The Future of Financial Planning Advice, Part 2

Misconception #1: Financial planning cannot become a profession until it abandons commissions and asset-based fees and migrates to hourly fees like other true professions

To quote from Bob Veres’ recent article,

“All other professions charge by the hour. Hourly fees are the revenue that other professions gravitate to eventually…Is it possible that, as the planning profession matures, all planners will eventually follow the same path that every other profession has followed, and charge on an hourly basis for the advice they give – like lawyers, tax professionals and accountants.”

This reasoning is flawed on many levels. Lawyers offer multiple compensation models including hourly, retainer, and contingency with several other “cost-plus” variations. Similarly, many CPAs bill on a flat fee-basis rather than hourly. - Most medical professionals (e.g., physicians, dentists, veterinarians) charge some version of a flat rate that is not disclosed up front and that often vary from person to person and defies explanation (“That’s what the insurance company allows” is a common explanatory refrain). Simply put, hourly billing is clearly not a prerequisite for an industry to be regarded as a true profession. Further as I will discuss in a moment, there is scant evidence that consumers celebrate the pricing models of any of these professions.

The converse of Veres’ position – that no other profession charges commissions or asset-based fees is equally flawed. The contingency billing model in the legal system contains the same conflicts of interest as the AUM model insofar as the law firms have an incentive to only accept contingency cases they are highly certain they can win. They have an inherent interest to settle rather than fighting for the clients’ desired full amount.

What makes financial planning fundamentally different from service professions such as law, accounting, and medicine is that it involves advice pertaining to specific products (i.e., securities and insurance). Yes, I am aware that some financial planner compensation models do not involve the planner receiving compensation for the sale of such products. But all financial planning compensation models entail payment for advice pertaining to securities and insurance products and that makes them subject to regulatory oversight – FINRA and the SEC for securities, NASA for insurance products, the DOL for retirement accounts, etc. While each of the three thought leaders points to the prevalence of commissions and AUM fees as the primary barrier preventing financial planning from operating independently as a self-governing profession, I believe the fundamental need for regulatory oversight is what distinguishes financial planning from pure professional service organizations such as the ABA, AICPA, and AMA.

Misconception #2: Commissions and asset-based compensation are hopelessly conflicted. Hourly and flat-fee/subscription-based compensation are better for clients because they are free from such conflicts.

The above-referenced articles advance the false narrative that the latter three models are ethically superior to the former two. According to Dan Solin, the AUM model is headed to extinction because it inherently contains pervasive, non-transparent conflicts of interest. Says Grillo, flat-fee financial planning “is the most transparent and fairest way to work with clients.” While the conflicts of interest in the commission and AUM models may be more obvious, the suggestion that the other models are conflict-free or even less conflicted fails to acknowledge Adam Smith’s invisible hand. To borrow a quote from the early 2000s best-selling book, Freakonomics, “Morality, it could be argued, represents the way that people would like the world to work, whereas economics represents how it actually does work.”

As the American Bar Association matter-of-factly states in its welcome package to new attorneys, “There is an inherent conflict of interest in every attorney-client relationship – it’s called attorney’s fees.” The financial planning industry is no different. With respect to flat-fees (retainers in the legal profession), the ABA cautions, “A lawyer on a fixed fee has an economic incentive not to take that extra deposition – the lawyer gets the savings.” The exact same principle applies to financial planners who work for a flat fee. If a financial plan is taking more work than anticipated to finish, the flat-fee planner has an incentive to wrap it up as quickly as possible.

With respect to hourly billing, I am always baffled when thought leaders hold out attorneys as the ideal model for financial planners to follow. Veres does this in his Don’t Fear the Meter article. One does not need to cast a metaphorical rock very far on Google Search to find a slew of articles pillorying the legal profession for its conflicted hourly billing practices. Here are four examples I included in my 2017 Advisor Perspectives article, “Why the Future is Bright for AUM -Based Advisors”:

The Inherent Client Conflict of Interest Caused by Hours-Based Billing – Legal Executive Interest
The Conflicted Billable Hour – Lexis Nexis Legal Newsroom
The Tyranny of the Billable Hour – New York Times
Suit Offers a Peek at the Practice of Inflating a Legal Bill – New York Times

In my 2017 AP article, I also raised awareness of the subtler ethical conundrum presented by hourly billing that applies to both the legal profession and financial planning – the issue “value-billing.” As I explained, it might take a planner 20 hours to write a financial plan from scratch, but because he or she has created many plans over the years, that advisor may develop time-saving templates or adopt new technology that may reduce the preparation time down to, say, five hours. Should the advisor now bill 20 hours or only five? Value billing and other subtle conflicts related to hourly billing were discussed in a March 2022 article in National Law Review, “Lawyer Billing Ethics: Billing Tips for New Lawyers.”

