PRACTICE MANAGEMENT Commissions to Fees ONE ADVISOR S STORY. For use with financial advisors. Not for use with clients.

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1 PRACTICE MANAGEMENT Commissions to Fees ONE ADVISOR S STORY

2 Robert J. Sampson is a Connecticut-based planner providing consultation to a variety of clients. His firm provides comprehensive services to its clientele including budgeting, debt management, investments, insurance and survivor planning. While his firm does not have a particular niche, many former military personnel are clients as a result of its location near the Naval Submarine Base New London in Groton, Connecticut. Founder and principal, Robert J. Sampson, is a former Naval Flight Officer. While Sampson has worked as an investment advisor for twelve years, he has been an independent financial advisor for only about one and a half. His shift from a commissionbased system to a fee-based one supported his efforts to become an independent financial institution committed to providing high-quality investment advice and planning to a select clientele. In Sampson s words, I wanted to provide a higher level of service to a smaller number of people.

3 The Need for Change The Decision There were other reasons behind the firm s transition to fees: Sampson thought that along with providing better quality advice and more comprehensive planning, he would receive more predictable revenue under the new system, a previous pain point. Also, based on his experience as a captive advisor, Sampson felt that commissions-based advisors tend to be more focused on completing a transaction with a product than providing the best advice. Though regulatory headwinds did not heavily influence his decision, Sampson feels that the Department of Labor s reforms to commission-based compensation in retirement accounts may be indicative of more reforms to come. With a commission-based business you need 1,000 clients to get enough residual cash to pay rent, staff, etc., Sampson says. If you think you can give 1,000 clients service at an acceptable level, especially now when you may need to be a fiduciary, great. But I think you are wrong. Additionally, he stated that the tides are shifting in terms of advisor-client relationships and that, were it not for the fact that many of his peers In order to become both independent and predominantly fee-based, Sampson solicited the opinions of his peers on how to best make the transition. Two respected financial advisors in his network suggested that a Turnkey Asset Management Program (TAMP) would free up his time and ease the transition by facilitating more commoditized work, improving his ability to focus his time and expertise on client engagements. The TAMP Sampson chose was AssetMark. Sampson has found that being part of the AssetMark community has both freed up his time to expand his service offerings to clients and given him access to great resources, including the experience of peers. As he put it, One of the things I appreciate about AssetMark is that they get advisors together to provide training on the best practices for managing a financial services firm, and also facilitate conversations between you and your peers. are complacent in the current commissions-based system, more financial firms would be making the switch. If you think you can give 1,000 clients service at an acceptable level, especially now when you may need to be a fiduciary, great. But I think you are wrong. AssetMark 01

4 The Transition The transition to a predominantly fee-based system was a multi-year process. Prior to becoming independent, Sampson worked with nearly 1,100 commission-based clients. He reduced this number to roughly 400 based on location and activity: he knew some clients were geographically too far away to easily provide excellent service to them. Of these remaining 400 clients, only 80 or so were fully engaged and actively seeking advice from Sampson. When he went independent, he decided to become predominantly fee-based. Even though this was a big funnel for Sampson s business, the transition also had an added benefit of a having an honest discussion with those clients that may not choose a higher level of service and would prefer to stay in the commissionbased world. Unfortunately, this decision required a difficult discussion with his current clients. It rings false to say, I want to serve you better with more personal touches but not say that face-to-face. A Tweet won t cut it. Sampson made this conversation easier not only by delivering the news in person but also by changing his service model and using industry research to justify his pricing. Sampson cited Vanguard research that shows advisors may add about three percentage points of value in net portfolio returns over time (see table on page 5). Under a fee-based system, Sampson explained he has better ability and the time to evaluate his client s portfolio investments, meet with them to discuss objectives, and help them through tough markets. According to Vanguard, all of these factored together potentially add value to the client s net returns over time. Since his industry standard, one percent fee, combined with platform costs, was still substantially less, Sampson felt he could justify his value. According to Sampson, Personal, one-to-one interaction is the best way to make the transition. Perhaps 30- year-olds and younger might be ok with non-personal communication, but Boomers and even Gen-Xers take the news better in person. It also makes it easier to immediately answer any questions that arise. It rings false to say, I want to serve you better with more personal touches but not say that face-to-face. A Tweet won t cut it. AssetMark 02

