may be focused on implementing investments, but their value isn’t meant to be hands-on management of the portfolio. It’s their ability to find good products, good third party managers, and bring those solutions to the table for their clients. This is where you see actively managed mutual funds, or maybe in the future, actively managed ETFs. This could be a series of separately managed accounts, this could be a TAMP, or several TAMPs.

And in fact, one of the key points of investment-oriented but product centric advisors is that they often use a pretty wide range of solutions. So, if the client wants a bond manager, they’ll get a bond manager. If the client wants a socially responsible investing approach, they’ll find a TAMP or an SMA to build it. If the client wants a certain portfolio, they’ll find a manager or bring it to the table. Because if they’re really trying to build a scalable business, they may eventually simplify that down to a couple of core providers, the go-to products that I know work, that I know I can sell my clients on, that they’re persuaded by.

But for the investment oriented product-centric advisor (and this is where most investment sales people really live), they function more like asset gatherers. Their goal is just to gather assets. I’ll gather assets into actively managed mutual funds, or SMAs, or TAMPs, whatever it takes. I’m just trying to gather assets, sell products, bring in dollars, and might use a wide range of solutions to do it.

But here again, asset gatherers exist across channels. There are RIAs that are very focused on asset gathering, they might use one or multiple TAMPs to collect assets. There are registered reps at broker-dealers that focus on asset gathering and might use a wide array of funds and SMAs and TAMPs in their platform. You know, whatever it takes to gather assets, they’ll find a product to fill the void.

But from the wholesaling perspective, this is a very different type of advisor. This is the advisor where you can give them products to check out and try to get a share of their wallet, or clients’ wallets, with that product. But you have to show them how to sell it, like what’s the pitch? How is it different and better than the products that they currently pitch? That doesn’t work for investment oriented firms that are advice-centric because the advisor says, “No, no, I’m the gatekeeper that picks the stuff. I don’t sell the stuff.” That’s the key difference between advice oriented advisors, where the value proposition is me, and product oriented advisors. With advice oriented advisors, they tend to be a gatekeeper. With product oriented advisors, they tend to be a sales distribution channel.

Now, the bottom left, the fourth of our little two-by-two grid is the financial planning oriented but product-centric advisor. This is the classic domain of needs based selling. Advisors who lead with a financial plan, find out what clients need, and then just implement whatever product they need at the end. But the key point is that they lead with financial planning and then get paid for product implementation. This is the domain of planning oriented brokers and planning oriented insurance agents as well. They’ll do financial planning for the clients because that’s how they determine what’s appropriate to sell at the implementation phase. They don’t lead with the products. They don’t say like, “Hey, I’ve got this cool fund that you should check out.” They lead with, “I’m going to do some financial planning for you, but ultimately, the value at the end is…” and then I’m going to implement some products to solve whatever problems come up.

Because these advisors are product-centric and get paid for products, they are in practice most likely to be at broker-dealers. Because, historically, that’s where needs based selling essentially emerged, broker-dealers and insurance companies. Do the financial plan, implement the client needs at the end. You know, financial planning is a highly effective way to determine clients’ needs and then sell them whatever they need. We’ve proven this over several decades now.

But from the wholesaling perspective, this approach is a little bit different. Investment-oriented advisors who are product centric want product ideas they can pitch and sell. Financial planning oriented advisors who are still product centric want planning strategies, sales ideas that fit planning strategies. If you see a client with this situation, here’s a cool product we have that fits this particular need. Because it’s not about selling the products, it’s about solving client needs with a product. It’s a different approach.

And, as a result, I actually find in practice that these are often the advisors that end up with the widest range of different investment products. Perhaps lots of actively managed funds that fit one client need and some SMAs that fit another client need. As a wholesaler, you can get a share of their wallet by only having a product that fits a specific planning strategy or need. Because, if they see a lot of clients with a lot of different needs, eventually you’ll get a share of that advisor’s wallet. But you have to lead with, “How does this fit a client’s planning need?” not, “What are the features of this product in particular?” It’s an important difference.

