Setting Proper Client Minimums: AUM Account Vs Retainer Fee Minimums For Advisors

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#OfficeHours with @MichaelKitces Video Transcript

Welcome, everyone! Welcome to Office Hours with Michael Kitces.

For this week's Office Hours, I want to talk about a very simple but very important issue that every advisor needs to consider: setting proper minimums for who you will work with as a client.

I know this is an unpopular topic with some advisors who believe we should always stand ready to serve anyone who needs our help, but the truth is that there's only so much time in the day, and you can't serve everyone. And serving clients has a cost even beyond just your time. There are regulatory compliance costs, there are staffing and service costs, and the larger your advisory business grows, the more all this matters. But it's one thing to say, "You should have minimums," and another to figure out how to actually structure a minimum and what it should be.

This week's question comes from Paul, who says:

"Michael, I'm a longtime listener of the Financial Advisor Success Podcast. One of the ideas on the podcast I've heard on a few occasions and am currently considering is instituting a minimum. But is it better to do a minimum quarterly fee or to have a minimum AUM requirement? What do you recommend?"

Executing A Minimum Annual or Quarterly Retainer Fee [1:18]

There are actually some important tradeoffs in deciding between asset minimums and simply having flat fee minimums, like a quarterly retainer fee. So I wanted to tackle this for this week's Office Hours. The virtue of having an asset minimum to work with a client is the sheer simplicity. If you set an asset minimum of $250,000 and you charge a 1% advisory fee, then you've effectively set a $2,500 minimum fee for clients, but it doesn't require a special billing process, you don't have to slap them in the face with the saliency of your fee or any other explanation about your minimum fees. You simply have an account minimum or at least a household minimum.

As long as we manage $250,000 or $500,000 or $1 million or whatever you set your minimum account size at, we can work with you and provide you with all of our investment management and financial planning and other services, because we know we'll be able to collect the fee that it takes to serve the client profitably based on the costs and the business model. And clients either have that amount of assets ready and available to transfer to manage, for you to work with, or they don't. That's that. It's a very simple way to create a process around minimums.

Now, the contrast is having a minimum retainer fee, and that's a little bit different. To be fair, I suppose it's still pretty simple to explain. Instead of saying, "We have a $250,000 account minimum and we charge 1%," you can just say, "We have a $2,500 minimum fee," period. There it is. That's the number. The caveat, though, is that while that's rather simple to explain, in practice it's actually a little bit more complex to execute. And the reason is that, now if you're going to do that process, you actually need a way to bill retainer fees. If you also manage an investment account for a client, you may be able to bill the investment account. But if the investment account is relatively small compared to the size of your minimum fee, you may actually set off red flag compliance warnings.

Most broker-dealers and even a lot of custodian systems will, at a minimum, make an inquiry to you if you start charging a $2,500 minimum fee to a client who has less than a $100,000 account with you because it's a 2.5% fee relative to the account. And that's a warning sign for a lot of broker-dealer and custodian systems. Now, you may be able to justify and explain the fee based on all the financial planning value you're providing outside of the investment account. It's not necessarily that it's an inappropriate fee in the end, but at least, it's likely going to trigger some questions, and there may be some broker-dealers that just outright prohibit it. They don't even want to make the exception for you. They just don't want to see any fees out of any account that are larger than X%.

And, at a minimum, you'll likely have to become an IAR (an investment advisor representative) of the broker-dealer's corporate RIA just to charge any kind of minimum retainer fee if you're not already tucked up under their RIA. And many corporate RIA's aren't even structured to allow retainer fees. They're only built for AUM fees (assets under management fees), which makes this impossible unless your broker-dealer changes its corporate RIA policies or you decide to leave and form your own independent RIA to do this.