5 I told my clients: You re going to get a lot more service, from one time per year to three times per year. It s about them. PRICING Sampson adopted a predominantly fee-based model with a set annual advisory fee that starts at one percent of assets under management (AUM) and decreases as their accounts grow. The only other fee Sampson charges is for creating a first-time financial plan for a new client, the cost of which is determined on a case-by-case basis based on complexity. Sampson does no billing; all fees are directly taken out of AUM by AssetMark. In Sampson s experience, clients prefer this system because, while fees show up on statements, clients do not have to do anything directly. This ease is desired to such an extent that during the transition when Sampson offered clients a reduced fee for a direct payment (for example, writing Sampson a check), they unanimously declined. SERVICES An important part of transitioning from a commissionbased system to a fee-based system for Sampson was reworking how often clients would meet. Since the feebased system allows for more priority to be placed on providing high-quality advice to his clients, Sampson moved from the annual meetings he had with clients under his previous BD to triannual meetings that took a more comprehensive look at client s entire financial life. Sampson expounded, I told my clients: You re going to get a lot more service, from one time per year to three times per year. It s about them. He broke down the meetings into three functional categories: Risk Management Analysis Meeting Sampson reviews and makes recommendations on all insurance policies: property and casualty (home, automobile, etc.), life insurance, disability, long-term care and healthrelated insurances. Financial Strategy Meeting Using financial planning software (such as Finance Logix) Sampson works with clients to set and revise goals, projections, and strategies, and review ongoing contributions. Budgeting is also reviewed. Wealth Management Sampson works with his clients to assess and manage investment risk by confirming risk tolerance, rebalancing based on goals, and tax implications of such moves. Now that he is predominantly fee-based and has a more in-depth client service model, Sampson has changed his thoughts on small accounts: If you are looking at what is better for clients, given the way the fiduciary winds are blowing, I would go as far as to say it should be your responsibility to take those smaller clients and say, You should go to an outside resource such as Betterment. It s a liability too, not paying attention to those small accounts. AssetMark 03

6 In my opinion, advisors need to get comfortable with, What do you think is the best way to go about serving your clients? OVERCOMING CONCERNS A common hurdle, and, ultimately a primary reason why some advisors don t move to a fee-based model is the potential that, for a short time during the transition, they may encounter reduced cash flow. While this was the case for Sampson during the transition to an independent fee-based system, he made it clear that a temporary reduction in cash flow is not a substantial enough barrier to stop any advisor that cares about providing quality advice to their clients. On the matter of advisors using money (or time) as a barrier to change, Sampson stated, In my opinion, advisors need to get comfortable with, What do you think is the best way to go about serving your clients? If you can say, A fee-based system is better for my clients because I can serve them better. and you can get comfortable with that, then you should switch. If you can t and justify that selling them a product and getting a commission is better, then you shouldn t switch. Additionally, this temporary reduction in cash flow will be more than offset by a future flow of continuous, stable revenue from fee-based accounts. Overall, aside from a temporary cash flow shortage, Sampson reports that the transition went easily and was straightforward. He said, Initially, it took me a while to get paid when switching from a commissions-based business, but that shouldn t stop anyone from making the transition. That was part of my plan, and after all, I am a financial advisor. When asked, Was the transition time consuming? Sampson answered, Extremely, but he cites that the number of face-to-face meetings was likely the reason why the transition took as long as it did. AssetMark 04

7 The Results While Sampson s AUM did go down temporarily after the transition, he notes that was more a consequence of going independent, and less a result of going fee-based. Sampson estimates that within the next six to seven months he should have about the same amount of AUM as he had before he went independent. According to Sampson, When I started the transition to fees, I had only about $1M AUM in fee-based business. It took me about 4 years to get that to $25M AUM. He expects to double his AUM in the next three years. Sampson also acknowledges that according to industry experts recurring revenues are valued more highly than commissions-based businesses. One common way to value the equity of a practice is to apply a multiple to revenue, based on a prediction of recurring revenues in the future. Typically, the multiple applied to a fee-based business is significantly higher, for example 2x recurring revenue, than that for transactional, commission-based revenue. This is because a fee-based business typically has higher, more predictable revenue. It s a powerful business equity combination, pairing higher valuation multiples with higher revenue. To put this in perspective a $1 million dollar revenue fee-based business would typically be worth $1 million more than a similarly-valued commission-based business when sold. Since the transition, Sampson s relationship with his clients has gotten ten times better. By being able to devote more time to providing quality advice and accountability to his client/advisor relationship, rather than just pushing to put a product or plan in place, Sampson has gained insight as to what his clients value in his input. That professional validation was an unexpected reward of transitioning to a fee-based business. your Potential value relative to Quantifying an advisor s value average client experience (in percentage of net return) Portfolio construction Suitable asset allocation using broadly diversified mutual funds/etfs >0% Use of low-cost index-based products 0.45% Asset location between taxable and tax-advantaged accounts % Total-return versus income investing >0% Wealth management Regular rebalancing 0.35% Spending strategy for drawdowns % Behavioral coaching Advisor guidance to help adhere to financial plan 1.5% Potential value added About 3% Source: Francis M. Kinniry Jr., Colleen M. Jaconetti, Michael A. DiJoseph, and Yan Zilbering, Putting a value on your value: Quantifying Vanguard Advisor s Alpha. Valley Forge, Pa.: The Vanguard Group. Note: For Potential value added, we did not sum the values because there can be interactions between the strategies. AssetMark 05

8 For more information, contact AssetMark at AssetMark, Inc Grant Street 10th Floor Concord, CA This case study is for informational purposes only. AssetMark cannot guarantee that all advisors transitioning from a commission-based practice to a fee-based practice will experience a similar outcome as described in this case study. This information is not intended as legal or compliance advice. AssetMark, Inc. is an investment adviser registered with the Securities and Exchange Commission AssetMark, Inc. All rights reserved M /2016 EXP 12/31/2017