The Breakdown Of Financial Services Industry Wholesaling Channels [Time – 13:30]

We’ve got these four different types of advisors: the fee for service financial planners, investment managers, asset gatherers, and needs based sellers. Four different ways that advisors approach client situations and frame their own value proposition, four different perspectives on what kinds of investments are best to meet the needs of their business, and very different likelihoods to use different types of solutions. TAMPs are primarily the domain of the advice oriented financial planners on the upper left, and the asset gatherers on the lower right. Those investment oriented product centric folks or planning-centric advisors who just don’t even really want to do the investment stuff. They just recognize the client’s money, hustle it in somewhere.

SMAs may also get used by asset gatherers, but unique SMA strategies are particularly good for those in the needs based selling category in the lower left. By contrast, ETFs are primarily getting bought by investment managers in the upper right, as well as TAMPs themselves that are kind of being investment managers and then gathering assets under it. Because they view their value proposition as being the investment manager, so they don’t want to pay an active fund manager, TAMP, or an SMA. They want to get that advisory fee for managing the assets and then pick the appropriate building block. I think that’s where a lot of the adoption of ETFs in particular has been.

But again, I can’t emphasize enough that for any wholesalers out there, just looking at industry channels at this point is a terrible way to segment advisors. There are investment manager types in broker-dealers, there’s Rep-as-PM, and then RIAs. But not all RIAs want to be investment managers. Some just want to do financial planning and might outsource to a single TAMP. And then others are aggressive asset gatherers and then they might also still outsource to some TAMPs and SMAs. But if you come with a better product, you might get a slice of their business. If it’s a planning-oriented advisor, you’re either going to win all their business or you’re probably going to win none of it because they tend not to split because they just want to find a straightforward investment solution so they can get back to focusing on the financial planning.

The other key point of this is to recognize that however the advisor is focused, that’s also how the advisor wants to be approached. But if I’m an investment manager who picks investments for my clients, you have to approach me as a gatekeeper that picks investments. You know, show me your one best product that might make the cut in my portfolio and maybe I’ll decide it’s worthy. Although, in all likelihood, I’ll probably just tell you, “Go away and stop bothering me. If your product comes up in my analysis, I will call you.”

But if I’m an asset gatherer and you can give me a product that I can easily gather assets into, ideally one that this is so great it sells itself, I might be very, very interested. Now, on the other hand, if I’m focused on needs-based selling, don’t come at me with products. Come at me with planning strategies and sales ideas which your product happens to fit into. And if I’m focused on fee for service planning, again, just don’t even bother trying to get a slice of my assets. Either be my trusted partner that I can outsource to entirely, or just don’t waste your time and mine.

But the bottom line is just to recognize that the whole advisory industry is in the midst of reorienting itself, of redrawing its dividing lines, where we’re reinventing our value propositions and we’re refocusing. And frankly, I think DoL Fiduciary is just accelerating some of this change, as is the tech innovation overall. And just think about it for a moment. There are advisors at large independent RIAs, Merrill Lynch, Vanguard, Schwab Private Client, who all operate as fiduciaries, use centralized investment management propositions, and lead with financial planning. Whoever thought that an independent RIA, Merrill Lynch, Vanguard, and Schwab would be a shared distribution channel in the industry, in the same category, or that RIAs and subset of asset gatherers at broker-dealers would fuel the growth of managed ETF portfolios? All of these dividing lines in the industry are getting redrawn across the channels to the point that channels don’t work anymore. You have to carve it up differently.

I hope that’s some helpful food for thought, and perhaps for some of you a new or different way to think about how to divide and segment the financial advisor landscape. This is Office Hours with Michael Kitces. Normally 1 p.m. east coast time on Tuesdays, but because I was onsite consulting with a large investment manager that’s trying to understand our space yesterday, I had to record today instead. Thanks for hanging out. I appreciate you joining us, and have a great day, everyone!

