The Future of Financial Planning Advice, Part 1

These views are misguided.

The flaws in their arguments are attributable to a difference of opinion regarding structural nuances of the financial planning business and to an analysis that fails to incorporate the economic incentives that exist in all compensation models. My previous authorship includes a 2006 Journal of Financial Planning paper, Who’s the Fairest of Them All? – A Comparative Analysis of Financial Advisor Compensation Models, and a 2017 Advisor Perspectives commentary, Why the Future is Bright for AUM -Based Advisors.

I am writing specifically about compensation models for the subset of financial advisors whose business models emphasize comprehensive financial planning. I am not commenting on the outlook for purely commission-based brokerage reps or insurance agents, or for investment adviser reps (IARs) who provide only portfolio management guidance. In Part 1 of this article, I introduce several significant but often overlooked structural/conceptual nuances that influence compensation model choice. In Part 2, I break down what I perceive to be flaws in the thought leaders’ thinking. I conclude with my alternative vision of how financial planner compensation should evolve.

Overlooked industry nuances

Brokerage and insurance licenses are often necessary for financial planning

While outside observers often suggest that financial planners should drop their securities and insurance licenses so that they may act exclusively in a fiduciary capacity when providing advice rather than wearing “two hats” (commission-based securities/insurance salesman and fiduciary adviser), this position is naïve. From a purely legal/regulatory position, once the advisor dons the “financial planner” moniker, they are automatically deemed to be wearing the fiduciary hat at all times. Per SEC Interpretive Release 1092 – Applicability of the Investment Advisers Act to Financial Planners, all advisors who hold themselves out as financial planners and whose service model includes guidance pertaining to securities are regulated by the SEC under the Investment Advisers Act of 1940 and are held to a fiduciary standard of conduct. Not having securities and brokerage licenses limits the financial planner’s ability to serve their clients’ best interests. For example, I routinely do flat fee-consulting for retirees seeking guidance in the face of premium increases on their long-term care insurance policies. I almost always have clients authorize making me the agent of record on the policies so that I can interact directly with the insurance companies on their behalf. No remuneration is paid for serving in this capacity, but it dramatically improves the efficiency of the planning process. Of course, an insurance license is required. As another example, there is a rapidly growing universe of fee-only insurance products. However, even though the financial planner receives no commissions from the sale, they are still required to have an insurance license.

With respect to needing brokerage licenses, for AUM-based financial planners, brokerage accounts may be used in conjunction with advisory accounts to reduce client fees. For example, I sometimes establish a separate brokerage account that is not subject to an asset-based fee to purchase and hold clients’ CDs and/or Treasury bills or to manage client corporate cash. Another example is the establishment of a separate brokerage account for a client with a substantial long-held position in their employer stock. It may be difficult to justify charging the client an AUM fee on an asset that requires little ongoing management. There are many similar examples of how a financial planner holding an insurance license and a securities license can offer services and value that a pure IAR-only financial planner cannot.

As a practical matter, there are also logistical challenges that prevent financial planners from dropping their insurance and brokerage licenses for the purpose of transitioning to a pure fiduciary model. For instance, each year I receive significant trailing commission revenue from variable annuity contracts with living benefit riders that I wrote for clients between 2002 and 2009. From a purely self-interested perspective, it would be foolish for me to walk away from these contracts. Dropping my brokerage license would provide no cost savings to my clients as the trail commissions would merely be reassigned to another licensed financial advisor. I would also no longer receive statement copies and would not be able to communicate with the insurance companies on their behalf.

AUM billing has a unique structural advantage

One important element of AUM billing that is overlooked in discussions of the relative merits of different compensation models is the fact that the IRS permits the payment of investment advisory fees from pre-tax accounts (e.g., IRAs and qualified plans). In contrast, hourly, flat-fee, and subscription fees for financial planning guidance must be paid from taxable accounts. To the extent that AUM-based financial planners include comprehensive financial planning with investment advisory fees, the ability to pay for services with pre-tax dollars represents a potential cost advantage. This advantage was even greater prior to the Tax Cuts and Jobs Act, when investment advisory (along with tax preparation fees) were deductible expenses. Flat-fees and hourly fees for financial planning have never been deductible and paying such fees from qualified plan accounts would be considered a taxable distribution by the IRS. [See Maximizing The Pre-Tax Treatment Of Investment Advisory Fees After TCJA (Kitces.com)]

