(Refiles to fix dropped letter in Osborne’s name in final paragraph.)
By Robyn Post
Jan 9 (Reuters) - Financial adviser James Osborne had an “aha!” moment when a client discovered that his single largest expense was the $40,000 asset management fee on his $5 million portfolio, even though the man had two houses, a boat and an upscale travel habit.
When Osborne figured out that he had spent only 30 hours on the client’s portfolio, he thought it was excessive, too.
At the time, Osborne’s firm charged clients a percentage of the investments they managed for them - a common pricing structure for investment advisers, typically averaging about 1 percent of assets under management (AUM) annually.
But he thought there might be a better way.
“It didn’t make sense to charge by portfolio size when for most clients, our work wasn’t related to their portfolio, but in helping them with charitable giving, tax planning, paying for college and wealth transfers,” says Osborne.
So when the Lakewood, Colorado adviser opened his own firm two years ago, he chose to charge clients a flat yearly retainer of $4,500 for all financial planning and portfolio management services - an uncommon practice for advisers. He says that after a year of operating on a retainer basis, he has broadened his client base without working harder or sacrificing his own income.
Though the AUM model may stick around for some time, the rise in passive investing through index funds and exchange traded funds has more advisers questioning its appropriateness, said John Anderson, a consultant for SEI Advisor Network in Oaks, Pennsylvania.
It’s hard to argue for charging 1 percent of a portfolio that is mainly invested in inexpensive funds that take only a small amount of time to select, he said. That AUM model works better for advisers who are selecting individual stocks or actively trying to outperform the market.
Furthermore, more investors may question high asset-based fees if the market turns south and their portfolios lose money or stay flat for an extended period, says Dennis Stearns, a Greensboro, North Carolina-based advisor, whose pricing is a hybrid AUM and retainer for clients with substantial planning needs. With a retainer, your revenue isn’t tied to the market which is out of your control, he said.
Advisers using a retainer model still make up a very small percentage of all financial advisers, said Ed Gjertsen II, a Northfield, Illinois, planner and president of the Financial Planning Association. The value of financial advice can at times far exceed that of investment advice, he said, so it makes sense to separate investment management and advisory fees.
David Canter, executive vice president for Fidelity Institutional Wealth Services, says he’s seeing retainers becoming more common among firms that provide planning services to high net worth and ultra high net worth clients. Often they call it a “counseling fee,” and may charge a separate fee for portfolio construction. Most have the ability to operate using both the retainer and AUM pricing and offer the choice to clients, he says.
Carolyn McClanahan switched from AUM pricing to a yearly retainer in 2004 when she found that she was doing a lot of work for little pay with her client base of young physicians (she is also a physician herself), who typically had meager savings in 403(b) plans.
The Jacksonville, Florida-based adviser began charging clients an annual fee tailored to the their needs, starting with a $5,000 minimum and building the fee in $1,000 increments based on how many accounts, trusts and tax returns they had, as well as other activities that might be time-consuming, like monitoring defined benefit plans or building bond ladders.
“Four million in an individual retirement account can be easy compared to tax planning and rebalancing on several accounts,” she says.
McClanahan says her profitability and total revenue are competitive with assets-under-management firms. Her 73 client families pay between $5,000 and $40,000 annually and she has a waiting list of prospects.
Osborne says that his firm grew faster then he expected because the lower cost gives wealthier prospects more incentive to work with him.
“It’s an easier decision for potential clients to make,” Osborne said. For clients with millions of dollars in assets, “the cost saving is dramatic.” (Reporting by Robyn Post; editing by Linda Stern and Nick Zieminski)