So what do you think? Do financial advisors vary based on client approach and value proposition? Do you wish wholesalers would better segment the market to provide value to you? 

Six Areas Where I Disagree with Dave Ramsey’s Retiring and Investing Advice

“A good financial planner is going to do more than pick your funds.”
–Dave Ramsey

Recently, personal finance guru Dave Ramsey engaged in a very heated discussion on Twitter with several financial planners regarding the appropriateness of his investment and retirement withdrawal advice. The questions were (and are) very legitimate ones, namely:

Why does Dave Ramsey keep telling people to invest 100% in equities and that they can expect 12% returns?

and

Why does Dave Ramsey keep telling people that they can safely withdraw 8% of their net worth each year in retirement?

Dave Ramsey’s responses?

1 Jun 13

Scott Truhlar @ScottTruhlar

@BasonAsset @behaviorgap @CarolynMcC @DaveRamseyExemption from the CFP/ethical requirements due to journalist role?

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Dave Ramsey

✔@DaveRamsey

@ScottTruhlar @BasonAsset @behaviorgap @CarolynMcC// I help more people in 10 min. than all of you combined in your ENTIRE lives#stophating

10:58 AM – 1 Jun 2013

• 1010 Retweets

• 88 likes

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Dave Ramsey

✔@DaveRamsey

The snobbery of some of the “Financial Pros” in not helping regular people is sickening. #ignorant #ineffective

11:03 AM – 1 Jun 2013

• 6363 Retweets

• 4545 likes

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1 Jun 13

Dave Grant, CFP® @davegrant82

@DaveRamsey You used to be an role model of mine until you lashed out at @CarolynMcC. Guess you have to change your hero at some point.

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Dave Ramsey

✔@DaveRamsey

@davegrant82 //Why? She has attacked me continually. I just responded. Dont want to get bit by the big dog, stay off the porch.

8:47 PM – 1 Jun 2013

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• 33 likes

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Here’s what he has to say about people who question him.

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Dave Ramsey

✔@DaveRamsey

Out of 387k followers I am amazed how many are postive they can win and how many are nit picking victims.

3:05 PM – 7 Jun 2013

• 1717 Retweets

• 3939 likes

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Instead of actually addressing the questions with a cogent, thoughtful, defensible response, he resorted to ad hominem attacks against financial planners who hold a fiduciary duty to their clients, Carolyn McClanahan and James Osborne.

I’m a fan of Mr. Ramsey’s debt advice. I regularly tell people to go to the local library and check out The Total Money Makeover if they’re deeply in debt because there’s no point in paying me to get the same advice that they can get for free by checking that book out of the library.

But, I have serious and deep concerns about the investment and retirement asset management advice that he gives to his listeners.

Six Areas Where I Disagree With Dave Ramsey’s Advice

There are six areas of disagreement I have with the investment and retirement advice that he provides to his listeners and to his readers.

Investment advice disagreement #1: You can expect a 12% average return

Even if the average returns of the market were 12%, which they’re not, he’s making a very simple, basic mathematical mistake. He is confusing average returns and compound returns. In average returns, the sequence of returns doesn’t matter. In compound returns, the sequence of returns does matter.

Let’s look at an example.

Say you invested $1,000 in Widgets, Inc. The first year, Widgets Inc. loses 10%. At the end of the year, you have $900 of Widgets, Inc. stock. The second year, Widgets Inc. gains 20%. At the end of year 2, you have $1,080 of Widgets, Inc. stock.

The average return during that two year period was 5%. But, applying an average 5% return over a two year period would mean that you should have $1,102.50 in Widgets, Inc. stock. You don’t. You only have $1,080 of Widgets, Inc. stock.

Your compound average growth rate (CAGR), or compounded annual return, was 3.92%.

If you report the average annual return, you get to say that you averaged 5% per year.

If you return the annual return that you see in your personal holdings, then you averaged 3.92% per year.