The conflicts presented by "heavy pencils" and "value billing" are well documented in the legal profession and map to financial planning as well. One could even go a step further to say that hourly billing is analogous to opaque commissions on the sale of insurance products in terms of lack of transparency. As a practical matter, the work done through hourly billing is opaque. The client has no idea how many hours they will be billed or if the hours billed were worked. Here is an article from the legal profession that highlights this problem – Bailout Watchdog Questions All $5.8 Million of Simpson Thacher’s Legal Fees. In applying this concept to our industry, if the financial planner bills a client for two hours of work reviewing tax returns, the client has no way of knowing if the planner spent that time or they merely ran the clients’ returns through Holistiplan in five minutes.

Misconception #3 Commission and AUM-based models are headed for extinction and financial planners who fail to adapt to this new reality will go out of business.

Veres and Solin have been positing this for years, but the commission-based and AUM-based models are still dominant. However, that does not mean the business of financial planning has not evolved. It has – just not in the manner that thought leaders have predicted. There has indeed been a paradigm shift over the past quarter century away from product sales and toward financial planning. This is evidenced by:

• The mass migration of financial advisors away from wirehouse brokerage firms to independent RIAs;
• The explosive growth in the number of small RIAs; and
• A sharp reduction in the number of FINRA-member brokerage firms from more than 5,000 in the early 2000s to fewer than 3,500 by 2020 (Source: FINRA.org).

Similarly, the number of financial advisors who have adopted the financial planning moniker by obtaining CFP certification has soared from fewer than 50,000 in the U.S. in the early 2000s to more than 90,000 today.

Among the factors confounding the thought leaders’ prediction has been the fact the CFP Board has embraced insurance and brokerage industry firms’ efforts to have their respective sales forces obtain the marks to lend credibility to those firms’ product distribution efforts. This trend was highlighted earlier this month by Michael Kitces’ in a Nerd’s Eye View blog post, “Will CFP Board’s Fee Increase Fund Product Sales Instead.” It is my understanding that the majority of newly minted CFPs each year go to work for either wirehouse brokerage firms or insurance companies.

As I outlined in Part 1, there are other structural and business factors that limit financial planners’ ability to entirely move away from commission and asset-based compensation models as well. To their great credit, Solin, Veres and Grillo have done much to raise awareness of the structural flaw and inequity in level-AUM fees. However, as noted, rather than spurring abandonment of the AUM concept, there seems to be a broad shift afoot toward tiered-AUM pricing instead.

At the end of the day, the thought leaders’ persistent prediction that the end is nigh for commission and AUM billing is reminiscent of a New York Times article boldly foretelling the end of the scourge of the practice of hourly billing in the legal profession. The article, Revolution in Lawyers' Fees: The Meter Is Being Shut Off, appeared in the Times in October 1993 (long before the adoption of billing in six-minute increments).

Conclusion

In this two-part article, I have presented a case for how three prominent financial planning thought leaders whom I greatly admire have been promulgating an inaccurate view of the mechanics and evolution of financial planner compensation models. In doing so, I have tried to demonstrate how their thinking results from misreading of industry structural nuances and from taking a moralistic view instead of an economics-driven view that incorporates and acknowledges the inherent conflicts of interest and incentives in all pricing models.

But there is one overarching theme in their approach that I have not mentioned with which I respectfully disagree – the implicit assumption that all three make that there is a single type of compensation model that is superior, and that financial planning must inexorably march forward toward that singular ideal. In this discussion, I hope I have clearly presented and supported an alternative archetype in which financial planners instead offer the complete range of compensation models.

Although my thinking has evolved along with the profession since my original 2006 Journal of Financial Planning paper on this topic, my broad conclusion remains unchanged – that the best financial planning practice model from the client’s perspective is one that offers a choice of different compensation structures paired with clear, plain-English, up-front disclosure of all compensation and potential conflicts of interest. The financial planner should be a fiduciary under the Investment Advisers Act of 1940 at all times and should also hold securities and insurance licenses.

Another important myth I hope I have dispelled is the notion that advisor compensation structure is a key factor that is preventing the advancement of the financial planning business from an industry to a true profession. I do, however, agree with many industry thought leaders that financial planning today falls well short of meeting such a standard. Those who may have read some of my previous commentaries in Advisor Perspectives are likely aware that I vehemently oppose the efforts of the CFP Board of Standards to become the de facto regulator of the profession by making the CFP mark a requirement for all financial planners. In fact, I have openly rebuked the Board for consistently putting its financial and political interest above those of consumers. It does so by fomenting consumer regulatory confusion and by setting consumers up to be victimized by spending millions of dollars in advertising campaigns promoting all CFPs as “thoroughly vetted” and trustworthy while simultaneously turning a blind eye to thousands of rogue members within its membership ranks. Beyond that, I tend to favor breaking off financial planning as a separate self-regulated industry under the SEC much in much the same way that FINRA operates as a self-regulatory agency for the brokerage industry. However, the political and regulatory machinations that are required to achieve that objective are formidable. Although that change would bring financial planning a giant leap closer to becoming a profession akin to law, accounting, and medicine, it is unclear when, if ever, that will happen.

