Why most advisers are leaving money on the table

Advisers who raised prices through the financial crisis and its aftermath attracted more new clients and assets than advisers who lowered prices. That counterintuitive finding was one of the more eye-opening results of a recent study on the pricing patterns of 15,000 financial advisers conducted by PriceMetrix Inc., which provides practice management software to thousands of retail wealth managers. The study aggregated data from 380 million transactions between 2007 and 2010. The trades were executed in 1 million fee-based accounts and 4 million transactional accounts, representing more than $850 billion in investment assets. Within the group, fee-based assets increased by 23.9%, compared with a decline of 1.4% in transactional assets; fee-based accounts now hold 25% of total invested assets in the group, and are responsible 37% of adviser revenue. According to the study, the 33% of advisers who raised their prices on new accounts by more than 10 basis points between 2007 and 2010 opened 25% more new accounts than advisers who lowered their fees. Those higher-priced advisers, in fact, raised prices by 18 basis points from bases that were already above their peer averages. “Fee-based financial advisers are leaving money on the table when it comes to setting their prices,” said Doug Trott, chief executive of PriceMetrix. “The most surprising thing we found was the wide range of prices charged for similar relationships on similar-sized fee-based accounts,” he said. On larger accounts, the disparity was less evident, with average fees declining inversely with account size. For accounts between $1 million and $2 million in assets, the average fee was 1.17%. It was 0.98% on accounts between $3 million and $4 million, and 0.63% on accounts with more than $5 million in assets. The range of pricing within those categories wasn't as wide as with smaller accounts. For accounts between $250,000 and $500,000, the range of fees was dramatically larger, with the lowest quartile of advisers charging an average fee of 81 basis points and the highest quartile charging an average 208 basis points. Although service is admittedly difficult to measure in the advisory business, Mr. Trott thinks it's unlikely that the lower-priced advisers are offering much less service than the higher-priced advisers. They are just charging much less for their work. Although some advisers who charge lower fees said that they make up for the low fees with higher pricing on transactional business done with the same clients, the data suggest otherwise. The transactional revenue on assets earned in balanced accounts of between $250,000 and $500,000 showed very little difference between low-priced fee accounts and higher-priced ones. “We conclude that pricing is not being driven by competition, because prices are all over the map. It appears that many reps are relying on hearsay from colleagues and clients in setting their fees,” Mr. Trott said. As a group, the advisers represented in the PriceMetrix data lowered their average fees from 1.47% in 2007 to 1.32% last year — though fees ticked up by 0.01% in 2010 versus the prior year. The decline in fees over the past several years in part may be a result of “guilt pricing,” in which advisers lower fees for existing clients to make up for perceived poor performance. This is a cardinal sin for advisers, said Frank Congemi, chief executive of Benefactor Financial, an independent adviser with LPL Financial Holdings Inc. The firm manages just under $100 million in assets. “Markets go up and down — that's what they do. If you're pricing your service based on what markets are doing, you should get out of the business,” Mr. Congemi said. The low-balling on fee-based accounts may be especially prevalent among newer advisers, as well as reps who have been commissioned-based historically but who are increasing their fee-based business, said Larry Taunt, chairman of Regal Investment Advisors, which manages about $150 million in assets. “Reps are used to getting 25 basis points while trading for clients, and they're afraid they'll lose clients if they ask for higher fees when they switch over to advisory business,” he said. The PriceMetrix study figures, however, dispel the myth that lower-priced advisers are stealing business from their higher-priced competitors, said Mr. Trott, who contends that demand for financial advice isn't price-elastic. “Those advisers doing the most business tended to charge more,” he said. “Financial advice is a high-value service, not unlike what doctors or dentists provide.” Advisers who are expanding their fee-based business should appreciate that their related costs and responsibilities will grow as well, Mr. Taunt said. “Advisers need to understand that their liability and fiduciary responsibility is higher, and other costs can be higher, too,” he said. “They deserve to get paid well.”

DIFFICULT STEP

Moreover, Mr. Trott thinks that advisers who charge low fees will find it difficult to change their pricing model with existing clients. Just 5% of the advisers who raised their fees by at least 10 basis points over the four years of the study did so with their existing accounts. The key, Mr. Trott said, is getting the price right at the very start of the relationship. “The message from this data is that many advisers should charge more for their services,” he said. That, however, can be a difficult psychological step for some advisers to take. Rick Kahler, chief executive of Kahler Financial Group Inc., which manages $135 million in assets, admittedly has been inconsistent with his fee structure. As one of a relative handful of fee-based advisers in South Dakota, he has few peers with whom to compare himself. “A lot of us are in the dark about what our peers are charging. It would be helpful to know that information,” Mr. Kahler said. In 2008, he settled on a fee structure for new clients, charging 1.5% on the first $500,000 in assets and 0.4% thereafter. Clients paying higher fees were immediately dropped down to the new schedule and he is “gradually” bringing lower-priced clients up to those fees. “I've worked through my resistance and am more disciplined about it now,” Mr. Kahler said. E-mail Andrew Osterland at aosterland@investmentnews.com.