24
For Advisor Use Only
January/February
2014
The Impact of Underpricing
After this brief review of industry data, maybe you are
ready to reassess your fee schedule. But how do you begin?
Let’s start by looking back at Figure 1 and considering
the tiers with the higher dollar amounts—$2 million and
up. If you underprice in these areas, it doesn’t really hurt
your business because managing these accounts at almost
any price is likely to be fairly profitable. A $4 million
account for which you charge 72 basis points, for example,
earns you $28,800 a year. For $28,800 annually, you
could spend a significant amount of time on the account
and provide your client with a lot of service while still
remaining profitable.
But if you focus on the lower-tier amounts—specifically
on the accounts valued at under $1 million—you can see
where underpricing could have a real impact on your
business. And these are the tiers in which the majority of
Commonwealth advisors’ accounts fit. You need to get
the pricing right here, as these accounts are drastically less
profitable, though probably just as much work to service,
compared with the larger accounts.
Take an account worth $200,000 for which you charge
a 1-percent fee to manage. This means that your annual
fee is $2,000. If you are worth $250/hour—and I would
contend that Commonwealth advisors are worth more,
based on their credentials and experience—that is eight
hours a year of work to remain profitable. If you add up
the number of hours you spend in meetings, prepping,
researching, and talking with clients annually, on average,
do you come up with more than eight hours? I bet that
most of you do.
So if you would like to make a pricing change, this is the
client tier you should target.
The Blended Approach
One way to increase the profitability on smaller accounts
is to switch to a blended fee schedule. Most advisors at
Commonwealth use a breakpoint schedule. In my opinion,
breakpoint
is a commission term—like the breakpoints
associated with A-share mutual funds.
A
blended schedule
is more of the industry standard. It’s
what institutional money managers and separate account
managers use. Let’s compare two almost identical
schedules—one a breakpoint and one a blended
option—as illustrated in Figure 2.
Figure 2. Breakpoint Vs. Blended Fee Schedules
Breakpoint
Blended
AUM
Fee AUM
Fee
Less than $500,000
1.15% First $500,000
1.15%
$500,000–$1,000,000 1.00% Next $500,000
1.00%
$1,000,000–$2,000,000 0.90% Next $1,000,000 0.90%
$2,000,000–$5,000,000 0.80% Next $3,000,000 0.80%
$5,000,000+
0.55% $5,000,000+
0.55%
Source: Commonwealth
At an initial glance, could a client even tell the difference
between the two schedules? They look pretty much the
same; however, with the breakpoint schedule, if you do
some simple calculations, you’ll find that your revenue
could drop even as the value of the account increases.
Suppose you handle a $995,000 account and use the
breakpoint schedule in Figure 2 to charge for your services.
Your fee will be 1 percent or $9,950 annually. If, over the
course of one year, the account value were to increase by
$5,000 (or slightly more than 5 percent) to $1 million,
your fee would actually drop, to $9,000 (0.90 percent
x
$1 million). So, even though you would have done a good
job and helped the client’s assets grow, your revenue would
drop more than 9.5 percent because of your fee schedule. It
is a flawed way to price the value of your expertise and labor.
If you were to use a blended schedule, however, your fee
for managing the $995,000 account would be $5,750 on
the first $500,000 and $4,950 on the next $495,000, for
a total of $10,700. If the account value were to rise to
$1 million, your fee would be $5,750 on the first
$500,000 and $5,000 on the next $500,000, for a total
of $10,750. So you would do better in both cases.
Wealth Management
/ Investments & Research
