Financial planning knowledge to help you better serve your clients.

Setting proper client minimums is an important practice management issue that every advisor needs to consider. For many advisors, the idea of having "minimums" is an unpopular, as their goal is to be ready and willing to serve any prospective client who needs help. But the truth is that there's only so much time in the day - which means not everyone can be served - and given the overhead costs to operate an advisory firm, serving clients that are "too small" may well be a money-losing proposition for the business (even if it brings some revenue in the door).

Of course, even for advisors who are ready to set client minimums for their advisory firm, it’s one thing to say “you should have minimums”, and another to figure out how to actually structure the minimum (e.g., a minimum account size, or a minimum advisory fee?), and what level it should be set at!

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss best practices in how advisors should actually go about setting client minimums, the benefits and trade-offs in setting minimums based on investment account sizes (e.g., an AUM minimum) versus a minimum fee (e.g., a minimum annual retainer), and how to figure out what the minimum revenue per client should be for the business to be profitable.

Most advisors that have a minimum simply set a minimum AUM requirement (i.e., a minimum household or portfolio account size). The virtue of having an asset minimum to work with a client is the sheer simplicity. If the advisor sets an asset minimum of $250,000, and charges a 1% advisory fee, then the advisor has effectively set a $2,500 minimum fee for clients. Additionally, the advisor has set a minimum without any special billing requirements or complexities.

By contrast, some advisors prefer to set a minimum annual fee instead (regardless of account size), such as $2,500/year, and simply charge all clients that fee at a minimum (either as an annual retainer, or sometimes billed quarterly or even month). The good news of such a retainer-fee minimum structure is that it opens up new markets - for instance, young professionals who have limited assets but high income and good wealth-building potential who can happily afford the fee from their income. The bad news, though, it that it introduces additional billing complexity, as now the advisor needs a way to invoice, track, and process those minimum fees and have a way to actually get paid by the client (especially if there is no investment account to manage and sweep fees from!).

Regardless of the structure, though - an annual $2,500 minimum fee, or a $250,000 account minimum at a 1% rate that adds up to $2,500/year - it's still necessary to determine what the minimum revenue should be, and whether any particular advisor needs a minimum revenue per client that is higher or lower than $2,500/year.

Ultimately, most advisory firms do this one of two ways. The first option is to set the minimum fee based on the cost to actually service a client in the first place, by adding up the total overhead cost of the business and dividing by the number of clients; for instance, if the firm has 180 clients and the total cost of overhead is $450,000, then the firm must charge $2,500/year just to cover its office rent, staff, and other overhead costs. The second option - especially popular for solo financial advisors - is to price the minimum is based on the value of the advisor's time (since that is his/her primary constraint as an individual advisor). Thus, if the advisor wants to earn $200,000 per year and can only generate about 1,200 productive client-facing hours, the advisor needs to earn at least $166 per hour when doing client work, which means if a client takes 12 hours per year to serve, the minimum fee must be $166/hour x 12 hours = $2,000/year.

The bottom line, though, is that some minimum level of revenue per client is necessary for an advisory firm to execute well as a business. It can be administered as either a minimum account size, or a minimum retainer fee, though each has its benefits and disadvantages and who the advisor can (or cannot) work with, and it's especially important to recognize that if the advisor is going to have a non-investment-account retainer minimum, the advisor had better be delivering some real financial planning value outside of the investment account!

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The need to manage conflicts of interest is a central issue in meeting an advisor's fiduciary obligation to clients, whether it's part of an RIA's fiduciary duty under the Investment Advisers Act of 1940, or any financial advisor's obligation when serving any retirement investors under the Department of Labor's fiduciary rule. Yet the reality is that prospective conflicts of interest go beyond just those that financial advisors may face with the product compensation they receive for implementing various insurance and investment products. In fact, financial advisors often face direct conflicts of interest with the very platforms they're affiliated with, particularly when it comes to practice management advice in how to grow their own business and serve their clients!

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss the conflict of interest that exists between RIA firms and their RIA custodian platforms (as well as between brokers and their broker-dealers), and why advisors should perhaps be a bit less reliant on their platforms for financial planning education and practice management insight, given the "conflicted advice" they're receiving!

A straightforward example comes up in the context of whether financial advisors should aim to serve "next generation" clients - in particular, the next generation heirs of their existing clients. Concerned about the assets that might leave their platform, RIA custodians regularly encourage and urge advisors to build relationships with the heirs of their clients, so that the assets don't leave. Yet ultimately, that just emphasizes that to the custodian, the "client" isn't even the client - it's simply their pot of money, that the custodian wants to retain, regardless of who owns it... which means pursuing the assets down the family tree. By contrast, financial advisors who are focused on their clients - the actual human beings - would often be better served by simply focusing on who they serve well... which means if the firm is retiree-centric, the best path forward is not to chase pots of money to next-generation heirs when their retired clients pass away, and instead is simply to go find more new retirees! In other words, advisors are getting advice from their RIA custodians to pursue next-generation clients is often based more on what's in the custodian's best interests, not necessarily what the advisor's best interests for their practices!

Another way that RIAs sit in conflict with their RIA custodial platforms is that in the end, one of a fiduciary advisor's primary goals is actually to proactively minimize the profit margins of our RIA platforms! Thus, advisors try to minimize transaction costs, lobby for lower ticket charges on trading, pick the lowest-cost share classes that don't have 12b-1 fees or revenue-sharing agreements, find the optimal balance in selecting No Transaction Fee (NTF) funds versus paying transaction fees based on the size of the clients' accounts and what will be cheapest for them, obtain best execution pricing regardless of order routing kickbacks, and minimize client assets sitting in cash. And all of this matters, because how do RIA custodians actually make money? Ticket charges, revenue-sharing from asset managers, getting basis points on NTF funds, order routing revenue on execution, and making a 25+ basis point interest rate spread on money market funds. Which means the better the job that the RIA does for its clients, the less profitable they are for their RIA custodian (a fact that advisors are often reminded of by their RIA custodian relationship managers!), and RIAs have a fundamental conflict of interest between being "good advisors" for their custodial platform and watching out for their clients' best interests.

Notably, this phenomenon is not unique to RIAs. It’s perhaps more noticeable because we usually talk about RIAs as being fiduciaries that are minimizing their conflicts of interest, but it’s equally relevant for those who work on a broker-dealer platform as well. Because as product intermediaries, broker-dealers ultimately make their money off of transactions, and it is impossible to sell financial service products without a broker-dealer! Yet the challenge is that the B-D can make more when they are offering both compliance oversight and getting a slice of GDC on all transactions, as opposed to just a compliance oversight slice of advisory fee business. Which means that while a fee-based business model may be more stable and valuable in the long run for a financial advisor, able to grow to a larger size and sell for a higher multiple, B-Ds are often at risk for making less money as their advisors shift to fee-based business that makes more for them (or alternatively, forces the B-D to increasingly try to reach into the advisor's fee-based business with ever-expanding "compliance oversight").

The point is not to paint every B-D or RIA custodian in a nefarious light - as they're just trying to run their businesses - but it's crucial to understand that in many situations, what's best for the broker-dealer or RIA custodian is not necessarily best for the advisor on the platform. Which is concerning, because too many advisors don't seem to acknowledge these inherent conflicts of interest, especially since advisor platforms are often the primary place they go for financial planning education and practice management insight, not realizing the conflicted advice they are receiving. And so, while it can be great to take advantage of some of the resources that these platforms provide, advisors should still be careful to consider whether the advice they receive is really in their best interests as an advisor, or ultimately about maximizing revenue for the platform instead!

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