When Should I Deduct Fees?
There is a lot to keep up with when you run your own advisory firm. Not that this is a surprise, but staying abreast of everything that must be done can be a bit overwhelming. Each client is on a different track and each is at a different stage in the process. With one client, I have completed the financial plan and we are in the implementation phase. We are transferring assets to me and getting an attorney involved to draft their wills. With another client, I am nearing completion of their plan but there are some special nuances which require me to do further research. Another client is gathering additional information so I complete their plan. On top of all that, keeping up with planning strategies, tax laws, changes in the insurance market, etc., requires a lot of time. Then the asset management piece, which leads me to this week’s topic, deducting the fees.
Last week I said I made an interesting discovery about fees and would share it with you this week. The question I had was this, “With what frequency should I deduct the fees?” Should I deduct them monthly or quarterly?
To analyze this, I built an Excel spreadsheet. I assumed an account of $1 million, an annual return of 8.0%, an annual fee of 75 basis points, and taxes were not considered. I projected each scenario out for two years so there were eight quarters in scenario A and 24 monthly periods in scenario B. The result was that the client’s account grew to $1,154,540 in scenario A when the fees were deducted quarterly and $1,155,535* in scenario B when the fees were deducted monthly. Also, the total fees paid in scenario A were $15,987 and in scenario B they were $16,090. The bottom line? At the end of the two-year period, the client’s account was worth $996 more and the advisor collected $103 more when the fees were deducted monthly. I will be deducting fees on a monthly basis now that I know it benefits both the client and me.
My next challenge that I hope you’ll help me with? I am currently looking for a system which will assist me in the investment arena. I need a tool which will allow me to track my client’s portfolios and put together proposals. I have used Morningstar Principia in the past and am in a trial period with Morningstar Advisor Workstation. I’ll let you know the results of this possibly in my next blog on June 28th.
When this entry was originally posted it included a typo listing the client’s account size as $1,554,535 instead of $1,155,535.—Ed.
Our compliance consulting firm, RIA Compliance Consultants, sets up many new investment adviser firms each month. Most of these firms are opting for quarterly deduction of fees. I presume this is due to administrative convenience.
In addition to the issue of whether an investment adviser should deduct monthly or quarterly, there are the questions about whether an investment adviser should deduct fees in advance or arrears of the management period and the appropriate methodology for calculating assets under management (“average daily balance” compared to “value on last business day of the period”).
Did your analysis consider such factors?
Michael,
Good start in determining when to collect fees. Though yes, the advisor does collect and additional $103, he/she just increased their administrative cost for billing by approx. 50% and if the advisor does not have an admin person managing this process, they just increased their administrative time (which is normally non-revenue generating time) by 50%.
While billing quarterly or monthly is neither right or wrong, good or bad, I have seen and managed a quarterly billing process that was very efficent and proactive.
I also wanted to thank you for taking the time to share your experience. I understand the amount of time it takes to establish a planning firm. Your articles and comments are great tools for others to use as they are setting out on there journey.
Michael,
I would agree with Gary Davis on this one. I think your analysis was a little to hypothetical, i.e., assuming a constant 8% return. I did a quick hypothetical spreadsheet using the monthly and quarterly returns of the S&P 500 to give a more “real world” return scenario.
My result showed quarterly billing providing and additional $120 to the advisor with only and $11 difference in the account values. Seems like a lot of admin work for very little benefit.
Good Luck!
Mr. Patton,
Just becoming “my own” Investment Adviser myself. My goal is to start billing by the quarter. Within three years or less my ultimate goal is to charge just once a year.
Whatever I made last year, will determine what to spend (and how to spend it) on the current fiscal year. It will take all the guesswork out of the picture and provide a marketing edge most of the time.
By having my clients hard earned money “scream” all year long, will show a little extra consideration on my part towards my clients.
Timothy J French
Lawmanfive Investing
a Social Entrepreneurial Company
There’s a typo. The correct number is $1,155,535 not $1,554,535 in scenario B. Sorry for the confusion.
Bryan, My analysis considered only “in advance” and “ending balance” of the period. I don’t plan to have a high number of clients. I’d like to have 50-100 HNW clients so I can provide a high level of service to each. I might change my mind but I don’t think it will be an administrative headache. We’ll see.
Gary & Robert,
If I deduct in advance then quarterly might be fine. I wanted to spread my income out. I thought about setting them up on rolling quarters (Jan-Apr; Feb-May, etc.) to get paid each month but I think that would be a headache. To your point of a constant return, I did consider this but didn’t take the time to simulate. I can easily add MCS to the returns and model reality and will do so as soon as I can. I mainly wanted to see if the client was hurt by a monthly fee deduction.
Thanks for your comments. I appreciate your thoughts.
Timothy,
Interesting point about an annual deduction. I would be very careful there. When you deduct a large sum like that, there may be a greater probability of hurting the client, especially during the times their accounts are down as during a bear market. Deducting a smaller amount on a more frequent basis is like dollar cost averaging in reverse and may help mitigate the risk of withdrawals during a market downturn. Interesting thought though.
Gentlemen,
I have several points to add to your discussion:
1. Based on my experience, the extra work of preparing, distributing, and deducting monthly billings would not be worth the small increase in revenues versus quarterly billing.
2. If you bill in advance, any revenue lost by billing quarterly would be reduced by interest you earn when you deposit the entire quarter’s revenue in the first month.
3. Quarterly billings mesh well with client’s quarterly portfolio reporting package, linking their payment with your deliverable service. A monthly billing, in contrast, might have the feel of a membership fee without the deliverable. It also forces the client to reconsider your value-added every few weeks rather than over the long-term.
3. I don’t believe regulations allow billing for an entire year in advance.
4. From both a cash flow and credit risk standpoint, I wouldn’t want to provide a year of service before being paid by billing annually in arrears.
5. Clients might be put off by the large amount of an annual bill, particularly following a down year.
6. The two firms I have been with over the past 15 years bill quarterly in advance, based on previous quarter’s ending account balance, with good results.
Mike
I am not sure how you constructed your spreadsheet but if you did use 2% per quarter and .0075 per month growth rates then effectively you used 8.24 and 9.38 growth rates which would explain why the client winds up with more money after monthly deductions.
Morris,
Actually I used .67% monthly (8.0%/12) and 2.0% quarterly. Both are an 8.0% annual return but you do remind me of something that in my haste didn’t occur to me. The compounding frequency is the same as the return frequency and that’s why the monthly grew to a slightly larger value at the end of the 2 years. So in all fairness, I suppose the ending value should not be much different. However, the volatility was much less in the monthly scenario when MCS (Monte Carol simulation) was applied. Monthly fee deduction does reduce the volatility as measured by the standard deviation. Thanks for the input.
I need to learn short hand division..
Hey, Mike, with regard to your statement…” next challenge that I hope you’ll help me with? I am currently looking for a system which will assist me in the investment arena. I need a tool which will allow me to track my client’s portfolios and put together proposals.” Have you checked into Fiduciary Analytics’ site? http://www.fi360.com. They have a free full use “kick the tires” trial subscription. Recommend it. Yours, Keith Schnelle, CFP, AIF.