Compounded over time, that’s a big difference.

I don’t believe that Mr. Ramsey is trying to lead anyone down the garden path here. I think he really thinks that the average annual return is the correct number to report when it’s not.

He does argue two counterpoints to this issue. The first is that saving 15% per year during your working lifetime for retirement is more important than the returns that you’ll get. He’s right, but not by the wide margin that he tells his audience. Furthermore, his newsletters encourage working backwards from a 12% return rather than saving 15%. That advice is contradictory.

If an average family, earning $52,762 (the national average family income), saves 15% of their income every year for 40 years and receives the compounded average growth rate of the market, adjusted for inflation, which is 6.69%, that family will end up with $1,556,686.83. Using a 4% withdrawal rate (which contradicts his advice, a point we’ll address below), that provides the family with $62,267.47 per year. The family will be in good shape, but not in the shape that a 12% return assumption would lead them to believe – $6,799,510.70 versus $1,556,686,83 – a 77% difference.

The second counterpoint is that he uses 12% as an educational example and that he can point to mutual funds which have made 12% over a long period of time. We’ll deconstruct his picks further down, but using 12% as an “educational example” brushes over an important aspect of the differentiator between a “guru” (which he undoubtedly is and deserves the title) and an actual, fiduciarily bound advisor. He’s not bound by a fiduciary duty. It’s not investment advice. That’s why he won’t tell people which mutual funds to invest in. I can’t either, unless you’re a client, but I can certainly tell you which ones to avoid, such as mutual funds that have exorbitant loads. Again, more on this later.

If you think that you’re going to get a 12% average return, then you’ll simply plug 12% into your numbers each and every year, and that’s wrong. The market has ups and downs. To simply say 12% per year every year is naïve and can lead you to significantly overestimate the value that your nest egg will hold when it comes time to retire. It is possible to become anchored (to read how the anchoring bias affects your retirement decisions, read “The Difficulty of Predicting Your Retirement Number”) to the 12% return and not follow the 15% savings rule, and that will lead to serious repercussions when you reach retirement age if you save less because you think that you can get a higher return than you probably will.

Which leads me into the second area of disagreement.

Investment advice disagreement #2: Continuing to be invested completely in stocks in retirement

Once you retire, you’re basically trading sources of income from wages to money produced by the assets you’ve saved up and invested in. While some of you may plan on working part-time in retirement, it’s quite possible to expect that you may not be able to work once you’re in retirement. Furthermore, as you age, the probability that you can get back to work declines, both because of mental and physical frailties and because the absence from the workforce will make it increasingly difficult to get a job.

Thus, unless you’re the rare person who will work until age 103 and die at the desk, you’re going to have to rely on your nest egg and Social Security to support you. In most cases, Social Security will not be sufficient to allow you to maintain the lifestyle you had during your working years (and hopefully, many of you will be able to retire before Social Security starts), so you’re going to need an additional source of income.

That income will come from your assets.

Now, it’s possible that you may never need to purchase bonds in retirement, butyou will need some source of income. Relying solely on the dividends and capital gains provided by stocks is an extremely risky way of doing so unless your asset base and the dividends it produces far exceed your income needs.

It’s not wise to go completely in the other direction, either, and dump everything you have into CDs. If you choose that route, while you won’t lose money, you willlose purchasing power. Ultra-safe, income-generating investments like CDs and money markets do not beat inflation. This means that, over time, what you can buy for your money will decrease. Given that the biggest increase in expenses and the biggest inflationary cost in retirement is healthcare, this failure to match or beat inflation will mean that when you need more money to cover declining health or long term care, you won’t have the financial wherewithal to afford the care that you need.

That’s why I generally suggest that people aim to have 110 – age as a percentage of the portfolio to keep in equities and the remainder in income generating assets. If you are retired and have all of your investments in equities and the market tanks, then you’re going to be faced with a double whammy of a shrunken nest egg and having to withdraw from it when it’s been hit. Since bonds and equities usually are countercyclical, the impact of a down market year won’t be as bad.

