Advisor Fee Deduction Part II
In the world of advice, discussion can be a very healthy thing. Even if you don’t agree with a particular point of view, it can still be beneficial. Because we are emotional creatures, we often make decisions based not on empirical data, but rather on our gut instinct. With this as a backdrop, I’d like to follow up on last week’s blog in which I discussed the frequency of the advisor fee deduction. There seems to be a lot of interest in this topic. On my blog, from last week, there were some interesting points brought up.
Before we discuss them, I had a typo in my last blog pertaining to the ending values that I should correct here. Although Scenario B (monthly fee deduction) did outperform Scenario A (quarterly fee deduction), the ending balance in Scenario B was $1,156,455, not $1,554,535 as I wrote. I apologize for the error.
Let’s get back to the topic at hand. One advisor commented that my analysis was based on static assumptions, which is true. Since returns were static, I was not taking into consideration the fact that markets fluctuate, which is also true. They suggested I use actual returns of the S&P 500 to model reality. The problem here is determining which two-year period to use. However, since the method I used was equally applied to both scenarios, it shouldn’t matter if I use static assumptions or S&P returns for some period. But it did make me a bit curious. So to satisfy my growing curiosity, I decided to use Monte Carlo simulation on the problem. I used an 8.0% return and a standard deviation of 12.0% on each portfolio (scenario). I also ran 10,000 simulations. Each time a simulation is run, the return varies, based on the standard deviation (risk) of the portfolio, and a new ending balance is recorded. This type of MCS is referred to as the parametric method and the results of the analysis are noted in the following table.
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Scenario A (Quarterly Fee Deduction)
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Scenario B (Monthly Fee Deduction)
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| Mean |
$1,153,493
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$1,155,703
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| Median |
$1,150,003
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$1,154,233
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| 1 Standard Deviation |
$96,383
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$56,060
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Notice the mean and the median were greater when the fees were deducted on a monthly basis. The other very important item to note here is that the standard deviation was smaller when the fees were deducted monthly. So the result was greater growth with less risk in Scenario B, and isn’t that what we’re all trying to accomplish? Deducting the fees monthly had a positive effect on the portfolio. It’s very much like dollar cost averaging in reverse.
Another issue which was brought up was the additional time needed to deduct the fees monthly rather than quarterly. I think this is a valid point. I suppose if you have a large number of accounts, this could pose a problem. I would view it this way. If it’s the right thing to do for the client, then we should find a way to do it efficiently!
I appreciate all your comments.
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Hi Mike,
I wanted to weigh in on the fee discussion. I don’t think this is an issue of the right or wrong thing to do. This is a matter of good practical business sense. My goal also is to service no more than 100 HNW clients. Offering investment management AND comprehensive financial planning, keeping abreast of tax law changes,etc dictates a service level that requires my constant professional energy and attention. It would be a disservice to my clients if that level was compromised in any way by the monthly administrative task of deducting fees. Therefore in my opinion deducting fees quarterly based on the previous quarter’s ending account balance is the only way to go and the standard best practice.
Alice W. Moore
Kennedy Wealth Management Group, Ltd.
Wouldn’t the most ethical, efficient — and best for the client — manner in which to bill be to simply charge an hourly fee?
Just askin’.
Hi Alice,
Let’s recap the analysis. Deducting the fees monthly nets the client a larger account balance with less risk (standard deviation), and the advisor receives slightly more in fees. This is called a win-win by any measure. If doing it this way takes too much time and detracts from your other duties, then perhaps for you a quarterly schedule may be best.
Let’s look at this a little closer. First, the time commitment issue. With the RIA custodian I use, I simply export my clients account balances into Excel, copy them into another worksheet I’ve set up (my template) and it calculates the fee based on the % applied to each account. Then I upload the data to my custodian, and the fee is deposited into my master account. Let’s assume this task takes 30 minutes to do each month. That’s a total of 1.5 hours each quarter but represents only a 1 hour net increase since we’re assuming it takes 30 minutes to do this task anyway. If there are 20 working days in a month, that’s 60 per quarter. If you divide the extra 1 hour needed per quarter (60 minutes) to deduct fees on a monthly basis, that equals 1 minute per day (60 minutes/60 business days). We waste at least a minute each day so it seems that if it’s a win-win, why not abandon our preconceived notions of how we’ve always done things and do what’s right for the client.
Very Sincerely,
Mike
P.S. How’s life after JPM. Give me a call to “catch up” on things.
Hal,
I do think an hourly fee is all you say. Attorneys have proven it’s a viable method. If we’re in the advice business, then we should charge for that advice and an hourly fee is a great way to go. I charge a fee of 2-5k for a plan +/- and it covers the plan and ongoing advice for the entire year. I’ll keep up with the amount of time spent on each client and reevaluate at the end of the year. The next years fee may need to be adjusted. We’ll see how this works, but I am always open to a better way to do things.
Mike
Hal,
I do think an hourly fee is all you say. Attorneys have proven it’s a viable method. If we’re in the advice business, then we should charge for that advice and an hourly fee is a great way to go. I charge a fee of 2-5k for a plan +/- and it covers the plan and ongoing advice for the entire year. I’ll keep up with the amount of time spent on each client and reevaluate at the end of the year. The next years fee may need to be adjusted. We’ll see how this works, but I am always open to a better way to do things.
Mike
We switched from quarterly to monthly a decade ago and our clients are much happier (fees look smaller, are more fair since not charged all when account is larger, easier to pro-rate new or terminating fees) and our life is much easier. The custodian that holds our clients’ assets does all the calculations, so there is no hassle for us. The fees are deducted monthly and a check sent to us.
Steve Kiernan
Anchor Financial Group
Two questions:
Do you mail a monthly statement to each client with a calculation of their fee?
Are you assuming fees are charged in advance or arrears?
Chris Oberholzer
Spectrum Financial Advisors, LLC
Chris,
I don’t anticipate mailing them a monthly statement of their fees since they will receive a monthly account statement which will show it. I am charging in advance.
Mike