Although the IRS requires investment advisory fees to be paid proportionately from taxable and pre-tax accounts, as noted above, artfully allocating client assets between taxable brokerage accounts and investment advisory IRAs may, in certain circumstances, allow the AUM fee to be entirely paid from pre-tax money. For instance, if a client has $500,000 in taxable investments and $500,000 in an IRA and the financial planner negotiates a .5% annual AUM fee, it may be in the client’s interest to allocate $500,000 to a taxable brokerage account with no or nominal advisory fees/trading costs and apply a 1% AUM fee to the $500,000 IRA so that the entire planning fee can be paid with pre-tax funds.

The rise of the tiered-AUM model

A common criticism of the AUM model is that it charges affluent clients more for the same service and advice as clients with smaller portfolios. To recount a common refrain I hear, a 1% AUM fee for a client with $500,000 costs $5,000 per year in AUM fees, whereas a client with $5,000,000 pays $50,000 per year for essentially the same financial planning services. The inequity of the level-AUM fee is a structural flaw that is difficult to dismiss. However, while the level-fee model undeniably persists, for many years there has been a shift by financial players toward tiered-AUM pricing models that effectively becomes a flat fee at a certain asset level. Below is my Financial Planning Hawaii AUM pricing schedule. I implemented this structure more than a decade ago, and do not consider myself an early adopter.

Hourly billing has a unique and potentially fatal structural flaw

Hourly billing is the only compensation model that creates a disincentive for the client to take time to share important financial planning background information with the financial planner. This is less of an issue in the legal and accounting professions, but in financial planning, information gathering is the most time consuming and arguably most important element of the planning process. Bob Veres’ “Don’t fear the meter” article featured an interview with Mark Berg and Matthew Jackson, whose book, A Matter of Time, is a treatise on the merits of hourly billing. When this issue cropped up in Bob’s interview, Berg suggested that this limitation may be considered an advantage rather than a drawback, because it “self-regulates” the client’s interactions with the advisor. In other words, it makes the model more profitable for the advisor because it disincentives clients from taking up the planner’s time. The potential impact of the disincentive for clients to share their complete financial planning picture should not be discounted. It should be also viewed as a conflict of interest that should be disclosed in the planners’ ADV. This conflict does not exist in any other financial planning compensation model.

Behavioral finance suggests that consumers have an inherent aversion to the fee-only billing models

Regardless of where one stands on the advisor compensation model debate, direct-billed hourly, flat-fee, and subscription fees may be viewed as less desirable to consumers than fees that are automatically deducted from the client accounts. This general concept was highlighted in a widely-cited 2005 Journal of Finance paper, Out of sight, Out of Mind, The Effects of Expenses on Mutual Fund Flows. In it, the authors observed that consumers preferred B-share to A-share mutual funds due to an aversion to the salient, “in-your-face” charges of A-shares. The authors noted that the same concept applies to any payment model that involves the consumer proactively paying an invoice as opposed to having the expense directly taken from an account. To the extent that hourly, flat-fee, and subscription fees can be set up for automatic bill-pay, this structural disadvantage may be overcome.

However, a related challenge for hourly, retainer, and subscription-based financial planners, particularly those whose practice models are decoupled from ongoing direct portfolio management, is that, for better or worse, consumers often perceive portfolio management to be the most important element of a comprehensive financial planning arrangement. From the consumer’s vantage point, the ongoing investment advisory element makes the deliverable more tangible and the recurring fees more palatable. A common lament among ongoing flat-fee and subscription-based advisors is that clients sometimes have trouble seeing the value they are receiving for their regular payments. This is not insurmountable, but the idea of bundling financial planning guidance with investment advisory services may be viewed as a subtle competitive marketing advantage of the AUM model over fee-only models that bundle (or don’t bundle) investment management with ongoing planning fees.