While Dave Ramsey says that you can withdraw 8% per year from your portfolio in retirement based on a 12% rate of return and 4% inflation, the reasoning behind how he gets to that conclusion is where the advice causes me to disagree. First off, as I have pointed out, he uses incorrect calculations in determining 12%, but that’s not really the issue. The issue is that you won’t get 12% (or 15% or 3% or whatever rate of return you want to depend on) every single year. If that was the case, and your returns were steady every single year and at or above the rate of inflation, then you could withdraw the gains and not have to worry about depleting your nest egg.

The problem is that returns aren’t always going to be above the rate of inflation.The way that Dave Ramsey reaches the 8% withdrawal rate is outlined below. His newsletter outlines the example of a hypothetical couple who has saved $1.2 million for retirement.

Now, envision what retirement will look like for you by estimating the income your nest egg will bring. Using the example above, our couple’s $1.2 million will remain invested and growing at the long-term historical average. Estimating inflation at 4% means they can plan to live on an 8% income, or $96,000 a year ($1.2 million x 8% = $96,000).

This plan allows you to live off the growth of your savings rather than depleting it. With careful monitoring and some modest adjustments in years with low returns, you can be confident that your savings will last throughout your retirement.

This hypothetical couple lived off of $50,000 per year. Suddenly, they’re going tojump on the hedonic treadmill and start living on whatever above inflation their investments return.

Unfortunately, they still have minimum living expenses. They lived on $50,000 per year beforehand, and they were saving 15% per year, so their true living expenses were $42,500 per year. Therefore, in down years, they have to still eat and live, meaning that they need to eat into the nest egg to pay for food, shelter, clothing, and transportation.

Although I’m no fan of aftcasting, it is instructional to use historical stock market returns to give you an idea of how often this plan succeeds.

I set forth a couple of rules.

• If the returns exceed the inflation adjusted annual expenses, then spend the returns. Do not deplete the nest egg.
• If the returns do not exceed the inflation adjusted annual expenses, then spend the inflation adjusted annual expenses. Deplete the nest egg only to the extent necessary to meet minimum spending needs.

Using 3% as annual inflation (which would benefit the Ramsey approach, as that requires less money be spent in lean times), if I run the hypothetical retirees through 30 years of retirement for every year since 1926 using actual stock market returns, the retirees run out of money 49.1% of the time.

I don’t want to use a plan which has a slightly better than 50% chance of succeeding.

The reason that academics and practitioners promote 4% (or even less) as a safe withdrawal rate in retirement is that you need to reinvest excess gains in years with strong returns to give yourself enough buffer so that you don’t deplete your assets in years when returns are below the rate of inflation.

An improved solution in this situation is to set up a maximum cap of spending. If we set up an inflation-adjusted cap of $100,000 per year, then the plan has a 93% chance of succeeding.

There’s one problem with creating a solution that has such a broad range of spending. These retirees are going to experience some serious shocks and whiplash in their lifestyles. One year, they’re spending $106,090 and living fast and free, and the next year, they have to slam on the brakes and live on $46,440.90. The constant hedonic adaptation that one must undergo to constantly vacillate between salad and lean years is going to take an enormous psychic cost and will be a very difficult to live within.

The better approach is to work backwards from a retirement spending goal and a much smaller range and adjust it for annual inflation. Then apply a withdrawal rate such that the chances of running out of money before running out of heartbeats is minimal.

Investment advice disagreement #4: Recommending front-loaded mutual funds

On June 4, 2013, Mr. Ramsey invited a Motley Fool staff writer onto his showto discuss an article that was published at the Motley Fool website discrediting Ramsey’s assumed rate of returns. I’ll discuss more about that hour of the episode later, but for this disagreement, I want to pull out a particular piece of the discussion.

