The Alternative to AUM-Based Fees: The Total Profitability Retainer Formula

Bob Veres

Three weeks ago, in this space, I made the case that a lot of advisors – perhaps most – are deliberately charging less than the market will bear for their services.  I'm pretty sure this is not what Adam Smith envisioned when he wrote about the "invisible hand" of capitalism.

But behind that profession-wide anomaly lies another perplexing peculiarity that may be equally pervasive.  Many – perhaps most – advisors are overcharging a few of their clients and undercharging the rest.  In other words, a small number of investment advisor clients are subsidizing the services that the others are receiving. 

Consider what that means for a moment! Most investment advisory clients are being served unprofitably – and the disparity seems to be greatest when the advisor is also providing financial planning services.

Try this experiment

To see if your practice fits this description, try a simple experiment.  Boot up a spreadsheet, and have somebody type in the names of each of your clients in the left-hand "A" column going down the page.  Then have somebody look up the total fees each of these people paid you last year, from all sources.  For most of you, this will be their annual AUM fees, plus perhaps a project fee for any planning work you might have done.  For those of you who earn commissions, put those into the calculation.  Tote it all up, and put that aggregate amount each client is paying you in the "B" column going down.

Now calculate your total office overhead last year, minus professional salaries – that is, the annual rent, the yearly cost of your computers and software, supplies, phone, salaries plus benefits of all your clerical employees, etc.  Divide that total cost figure by the number of clients you have, and put that dollar figure – it should be the same for every client – in the "C" column.

Finally, calculate your compensation (I would leave out dividends the company is paying you, but include any bonus you earned plus the cost of any benefits you receive from the company) and the total compensation of your professional staff members.  Then look at your client list.  Are any of your clients using up more of your time, and/or your professional staff's time, than the others?  Chances are, the answer is yes; you have a whiny client who calls every time the market goes down half a percent or more, and another client who always seems to be going through a crisis, and yet another client who asks you for a lot of charitable planning work – and so forth.  Assign these clients a proportionately higher percentage of your professional costs (this is the creative part of the exercise), and identify a few clients who take up no professional time whatsoever.  (Are they still living?)  In the "D" column of your spreadsheet, assign variable professional costs to your different clients.