Executive Summary
In an increasingly competitive environment for financial advisors, from the rise of robo-advisors and Vanguard Personal Advisor Services, there are more pressures than ever on us to justify our cost to clients. Leading many financial advisors to question whether it's time to cut AUM fees - or even abandon the AUM model altogether.
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, I look at when and whether it ever makes sense to cut AUM fees in an effort to grow the business and bring in more clients.
Clearly, for advisors who are far more expensive than their competition, cutting fees to at least be "reasonably competitive" may be inevitable. But for those whose AUM fees are already reasonable, beware the strategy of trying to attract clients by being the lowest cost financial advisor. Because ultimately, that may attract the most cost-conscious and price-sensitive clients - who may come to you for being the lowest cost, but will just as quickly leave you for another advisors who is just a basis point or few lower... because that's the behavior of clients who seek out the lowest cost solutions!
More generally, though, the real challenge of trying to compete by being the lowest cost provider is that it sets the focus to competing on price, instead of competing on value instead. In fact, for financial advisors who find their prospective clients challenge their pricing, usually the biggest issue is not their pricing at all - it's a lack of differentiation, and the perception from clients that your services are no different than any other financial advisor... which means price is the only comparison left.
In other words, most "price" conversation are actually value and differentiation (or lack thereof) conversations. Which means the real solution is not to adjust your prices - or change your entire business model (e.g., from AUM fees to retainer fees) - but instead to try to improve your differentiation by focusing on a niche or specialization, such that clients will focus on your unique value instead of comparing you to others on price alone! Because for advisors who are truly differentiated with a unique value, clients don't often ask very many questions about price and cost in the first place - because there's nothing to compare you to anyway!
(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)
#OfficeHours with @MichaelKitces Video Transcript
Welcome, everyone! Welcome to Office Hours with Michael Kitces!
Today, I want to talk about something that I see as a dangerous trend emerging among a subset of advisory firms. It's the proactive decision by many advisors to try to compete against other advisors by being the lowest cost financial advisor.
I was reminded of this issue with a recent question that came in from an advisor, Megan, who asked:
"I charge a 1% AUM fee, which is pretty similar to most other advisors in my area, but I'm finding it a lot harder these days to bring in new clients. Everyone wants to know what I'm going to give them that other advisors won't. So I'm thinking about cutting my AUM fee to 0.9%, so that I'm under that 1% line, to make it easier for the cost-conscious clients. But I'm worried that if I do, I'll just cut my income from current clients, and still not grow. I'm curious what you think? Does it make sense to cut AUM fees to try to get growth going again?"
Great question, Megan. With all the discussion these days around fee compression for financial advisors, I'm hearing this question come up more often. Especially given the evidence that advisor growth rates are slowing a little. There's a lot of discussion about whether the infamous 1% AUM fee may not be as competitive anymore.
In essence, I think we're having a collective crisis of confidence in the AUM fee structure!
A Lack Of Differentiation Leads To Price-Sensitive Prospects? [Time - 1:48]
But in reality, Megan's question actually stems from a more fundamental issue: Is the problem really that AUM fees are broken (or that a 1% AUM fee isn't competitive anymore), or is the real problem that most advisors aren't differentiated enough to compete in any way but price?
Because when a conversation with a prospective client starts focusing that much on price comparisons, and whether you're 5- or 10-basis points cheaper than the next advisor up the street, what that really says to me is that the prospect views us as so commoditized and undifferentiated that you could literally just swap one adviser for another! And the only distinction would be how much each one costs, down to the last few basis points.
If you're getting this message from a prospect, what it basically says is:
"I can buy financial advice from anyone and get the same result, so I'm just going to buy it from whoever gives it to me for the lowest cost. What are you going to do for me?"
That's how we buy interchangeable commodities. But that should not be how we're selling financial planning services! If it is, then the real problem is not actually a cost problem. The real problem is a differentiation problem!
In other words, if you do generalist financial planning the same way that everyone else does, and for the same generalized clients, of course clients are going to price shop you! Because that's the only thing they have left to compare, if you're a generalist advisor like every other generalist advisor!
That doesn't mean, though, that the only conclusion is that you have to lower your prices to stay competitive, because the alternative is that you improve your differentiation.