The crux of the hour-long dialogue was that Ramsey often quotes 12% as an average annual return, which is close to the S&P 500 average return (discussed in disagreement #1). Ramsey’s retort was that he has found funds which return more than the S&P 500 and have a history of doing so.

He cited two funds: Investment Company of America (AIVSX) and Growth Fund of America (AGTHX). He also encourages people to utilize loaded mutual funds on his website.

Both of the funds he cited have a 5.75% front load.

I’ve previously explained why loads on mutual funds destroy your nest egg. Let’s demonstrate how the 5.75% front load affects the returns for the hypothetical couple that we discussed above. As the example pointed out, this was a couple that made $50,000 per year and invested 15% of their earnings. How would they do with each of these mutual funds after paying a load?

AIVSX

Since the historical data from Yahoo Finance goes back to May 31, 1996, I’ll assume that this family invests 25% of their $7,500 per year, or $1,875 on May 31 of each year (or the first available trading date after May 31). They pay a front load varying from 5.75% down to 4.5% based on the breakpoints for loads in the fund (for which their salesman thanks them), and between $1,767.19 and $1,790.63 goes into the actual mutual fund. They will reinvest dividends and capital gains.

As of June 4, 2013, their investment would be worth $57,079.74. 17 years of contributions totaling $31,875 has gained them $25,204.74 in profit, for a 79.1% return. This is an average return of 4.65%, or an annualized return (CAGR) of 3.49%. They paid $1,818.75 in loads for this privilege.

AGTHX

Since the historical data from Yahoo Finance goes back to February 11, 1993, I’ll assume this family invests 25% of their $7,500 per year, or $1,875 on February 11 of each year (or the first available trading date after May 31). They pay a front load varying from 5.75% down to 4.5% based on the breakpoints for loads in the fund (causing glee in the salesman’s heart), and between $1,767.19 and $1,790.63 goes into the actual mutual fund. They will reinvest dividends and capital gains.

As of June 4, 2013, their portfolio would be worth $100,789.89. 20 years of contributions totaling $37,500 has gained them $63,298.89 in profit, for a 168.8% return. This is an average return of 8.44%, or an annualized return (CAGR) of 5.39%. They paid $2,001.56 in loads for this privilege.

Now, let’s compare how these two investments would perform versus their Vanguard Index counterparts.

VFINX vs AIVSX

The Investment Company of America’s fund invests in blue chip stocks, comparable to the S&P 500. Thus, an appropriate index fund comparison is the Vanguard 500 Index Fund (VFINX).

If the same family had purchased VFINX compared to AIVSX, they would have $57,696.02 as of June 4, 2013. That is $616.28, or 1.08% more.

To break even and erase the effects of the loads on performance, the family would have to contribute $1,999.94 per year, or $21.36 more to that fund.

NAESX vs AGTHX

The Growth Fund of America is a growth fund that invests in smaller capitalization stocks with the intent of gaining appreciation over time as these stocks grow. Thus, an appropriate index fund comparison is the Vanguard Small Cap Index Fund (NAESX).

If the same family had purchased NAESX compared to AGTHX, they would have $113,357.18 as of June 4, 2013. That is $12,558.29, or 12.5% more. To break even and erase the effect of loads and underperformance, the family would have to contribute $2,223.08 per year, or $244.50 more.

In the first case, the loads outweigh the outperformance of the fund. In the second case, even if you took away the load, the fund still underperforms its index counterpart.

Ramsey’s argument for loaded mutual funds is that purchasing a loaded mutual fund keeps you in the market when the market goes down and it prevents you from panic selling. This is an argument we’ve discussed before, but the simple counterargument is the best one.

If you’re taught to properly invest and understand the risks involved in jumping ship when the market declines, you’ll act correctly. It costs a whole lot less to get that training (and a full, comprehensive financial plan while you’re at it) than to rack up thousands of dollars in mutual fund loads.

Investment advice disagreement #5: Disregarding fees in investments

In his book Financial Peace Revisited, Dave Ramsey states the following:

The biggest mistake people make is putting too much emphasis on expenses as a criterion.

