By Alan Smith
If there's are one subject that's guaranteed to generate heated debate within the financial planning community, it's the thorny issue of how advisers charge for their services and recent press coverage has brought it right back into the spotlight again.
Many of the discussions have focused on the client experience and the view that there is an inherent conflict of interest within an ad valorem (AUM) fee structure due to its contingent nature. There is also the corrosive effect on clients' savings with a fee model which compounds annually line with long term capital market returns.
So, clients need a fair fee model, but what about the future security and growth of your financial advisory firm? As we enter a new decade and smart advisers spend time thinking about longer term strategy many will run a classic SWOT (Strengths, Weaknesses, Opportunities, Threats) analysis. I suggest paying attention to the O and T.
The nature of the AUM fee model excludes the vast majority of potential customers from receiving much-needed financial guidance and advice. Let's face it: unless the client has north of £200,000 (near London, you can double that) in liquid, investable assets, they will struggle to find a high-quality adviser. The economics won't add up, even at a 1% annual fee.
No doubt, a large sector of the UK population would benefit from working with a professional financial planner and would pay for the privilege, but they don't have several hundred thousand ready to invest - yet. Who are these people?
Entrepreneurs
There are currently almost 6 million small businesses in the UK, accounting for 60% of all employment and over half of the turnover in the private sector (£2.2 trillion).
In my experience, few of the founders and owners of these businesses have large amounts of money in ISAs or Pensions, as they've often funneled most of their savings into their business.
Imagine the value a talented financial planner could bring to a busy entrepreneur growing a business. The opportunity to co- create their personal ‘financial life plan' to complement the business plan would bring real meaning to their money and business, identifying the important issues at the intersection of business and life. In most cases a client will eventually sell their business for a capital sum and will of course have enormous loyalty and stay as a client for life.
Younger Clients
Most advisers focus their energy on boomers - clients who are retired or about to. These people are at the peak of their wealth accumulation and fit the percentage charging model neatly - initially.
But what about the millions of ambitious younger people - the future leaders, entrepreneurs, CEOs, and sports stars?
Generally, under 40, these clients haven't yet accumulated significant savings or retirement funds like their parents. They might be starting a family, have issues around finding the best mortgage deal, the most appropriate insurance. At the same time, auto-saving into tax-efficient plans such as their workplace pension, securing ‘free money' from their employer and ensuring they allocate long term savings to the right asset class to benefit from compounding over the long term.
They need high-quality professional advice but advisers using a percentage model will turn them down as not having sufficient assets.
Red Ocean v Blue Ocean
In 2004, two professors at the INSEAD wrote a book called Blue Ocean Strategy. In it they explained that most businesses are competing in the same sector for the same, limited client base, each trying to outperform or undercut to secure their share of a crowded market.
In the years ahead, advice firms will experience more competition from the likes of Vanguard as well as other IFAs willing to offer similar services at lower cost - the national press will ensure it.
In the Blue Ocean, there are almost no competitors: no robo-advisers, no private banks, wealth managers, and very few IFAs. The early entrants in these markets get to set the terms, build their model, create revenue, scale, and dominate, making it hard for later entrants to steal market share.
If you're not thinking about your Blue Ocean Strategy you may be missing out on a once in a generation opportunity.
The other side of the coin is, of course, the Threats to your business created by retaining the AUM model as your primary revenue source.
Decumulation
The great thing about working with clients in retirement is that they've got money. The challenge is they're spending it!
If you charge an AUM fee which reduces each year as clients draw down (without the commensurate reduction in the workload) you're heading towards a slow-motion financial car crash.
I know of one firm where the revenue from retired clients declines 5% annually, broadly in line with client spending patterns. The only way to offset this is to find new clients to plug the gap. This challenge can feel like running on a hamster wheel.
Market
Over the past decade, the average investor in a 60/40 portfolio has seen the value of their investments double: advisers AUM fees have therefore also doubled.
Now, without attempting to make any market predictions, it would seem reasonable to expect a temporary market correction at some point over the next couple of years. If history is anything to go by, such a correction could last a couple of years or more.
Have you stress tested your business to ensure it would be robust in the event of a reduction of revenue of, say, 30% lasting two or three years? Keep in mind, you're likely to be working twice as hard to manage client's emotions and concerns.
Same rules apply to the sale value of your business - if markets fall 30%, guess how much your business value has also fallen by?
The last 10 years have been great for financial planners with rising markets, positive legislation, and increased demand from consumers for advice. Now is the time to consider the future opportunities and threats inherent in your current business model and get ahead of the curve.
Alan Smith is the founder and CEO of Capital Asset Management, one of the UK's leading firms of independent Chartered Financial Planners. From their origins as a small, transaction-based IFA, Alan and his team have grown the business into a modern, profitable, boutique firm, delivering lifestyle financial planning services to a growing client base of affluent families.
