One common topic of discussion at financial advisor conferences is fee compression vs. margin compression.
Several years ago, the industry press was predicting that robo advisors and the proliferation of ETFs in client portfolios would cause RIA management fees to plummet, as clients would no longer be willing to pay their advisor for asset management services they could receive from a low-cost robo or ETF. Our industry was quick to adapt, however. If clients weren’t going to value our ability to select securities for their portfolio, we’d bring value to the client in other ways.
We focused on financial planning—diving into clients’ goals and spending habits and ensuring their portfolios yielded enough return to live a meaningful life. We added tax analysis and, in some cases, even started preparing and filing tax returns on behalf of our clients. We dug into estate planning and broadened our product offering beyond traditional investment vehicles to include insurance (both life and P&C).
By adding these services, we justified the value we provided clients and therefore justified our fee. The well-publicized fee compression never materialized, but the delivery of these additional services didn’t come cheap. Profit margins decreased significantly as revenue stayed constant with a considerable increase in expenses, as CFPs, CPAs, attorneys and licensed insurance agents were all brought on board. Margins were further compressed recently as labor costs spiked in response to the Great Resignation.
In light of increased expenses, the only way to balance the profit margin equation is to increase revenue. Many conference sessions last year highlighted the fact that organic growth has stalled at most firms, as the average RIA is posting negative growth when you back out market gains. If we’re not adding more clients at our current fee rates, the only other way to increase revenue is to raise fees on the existing clients, which should be easily justified considering all of the additional services we’ve added over the past decade. Many RIA owners balk at the notion of raising fees, despite their decreasing profit margins, because they fear clients will leave them. Considering the tough market environment we’ve experienced over the past few years, even more advisors dread having fee conversations with their clients.
But one RIA owner stood up at a recent conference breakout session and confidently declared the current environment to be “the best time to raise fees in a decade!” He said he’s had no trouble raising fees across his book of business, reminding clients of inflation and labor cost increases. “Everywhere our clients go, they are experiencing price increases—hotels, airlines, grocery stores and even fast food restaurants are raising their prices. Why should we be any different?” He said he has received zero pushback from clients after notifying them of a fee increase. “We tell them, ‘We want to keep our team happy so they can continue to provide the exceptional service you’ve come to expect from us,’ and we haven’t received one complaint.”
At a DFA Operations Strategy Group meeting I attended in Austin, Texas, 30% of the RIAs in attendance had successfully raised fees last year and an additional 30% intended to announce a fee increase by the end of this year. The firms who already implemented the fee hike framed the conversation around all the additional services added over the years, and reminded clients that the last time the RIA had raised fees was approximately 10 years ago. After a few seconds of contemplation, the most common reaction from clients was, “You probably should have raised our fees several years ago.”
The number of clients lost by one of the RIAs who recently raised fees was two. However, the advisor admitted, “Neither client was a great fit—we hadn’t been happy with them, and they hadn’t been happy with us. They just used the fee increase as the excuse to leave. We’re happier and they’re happier.” And the additional revenue captured from the increased fees across her remaining clients more than offset the fees lost by these two smaller clients that didn’t fit the ideal client of the RIA.
I acknowledge these are awkward conversations to have with clients and understand why many advisors dread them, but without a steady inflow of new clients to offset the additional expenses RIAs are incurring due to added services and increased labor costs, fee increases are a necessity for many businesses. And “fee increase” doesn’t have to mean a wholesale increase in your firm’s standard fee schedule—most RIAs have heavily discounted the majority of clients’ fees well below their firm’s stated fee schedule—simply moving the lowest-paying clients up toward the stated fee schedule would rebalance the profit margin equation for many RIAs that are suffering from compressed margins. In all my travels speaking with RIA owners across the country, I have never heard of a client leaving solely because of a fee increase. By framing the conversation around the additional services now being provided, the increased cost of labor to support the team that the client has come to love, and the length of time since the last fee increase (which in many cases was never!), hopefully these conversations don’t need to be as difficult as advisors fear.
This article originally appeared on Wealthmanagement.com