Perceptions of value
The concept of Value being in the eye of the beholder is familiar to most people. The premise of this concept is that value is subjective; different to everyone and essentially defined by the person purchasing the good or service.
If that person does not see value, then they simply choose not to make the purchase.
But what about when roles are reversed? FASEA Standard 7 says in part, “You must satisfy yourself that any fees and charges that the client must pay to you or your principal, and any benefits that you or your principal receive, in connection with acting for the client are fair and reasonable, and represent value for money for the client”.
This means that the adviser now must have a view on what would constitute Value in the eyes of each client, for their individual circumstances. It’s not just enough to rely on the client being prepared to pay. ‘Buyer beware’ is no longer a concept that works in financial advice.
Because value is subjective, advisers have tended to use a proxy as a means of calculating what is charged for advice. In the past this was commonly asset-based fees. “I charge 0.8%, you’re investing $1mill therefore my fee is $8,000 per annum”.
From a business perspective, this may have made sense when the value in a financial planning business came from building up Funds Under Advice (FUA). The more FUA, the more valuable the business was. Therefore, having a revenue model based on FUA made for neat synergy when running a business.
Today’s businesses are being valued on more than just FUA – in fact, with the separation of advice and product (goodbye grandfathered remuneration), the relevance of FUA is almost non-existent, unless you’re talking to a Fund Manager or platform eager to win your favour.
The profitability of the business and then a multiple based on various quality factors generally drives value.
Certainly, as a business owner, it is the level of profit the business creates that should be the key consideration, not just FUA or gross revenue.
Moreover, the value being provided to clients is rarely defined purely by the returns that are generated from an investment recommendation. Indeed, there may be a greater net return for a client to pay down debt, or reinvest in an asset that is not ‘managed’ by the advice firm, or the myriad other benefits that a great financial plan will generate.
So, when the objective of clients is to make the most of their financial resources to live their best life, and the objective of the business is to grow advice revenue and profitability (through acting in their clients’ best interests), what is a suitable proxy for Value when it comes to determining the Price of your advice? Some advisers still want to use a percentage of portfolio value as the determinant of the fee, largely because “this has always worked”. However, as a determination of value, FUA is a poor proxy as it doesn’t truly reflect the cost of delivering the advice nor does it reflect the value as seen by the client.
Pricing what’s valuable
Client need and client complexity should be how you link fees to value. Simply put, where there is compelling client needs and greater complexity in their circumstances, there is a greater opportunity for an adviser and the support they provide to be valued by the client.
What this creates is an ability to calculate a base pricing model that takes into account, complexity and effort and then determining when a client should be charged more than the minimum fee. We refer to this last step of the pricing process as a Value Overlay as it reflects the subjective nature of the additional value created by the adviser.
Where to start?
First, calculate the Minimum Recoverable Amount, that is, the minimum fee you will need to charge in order to deliver your standard service including a desired profit margin. Any client that you cannot recover this fee from, you have to say “no” to, as they will not be profitable.
The next step is to identify additional items of work and calculate the additional costs in providing this advice which need to be incorporated into the fee quoted (including your desired profit margin). These can include (among others):
- Complex family situations requiring sophisticated Estate Planning strategies
- Limited excess cashflow requiring greater focusing on budgeting advice and accountability
- Self-employed clients with variable income and changing advice and tax requirements throughout the year
- Complex SMSF or Family trust structures requiring additional work
- Aged care advice for an ageing on infirm parent
The additional fees for each element can be calculated based on the increased work expected to address these issues. By adding these elements to your base fee you have a total fee calculated.
You can now determine whether a Value Overlay based on the particular client needs is appropriate or required. Some of the considerations that may create the need for the Value Overlay are:
- A client anxious about investing in the market may require additional contact both proactively and reactively.
- A larger portfolio may require additional investments to provide greater diversification leading to additional research and administration effort.
- A more sophisticated client may desire an investment portfolio with more exotic assets also requiring additional research and administration effort.
By definition, a Value Overlay is about intangibles and hence harder to quantify. For this reason, it is often calculated as a percentage increase to standard fees reflecting the specific needs of a client.
For example, as a result of the client’s needs you may determine that you need to increase your standard fee by 10%. Another client with different needs might have a value overlay of 15%; it is a judgment call based on the client’s individual circumstances.
While a pure asset-based fee is rarely an effective method to determine price, you may find that applying a premium to your fee for larger portfolios is warranted. Not so much for the risk involved, but to recognise the additional net return your advice can provide, and the impact on your PI premiums that can be difficult to quantify across a client base. As an example, your minimum fee may cover clients who invest up to say $1M through you, and then anything over that attracts an additional fee added in bands of FUA. (eg $200 per $100k over $1M).
Regardless of which method you use to apply a Value overlay – or if you apply one at all, it’s imperative that you first ensure that the clients you are attracting to your firm will be of the ilk that will obtain value for the quantum of fees that you need to charge to run a sustainable business. You must also reflect on each client, and be satisfied that your fee (whether it be your minimum or inclusive of an overlay) will represent value for them. The client can of course, still make their own determination, but you as the adviser must first be satisfied.
When properly calculating the cost to serve then applying an appropriate value overlay, you can ensure you are profitably running your business while satisfying the FASEA requirement of ensuring it represents value for money for the client.