As I demonstrated in the above example, for disagreement #4, fees killed the returns in the VFINX versus AFINX horserace. Without fees, AFINX would have been a superior investment, but fees made the Vanguard counterpart a superior investment.

Investment advice disagreement #6: Promoting actively managed mutual funds

I have previously discussed how, in a time when information becomes more and more widespread, luck plays an increasing role in explaining extremes in performance. Since the highest skilled investors are, relatively speaking, only marginally better than the least skilled investors, the remaining differences in performance are generated by luck.

But, let’s say that you poo-poo the notion that you have to be lucky to get outsized returns in the market. Let’s assume that the mathematics are wrong and it doesn’t take up to 64 years to determine if you’re skillful. You can look at the past 20 years of returns, as Ramsey suggests, to determine whether or not you have a winner on your hands.

There are still risks involved in choosing an actively managed fund:

• The manager’s retirement risk. Few people like to continue to work at picking stocks like Warren Buffett does. Even Benjamin Graham retired after a few years. What happens when a fund manager decides to hang up his boots and ride off into the sunset? You now get to start all over with a new fund manager and have to wait another 20 years before determining ifthat manager knows what he or she is doing.
• Tax risk. Actively managed mutual funds, as is implied by the name, trade more often than index funds. Because of the increased trading, the investor must pay short-term and long-term capital gains taxes. If the funds are in a tax-deferred or tax-free retirement account, this is a moot point, but for investments in normal brokerage accounts outside of a tax shelter, this is important and reduces the after-tax returns of these investments.
• Concentration risk. I don’t mean that the manager is going to daydream, but, rather, that you’ll be more concentrated in an actively managed fund when you will be in an index fund. The active manager should, by definition, be picking fewer stocks for the fund than the index counterpart, since he’s supposedly picking the best of the litter. This is great when his bets are right and disastrous when his bets are wrong.

The statistics simply are not on the side of actively managed mutual funds. First off, for the past five years, of all of the different mutual fund categories, active management underperforms the index counterparts in all but one: large-cap value funds, where 50.22% of actively managed funds outperformed their index counterparts. For the other 16 categories, index funds outperformed actively managed funds.

Secondly, even if you pick a high performing fund, there is little assurance that said high-performing fund will continue to do well. If you picked an actively managed mutual fund that was in the top 20% of performance over the previous five years, there was only a 0.18% chance that it would remain in the top 20% of performance over the next five years. If you were a little more lax in the standards and only picked a fund that was in the top half of performance (which would not guarantee that it outperformed its index counterpart) in the previous five years, there was a 4.46% chance that the fund would remain in the top half in the next five years.

The statistics simply are not in your favor if you choose actively managed funds and are investing for the long term; it is more likely than not that you will choose funds which underperform their index counterparts.

In the previously discussed June 4, 2013 show, Dave Ramsey categorized people who questioned his advice as one of two types of people:

• Bitter people who say that they can’t win and they can’t be millionaires. I daresay that any casual reading of my body of work will disprove both of those notions.
• Financial nerds who analyze and analyze (his emphasis, not mine) everything to the nth degree and don’t learn about what Dave Ramsey teaches. I’ve gone through the Financial Peace University course, read The Total Money Makeover, and listened to hundreds of his podcasts. I understand his advice, quoted his website (which he, in the show, admitted he doesn’t read everything which gets published there), and have applied analytical rigor to what he teaches. He also says that those financial nerds don’t have a business and are bored. I have a business, serve my readers, and am far from bored (oh, and I already built and sold another business). I just want people to get proper guidance, regardless of the source.

Dave Ramsey’s biggest argument during the discussion was “If they [his listeners and readers] follow all of my advice, they are not being harmed.” That is true. They should not be harmed, although his advice for withdrawing funds during retirement could be harmful for retirees; however, just because someone isn’t harmed doesn’t mean that the person can’t do better.