And the process gets even messier if you're working with a client who doesn't have available assets to manage. Maybe it's a young doctor making $300,000 a year and still has over $100,000 in student loan debt who will happily pay $2,500 per year for non-investment advice, because they have the financial wherewithal, but can't have it billed from an investment account because the doctor doesn't have one. So now you need a process to bill the client directly, either by writing a check, but now you need to get the check, track outstanding invoices, make sure all the checks are written, actually deposit the check to get paid, reconcile the checks in QuickBooks, or do it electronically with maybe an ACH bank transfer or a credit card... but now you need technology to process that payment.

Now, in point of fact, we're actually in the process of launching a new payment processing platform for advisors called AdvicePay, specifically to help support advisors who want to do this kind of retainer fee billing from a bank account or a credit card, for when the client doesn't have an investment account to manage that you can sweep the fee from. But the point is that it's crucial to consider when you're choosing between AUM account minimum or a retainer fee minimum. What is your plan to actually execute the billing process for that minimum, especially if it's a retainer fee minimum and particularly if that retainer fee can't fit the traditional investment account billing process because the client won't have assets to manage?

And that's also true even if you're going to have the retainer fee minimum but keep your AUM structure because you need a way internally to track when a client switches from the retainer fee minimum to the AUM fee once the account is big enough. If your fee is 1% of assets with a $2,500 fee minimum, you need a system in place to switch from the $2,500 fee minimum to the 1% of assets when the client's account actually crosses over $250,000, or a regulator's going to get very unhappy that you're misbilling your clients. So now you need tracking to go from one to the other, and not that that's impossible, but just to recognize there are real-world business execution issues you have to consider when you're choosing these fee structures.

Choosing Between AUM Account Vs Retainer Fee Minimums [6:30]

Beyond just having a plan about how to execute either an AUM account size minimum or a retainer fee minimum though, the broader question is which is better for running an advisory business? And here there are a few issues to consider as well. First and foremost, recognize that as long as you have an AUM account minimum, you will always be constrained to people who have assets to manage as your target market. Now, if you're in the business of managing portfolios, that makes sense. You manage portfolios, you need people who have portfolios to manage. AUM account minimums work great. But if your primary focus is financial planning, and you simply offer investment management along with it as one of your services, and get paid through AUM fees just because it's so straightforward to execute as a billing process, recognize that using an asset minimum, you will exclude clients who might have happily paid for your advice, but just want to pay for your advice, and not have you manage their portfolio.

For instance, the doctor example I mentioned earlier... this high-income doctor with student loans. If you're a great comprehensive planner for upwardly mobile young professionals like this and you can give advice about student loans and employee benefits and negotiating compensation and cash flow and budgeting, and all the other things that are valuable to this client, the doctor may happily pay you that $2,500 a year fee for advice. But if you have an AUM account minimum, you can't work with this doctor under any circumstance, because there's no account to manage, nor is the doctor looking for that service. If the doctor had assets, but they're tied up in the 401(k) plan he's still working at and can't roll it over, you still have this problem unless you're using a retainer fee model because then you don't need the AUM to work with a doctor. You simply bill a minimum fee for whatever that level is, and he has the income to pay it directly without being billed from the investment account.

This is actually why I think the industry trend towards minimum retainer fees is so interesting because it opens up new groups to work with. Because now it doesn't matter whether the prospective client has an account to manage or not. As long as the person finds some value in your advice and has some financial wherewithal to pay for it, even if it's directly from personal income, you can work with them with a retainer fee minimum but not an account size minimum.

For the simplicity of billing, I know some firms that just do an annual retainer fee in this case, so you don't have to handle checks four times a year. Others prefer to do it quarterly simply because it makes the payments smaller and more bite-sized and easier to pay for the client. In fact, with AdvicePay, we see most of ours at XY Planning Network who work with younger clients do minimum retainer fees, and they charge it as a monthly retainer fee, so that the client just pays the fee directly from their income through bank account ACH transfer or even a credit card, and it's just another monthly fee like their gym membership and Netflix account and smartphone data plan.