Similarly, clients like the idea that the financial planner gets paid more if the account values rise and less when the portfolio declines. Anecdotal support for this position may be found in Fisher Investments’ irrepressible and seemingly ubiquitous We do better when our clients do better television advertising campaign. Most AP readers will recognize that this is a straw man argument and that such an approach may bias the financial planner toward being overly aggressive in portfolio allocation decisions. However, as Fisher’s multi-million dollar advertising wager suggests, consumers may naively favor that AUM-paradigm. This structural nuance is expressly not offered as a defense of the AUM model, but it may explain why consumers have been slower than the thought leaders predicted to abandon AUM pricing and adopt models that involve separately invoiced fees.

Fee-only planning takes many forms

Sara Grillo’s AP article, “The price advisors will pay for ignoring flat fees,” features an interview with up-and-coming fee-only financial planner Andy Panko, owner/founder of Tenon Financial. Andy built his practice from scratch to approximately $50 million in assets in just over five years. His practice features comprehensive financial planning including tax return prep and discretionary portfolio management using TD Ameritrade Institutional for custodial services. He intentionally plans to limit his client base to around 50 clients who pay a recurring flat fee of $10,000 per year. Because has less than $100 million in assets at TD, his RIA is regulated by New Jersey’s state securities commissioner. His business is supported through his membership in XY Planning Network, which provides many of the same support functions (e.g., compliance/audit assistance, E/O coverage, tech stack, etc.) as a typical independent B-D/RIA. There is little not to admire about Andy and the way he has developed his practice.

However, a point that is overlooked and that may explain why their predictions of the rise of hourly, flat-fee, and subscription-based planning continue to fall “flat” is that only a small percentage of financial planners start from scratch and survive to profitability. Most of the rapid growth in the number of independent financial planners in the past two decades has been and continues to be fueled by the migration of financial advisors away from the wirehouse brokerage firms. Many of these (including me) have made the transition to gain greater autonomy over our practices and to provide more objective comprehensive financial planning guidance to our clients. However, to the extent that most of these planners have built their practices in the hybrid B-D/RIA/Insurance wirehouse ecosystem, the transition to the pure fee-only model idealized by the thought leaders is far more complex than it is for the new planners, such as Andy, who start with a blank canvas. It is for this reason that many financial planners from the wirehouse world elect to piggyback on the B-Ds and RIAs of large independent firms instead of setting up their own RIAs.

Using my own firm again as an example, I willingly pay an 8 basis-point AUM fee to my “parent” RIA, JW Cole Advisors. This works out to approximately $200,000 per year. From my perspective, it is worth it to me to be able to outsource the chief compliance officer function. This basic platform fee structure tends to encourage the financial planner to maintain the AUM billing model. In my practice, the average client AUM fee is .5-.6% out of which 8 basis points goes to the platform fee.

Additionally, as noted previously, the legacy structure of my business requires me to maintain brokerage and insurance licenses to continue to service clients. Thus, in order to offer the same flat-fee, subscription, and (rarely) hourly billing options as pure RIA financial planners like Andy do, I have my own separate Hawaii-registered RIA that offers comprehensive financial planning guidance that includes investment advice but is decoupled from ongoing portfolio management. Because clients who choose this portfolio model direct their own portfolios through the custodian of their choice, our state-registered RIA has no AUM and is very simple to maintain over time.

There are tens of thousands of hybrid-model financial planners like me and only a comparative handful like Andy. XYPN is the largest network of independent financial planners with only around 1,000 members – and even the majority of those advisors employ AUM-based pricing. As it says on the XPYN membership page, “There is nothing wrong with offsetting planning fees with AUM.”

Even within the flat-fee ranks there are important nuances. Some planners, such as Andy, operate as discretionary portfolio managers, while others, like me, involve the client in every investment decision. Still other financial planners commoditize portfolio management by adopting turnkey asset management platforms (TAMPs).

Business structures are highly variable even among fee-only models and the transition to an idealized financial planning RIA vision is more complex and nuanced than many thought leaders suggest. In part 2, I will explain how the three common themes advanced by the thought leaders are flawed and I will present an alternative vision for how financial planner compensation will evolve over time.

John H. Robinson is the owner/founder of Financial Planning Hawaii, Fee-Only Planning Hawaii, and Paraplanning Hawaii, and is a co-founder of software-maker Nest Egg Guru.

Read more articles by John H. Robinson