The lesson of all of this is to apply a critical eye to everything you hear or read. Just because information comes from a “guru” or from a website you like doesn’t mean it’s always going to be right. Don’t take things at face value. Think. Question. Ask yourself how something could go wrong. Determine what would happen to you if the assumptions you make about future outcomes don’t work the way you planned. Have a backup plan and a backup plan after that. Don’t just take it on blind faith that because someone told you that something would work a certain way that it well when it comes to planning for your retirement. Make sure that you understand what information and assumptions are being used to make your plan and how those affect the outcome.

Then, you might have financial peace.

What do you think? Am I wrong in disagreeing with the points that I do? Do you agree with him on those points? If so, why? What other advice, if any, do you disagree with? Let’s talk about it in the comments!

2017 Consulting Fees Study

We recently asked over 25,000 consultants about their approach to pricing and fees as part of our 2017 Consulting Fees Study.

Below you’ll find the results from our survey as well as my commentary and observations.

Pricing Structure

The most common pricing structure and approach for consultants is project based pricing.

However, when you combine hourly rate and daily rate pricing (both are often, but not always, driven by number of hours involved) the ‘Hourly’ driven approach has the majority at 41.3%.

Consulting fees based on a monthly retainer equal 15.1% of the total.

Average Project Value

43% of consultants who participated in the survey earn $5000 or less per project.

About 15% earn $5,000 to $10,000 per project.

13% of consultants earn between $10,000 and $20,000 per project.

13.9% of consultants charge on average between $20,000 and $50,000 per project.

8% of respondents charge $50,000 or so per consulting engagement and about 6% charge over $100,000 per project.

A whopping 80% of consultants would like to earn higher fees. While about 20% are happy with that they are currently making as a consultant.

Annual Consulting Income

The chart represents monthly income.

Almost 50% of all consultants who responded to this survey are earning less than $60,000 per year as a consultant.

However, 22% earn up to $120,000 per year and 20% earn up to $240,000 per year.

A minority of this group currently earns between $300,000 and $1.2M or more per year.

Consulting Profit Margin

54% of consultants run a high margin and usually very profitable consulting business and enjoy a 60% or greater margin.

The largest single majority, at 25.5%, enjoy an 80% margin or better. Few businesses have such a great margin.

About 22% of consultants run their consulting business at a 30% or lower margin.

Consulting Experience

23.7% of consultants have been consulting for over a decade. 35% or so have been consultants for over 7 years.

Close to 40% are new to consulting and have been consultants for less than two years.

Location of Consultants

A large majority, almost 60% of all respondents are based in North America.

While Europe, Asia and Africa being the next largest with about 33% collectively.

Deeper Insights

The next thing I did was look deeper into the data and cross-reference different categories. Here are some additional insights for you.

Consultants earning over $20,000/mo are split almost equally between project based fees and hourly and daily rate pricing structure. This is the same for consultants earning $10,000/mo or less. On question we’ll look at in a further study is “The intensity and number of hours worked to generate a certain level of income.” I believe we’ll see consultants using a project based fee approach will conduct their work with more freedom, flexibility and less time intensity.

While consultants who try to figure everything out themselves and don’t take the time to really learn how to grow their business the right way or are not committed to consistently implementing are the ones that struggle.

Another interesting finding is that many consultants are earning well into six-figures in their first 1-2 years as consultants. And this study showed that there are plenty of consultants who have been consulting for over 10 years and yet still struggle to create a high-level of income.

Why?

My observation from coaching and working with hundreds of consultants is that those that focus on their marketing and have a clear plan of action are the ones who most often reach six-figures, then into mid-six figures and then create million dollar consulting businesses – and this can happen quickly.

While consultants who try to figure everything out themselves and don’t take the time to really learn how to grow their business the right way or are not committed to consistently implementing are the ones that struggle.

The consulting industry continues to grow as we see the number of consultants who are new remains strong.