But the key point is that while there may be some administrative complexity with retainer fee minimums because you need a different billing process. Retainer fee minimums also open up new markets, particularly groups like young professionals with limited assets, but good income and good wealth-building potential when you give them a means to pay you directly from their income instead of the assets they don't have yet. But that only works if you actually have a value proposition that's built to go beyond the portfolio. Otherwise, they're going to say, "Why would I pay you for investment management? I don't have investments to manage."

At the same time, it's worth noting that for the more affluent prospective clients, the more likely it is that they'll actually have enough assets to manage anyway. And as a result, when we actually look at the industry benchmarking studies on this, the larger the advisory firm and the more affluent its clientele are, the less likely they are to use retainer fee minimums, and the more likely they are to simply have AUM account size minimums. If you're working with multi, multi-millionaires, just a $1 million asset minimum is not such a big deal for really affluent clients. For the rest of us, though, that don't necessarily work with super wealthy, where big accounts are out there and it's easy to hit sizeable minimums, using a minimum retainer fee appears to be more popular. It lets us ensure some minimum level of revenue per client that we need to have to run a healthy business, but doesn't exclude people who want to pay for our advice and just don't have assets available to manage.

Setting Your Minimum Fee Based On Time Or Cost Of Service [10:42]

All that being said, though, it does still leave open one other important question, which is how do you actually set the minimum fee? And whether it's going to be a percentage of some minimum AUM account size or a flat dollar amount billed annually or quarterly or monthly, you still need to actually set the minimum dollar amount. Now, I find most advisory firms tend to do this one of two ways. The first is to set your minimum fee based on the cost to actually service a client in the first place, and this is especially important once you have several staff members in place as a growing advisory firm.

As a starting point, pull out your business' profit and loss statement from last year and add up the cost of overhead. Your office rent, your admin staff cost, your technology cost, everything it takes to keep the lights on and the doors open to run your firm. So let's say last year your firm did $1.2 million in revenue across 180 clients that you and an advisor partner are serving. Your total staff and overhead costs last year were about $450,000. That includes a couple of staff members, your rent, your technology, compliance, consultant, everything together. So if you have $450,000 of total overhead across 180 clients, that means your raw overhead per client is $2,500 per client per year, which means, at a bare minimum, you need to be generating at least $2,500 of revenue per client, or otherwise the fees aren't even covering the overhead to run the business. So if your AUM schedule is 1%, you'd have a $250,000 minimum. If your advisory fee is 1.3% for smaller clients, you could have a $200,000 minimum or you might just set a minimum retainer fee of $2,500 a year or even $200 a month, whatever it takes to make the math work.

Now, that's just for covering overhead. As the advisor and owner of the business, you're not making any money yet. If we assume that you and your advisor partner are paid $175,000 a year for servicing your clients, you know, you pay yourselves a fair market salary for the job you do in the business, then your total cost for clients in the business is $450,000 for overhead, $350,000 for two advisors, or $800,000 total, which means across 180 clients, it takes about $4,400 a year to get paid for what you do. Which means your minimum fee needs to be at least there, ideally with a reasonable profit margin on top. So maybe you set a minimum client fee of $4,500 or $5,000 a year, which then again you can make a $5,000 annual fee minimum or a $500,000 account size at 1% or $400 a month ongoing monthly retainer fee, which gets you pretty close. But the key point is that you've set the fee high enough to ensure you're actually covering the costs to run the business profitably.

Now, for those of you who are solo advisors, maybe you're running independently as an RIA or you're an independent advisor on a broker-dealer platform or you run your practice on your own, this kind of allocate the overhead across the clients approach doesn't make a lot of sense, because you're a solo that doesn't have a lot of overhead. I mean, your primary constraint is your time. So if your primary constraint is your time, then the way you should base your minimums is the value of your time. So if your goal is to earn $200,000 next year, there are about 2,000 working hours in a year, just assuming 40-hour workweek, 50 workweeks in a year with a little vacation, which means you need to earn $100 an hour for your time to make this work.