Epilogue: – Evolution is messy -A future model for financial planner compensation

To give readers an idea of how a financial planning practice might operate when its service platform includes the full spectrum of pricing models, I offer my own business as an example. By no means do I suggest that my financial planning business and/or compensation structure is ideal, but rather I offer it to support the theme of this article by illustrating how it arose out of circumstance and necessity.

Service model and pricing

My firm is Financial Planning Hawaii, and its business model features comprehensive financial planning advice to individual consumers and families. Our target is the mid-market affluent segment. A number of our clients are small business owners and professionals, but our clients are diverse occupationally, demographically, and geographically. Many of our clients are retirees, but we strive to foster multi-generational client relationships. As stated in our client services agreement, our comprehensive financial planning service model encompasses tax planning and portfolio optimization, retirement saving and spending analysis, education planning and funding strategies, Social Security planning and optimization, estate planning document reviews and implementation, beneficiary designation and asset registration reviews and document management, insurance risk management reviews, employ benefits reviews, IRA/Roth IRA and qualified plan review and selection guidance, and more.

We offer two primary pricing models. For clients seeking guidance that includes ongoing portfolio management, we apply the tiered asset-based pricing structure presented in Part 1 of this series. Portfolio management is non-discretionary because we want our clients engaged in and educated about the portfolio management process. For clients seeking comprehensive planning guidance that includes a review of their current investment strategy but is decoupled from ongoing portfolio management, we offer flat-fee planning. The fees are negotiated in advance and vary depending upon projected time and complexity. The typical fee is $3,000 – $5,000. The reviews are usually one-time engagements, but clients are welcome to meet with us either on an ad hoc or regular review basis for a negotiated fee. We are agnostic with respect to the client decision between the AUM versus flat-fee models.

We use eMoney for our financial planning platform. eMoney is included for free in our tiered-AUM model and is available for a monthly subscription fee in our flat-fee model. AUM clients access our platform and services through the Financial Planning Hawaii website while flat-fee clients are directed to our Fee-Only Planning Hawaii website. While we tend to eschew hourly billing due to the information gathering disincentive, we have recently begun offering an hourly billing option in addition to the flat-fee and AUM model pricing models for clients seeking labor-intensive tasks such as budgeting and manual entry of securities portfolios that fall outside of our usual scope of service. As discussed in Part 1, we occasionally offer a brokerage account(s) as a courtesy or value-added service to pair with clients’ AUM accounts. We do very little new commission-based brokerage or insurance business, but on rare occasions when we do, the dollar amount of commission is disclosed to the client up front, regardless of whether the commission is transparent or opaque. In this manner, Financial Planning Hawaii’s practice incorporates all forms of planner compensation.

Logistics – evolution out of necessity

Financial Planning Hawaii’s origin began with my decision to leave the wirehouse environment after 21 years (A.G. Edwards then Smith Barney/Citigroup then Wachovia/Wells Fargo) to become an independent financial planner. The decision was motivated by a desire for greater entrepreneurial freedom, to gain autonomy over my client base, and to institute my vision of comprehensive financial planning guidance instead of the constrained, scripted advice model pushed by the wirehouses. In 2010, I established Financial Planning Hawaii as a Hawaii C-corp.

However, while the move to independence garnered ownership of the client relationships, both the amount of variable annuity trail revenue and several clients who maintain brokerage accounts paired with advisory accounts necessitated establishing a “parent” B-D/RIA affiliation. In my capacity as a financial planner, I operate as an investment adviser representative under J.W. Cole Advisors’ SEC- registered RIA. I also maintain my brokerage registered representative and branch manager’s licenses (Series 3, 7, 9, and 10) with J.W. Cole Financial along with a state of Hawaii insurance license. The independent affiliation with J.W. Cole allows me to use Financial Planning Hawaii as a D/B/A name. A few years after setting up shop, I also established Financial Planning Hawaii as a state of Hawaii RIA using my Series 24 to serve as the requisite Registered Principal to offer flat-fee financial planning guidance.

While I am pleased with the way my business has evolved from investment brokerage sales to true comprehensive financial planning, the structural changes to the business model arose more out of necessity than design, which is why Financial Planning Hawaii’s practice structure is decidedly more complicated and messier than Andy Panko’s sleek, efficient, and eminently well-conceived fee-only practice I described in Part 1. Of course, a central part of my thesis is that as much as the three thought leaders (and I) may admire Andy’s practice model, for the thousands of hybrid registered financial planners who transition to independence each year, his model is next to impossible to replicate. As a New England farmer once quipped to a lost couple who stopped him to ask for driving directions, “You can’t get there from here.”

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.

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