This is why I pound the table so hard all the time around niches and specialization. I know a few of you are sick of hearing me talk about it, but I'm going to continue to beat this drum. Because the adverse consequences of not having a niche or specialization is what we're seeing play out live in real-time! All of this discussion around price competition is, to me, not a price competition discussion. It's a lack of differentiation discussion. That's what's really going on!
Think about it for a moment. If I'm an expert in working with divorcees, and I'm sitting down with a prospective client who's stressed about rebuilding her financial life after a divorce, this is not going to be a price conversation anymore. I'm not going to get compared as a leading expert in post-divorce planning to every other generalist financial advisor up the street who doesn't necessarily have that expertise. I'm going to get compared based on the fact that I have a specialization in the exact problem this client has, and no one else has that expertise. Which means, now, I'm getting compared on my unique value, not my price.
And this works similarly with any kind of niche or specialization. If I focus on retirees from the local big company and I know everything there is to know about their employee benefits, retiree health plan, 401(k) rollover rules, net unrealized appreciation considerations, and pension rollouts – then I'm going to win the majority of the prospects that I meet from that company. And it's not going to be about whether I'm cheaper than any other advisor that can help them – it's going to be driven by the perception that I'm a specialist in their problems and other advisors are not. The whole point of differentiating with niches and specialization (or just more generally differentiating on value), is that it gets you out of this trap of differentiating on cost and trying to be the cheapest!
Competing On Cost Attracts The Most Cost-Conscious Clients [Time - 5:17]
The second problem that arises when you go down the road of trying to cut your fees and differentiate on cost alone is that it's a double-edged sword. I've seen a couple of advisors do this, and then regret it years later.
Because here's the problem that occurs when you compete by being the lowest cost advisor (effectively acting like financial advice is just a commodity): you're going to attract price-sensitive, cost-conscious clients who respond to that kind of messaging and marketing. These are clients who don't actually care about you, or the value you provide, because you've already made yourself an undifferentiated commodity that competes on price. They're just going to buy you based on price.
And what that means is that as soon as someone else reaches them with a slightly lower cost solution, you're going to lose the client. And I think that's a real risk in a world where we have other platforms like Vanguard Personal Advisor Services providing an advisor for a mere 30 basis points (0.3%) and a $50,000 minimum.
In other words, if you want to really be a lowest cost financial advisor, you have to sustainably remain the lowest cost provider. Realistically, that's tough for most of us. We don't have $100 million dollars of venture capital like a robo-advisor. We don't have $3 trillion of scale like Vanguard.
Which means that trying to compete to be the lowest cost advisor against companies that have more capital, more depth, and more scale, is going to be a losing proposition for almost all of us. You're going to end up attracting clients that find low costs appealing, but are going to bounce to the next person that just gives them a slightly lower cost – and then you have to keep cutting your prices just to compete.
The end result: you're not going to end up being the lowest cost advisor. You're going to end up being the worst paid advisor, who has to cut fees to unprofitable levels just to keep those price-sensitive cost-conscious clients. Because trying to be the lowest cost advisor is a slippery slope that never ends!
Are You Differentiating On Price Structure, Or Unique Value? [Time - 7:14]
Notwithstanding the horrible slippery slope of trying to be the lowest cost provider, I'm seeing advisors try to make it happen frequently these days. In some cases, the advisor is cutting their AUM fees to compete on price. But the more recent trend has been advisors that are looking to switch to retainer fees in an effort to basically change the way they charge and price their services, and make that their differentiator. It's basically saying to prospective clients:
"Well, sure, I provide financial planning like others, but I do retainer fees and the other people do AUM fees. And retainer fees are better for you in the long run because..."
This is another dangerous strategy.
I'm not really here to bash retainer fees. But be cognizant of why you're doing it. As many of you know, for our XY Planning Network, we champion monthly retainer fees. We actually just built a new fintech solution called AdvicePay just to help advisors do retainer fee billing. But the point of XYPN isn't to differentiate on retainer fees. It was to create a business model that could work for Gen X and Gen Y clients who don't have a portfolio and can't be served by AUM fees at all. In other words, it's not about doing retainer fees to differentiate; it's about adopting a retainer fee business model to reach clients the AUM model can't serve.