Now, the reality is that not all of your time will be client-facing, billable time though. You may only have 1,200 or 1,500 hours a year of client-facing time because you also have to take the time to run the business, maintain your continuing education, read really long "Nerd's Eye View" blog posts, and so if you want to earn $200,000 a year and you can only generate about 1,200 productive client-facing hours, you actually need to earn $166 an hour to make this math work. Which means if you take 12 hours a year to service a client based on maybe 3 2-hour meetings each year plus an hour of prep time for each meeting, plus a few hours of miscellaneous questions and service issues that come up, if it takes you 12 hours a year and you need to generate $166 an hour, then your minimum revenue per client is $2,000 per year. And now you can set your AUM account size minimum or your retainer fee minimum based on the right number to get you to your income goals for the practice.

Instituting A New Minimum Fee For Your Existing Clients [14:56]

If you're doing all this as a new advisor just getting started, as I think Paul was asking at the beginning, the reality is that you'll have to do it based on allocation of your time, because you don't have the rest of the staff and overhead structure yet to allocate costs. But I know for most advisors who listen to this, you may already have an advisory practice or in a larger business and already have clients and staff, which means you can actually go through the math of this exercise and figure out what does it cost for you to actually deliver your services profitably to a client, and then revisit whether you need to make changes for your existing business. Because if you go through this exercise to determine the minimum revenue per client that you should be getting to run profitably and then look at all your clients, you are almost certainly going to find that some of them don't meet the minimums, which means it's time to implement minimum fees in your practice.

For those who want a full discussion about raising fees on existing clients, it's kind of beyond our scope today. You can check out some of our prior Office Hours videos on the blog where I've specifically talked about how to do this. But the basic gist is that first you need to figure out what the minimum fee should be, then you need to decide how it's going to be structured. Is it an account size AUM minimum or a retainer fee minimum? Then you need to go back to all your clients who don't meet the minimum and explain, "In assessing what we do to service all of our clients like you, we've determined that it takes a minimum of $X", ($2,000 a year, $5,000 a year, or whatever it is), "to deliver our best value to clients. Unfortunately, right now the size of your account or your assets does not meet the minimum that it takes for us to do our best work for you. So as a result, going forward, we're going to be instituting a new minimum. We'd love to keep working with you at this new fee level, and if you don't think we're a good fit anymore, that's okay, too. We'll work with you to find a new advisor who's a better fit."

When you do this, you will lose some clients. Many, you'll find, actually will step up and pay your minimum, particularly if it's a retainer fee minimum and they just get to choose to pay you if they feel you're worth the value. They don't even have to move other assets. But some clients will say no. But again, since you already figured out what the fee is that's necessary to cover the costs of the business and your time and be profitable, by definition, the only clients you'll lose in this process are the ones who were losing you money anyway. And their departure just gives you more capacity to serve the clients who can meet your minimums and will better value the value you deliver. But the bottom line here is that you really can do this with either an account size minimum for clients or a minimum retainer fee. Either works, but there are tradeoffs in who you can and cannot serve with each type of minimum, and the kind of value you have to deliver to justify that minimum. Because again, if you're going to have a non-investment account retainer fee minimum, you better be delivering some real financial planning value outside of the investment account to justify it.

And bear in mind the differences in just who you can work with as account size minimums are naturally simpler, do fit most advisors' existing business models, but does limit you to working with people who have assets (i.e., not just those who are willing and ready to pay your fee), which indirectly can end up skewing your client base towards older retirees and away from younger clients who may be good for the business in the long run. And you have to have a plan for how you're actually going to execute the fee, particularly if you're going to move away from kind of an industry standard AUM fee, and towards a retainer fee which necessitates some different billing structures.

I hope this is helpful as food for thoughts. This is Office Hours with Michael Kitces. We're normally 1:00 p.m. East Coast time on Tuesdays. Unfortunately yesterday I was tied up in meetings, so here we are on Wednesday this week, but thanks again for joining us, and have a great day!

So what do you think? How do you set your minimum fees? Do you have a process for determining whether clients are profitable? What other differences are there between the AUM and retainer models? Please share your thoughts in the comments below!