In fact, even within XYPN, I constantly pound the table that every advisor still needs a niche or a specialization. Even for doing monthly retainer billing! Because, at the end of the day, you don't want to compete on price, you want to compete on differentiated value! Otherwise, you're going to differentiate by being an advisor that charges $150 bucks a month, and you're going to lose to the next advisor who charges $125. And that person's going to lose to the next one that charges $110. Because that what happens when you try to sell yourself as the lowest cost provider. You're just waiting for another person who's slightly cheaper to come in and try to undercut you and take away your clients!
The fundamental point here is simply that it's a bad strategy to use retainer fees to compete against AUM as a differentiator. Because that's trying to differentiate on price. Instead, use retainer fees because you're opening up new markets that can't be served any other way. And then you still need an niche or a specialization that's relevant for those clients!
Before Your Change Your Pricing, Take A Hard Look At Your Business! [Time - 9:44]
So for Megan, and any other advisors out there who are feeling these competitive pressures on AUM fees these days, I want to encourage you to take a hard look at your business first.
Now, it might be that you actually do have a pricing problem. If most advisors in the area are charging 1.0% and your fee schedule starts at 1.7%, then that might legitimately be a pricing problem. But for many advisors out there, when I hear them talk about their fees and I ask, "What do other advisors in your area charge?" The answer is often, "They're all pretty similar."
If that's the case, recognize that what you really have is not a pricing problem. It's a differentiation problem. It's a lack-of-perceived-value problem. Because the truth is that when people perceive value, there's a subset of people who will buy it, almost regardless of what your actual price is!
For instance, both Wal-Mart and Tiffany's are good value for what they provide. Even though their price points are ludicrously far apart. People buy Kias and they buy BMWs – drastically different price points for what are both capable of fulfilling a basic transportation need – but people have different perceptions of value, and will pay at different price points.
In other words, you don't have to be the lowest cost to get clients. You just have to be a reasonable cost for the value that you provide, and that value is relative to cost. Assuming you can differentiate your value.
We see a version of this happening already in the latest advisor benchmarking studies. If you actually look at what's happening in our financial advisor world, what we see is AUM fees have actually remained stubbornly stable, despite the emergence of robo-advisors. In fact, at some price points, particularly for multimillion-dollar clients, the median advisor AUM fee has actually gone up in the past seven years (bucking the robo trend altogether!)!
But while advisory firms are actually raising fees more often than lowering fees, their profit margins are declining. They're charging more, but they're taking home less. And the gap in the middle is reinvesting to provide more value to clients to justify the fee.
And so the pressure really is on for all of us – I feel this in our advisory firm as well – to demonstrate the value that we're providing for clients, and differentiate ourselves from the competition. The forces out there are real, and I don't want to betittle their significance.
But be very careful when you look at your business. Take a hard look and decide: is the challenge you face really a price problem, or is it really a value and differentiation problem?
Because, if it's really a cost issue and you have to lower costs to stay competitive, that's one thing. But if you're going to keep lowering costs to be the lowest cost advisor, be aware (and beware!) that you're going to attract cost-conscious clients, who may not stick with you in the long run. But if what you're really shooting for is a better value business, you can attract clients that appreciate the value regardless of the actual price, as long as it's reasonable relative to the value.
So recognize what you're going for. Which client you really want to work with? Do you want to work with cost-conscious clients by being the lowest cost provider, or do you want to work with clients who value the service you provide?
The bottom line is this: recognize that sometimes pricing problems are not actually pricing problems. They can be, but in a lot of the consulting work I do with advisors, I find most often it's not actually a price problem. It's a differentiation issue. It's a value issue.
Value issues matter and are still something to work on in your business, but the solution is not figuring out, "How do I drop my AUM fees or switch to retainers or do something else to differentiate on price?" It's, "How do I get more focused and pursue a niche or a specialization? How do I add value-added services that are unique to the clients that I serve, so that I can complete on value and differentiation, and not price?"
So I hope that's helpful as some food for thought around the pricing landscape for financial advisors, and why I think you really have to be careful about trying to be the lowest cost financial advisor out there in your market.
This is Office Hours with Michael Kitces, 1 p.m. East Coast time on Tuesdays. Hope this has been helpful. And have a great day, everyone. Take care!
So what do you think? Are you finding clients are more cost-conscious than they used to be? Or are you struggling to differentiate your services and relying on price as a differentiator instead? Have you cut your fees recently? Or raised them? Please share your thoughts in the comments below!
