Fee Compression Hasn’t Played Out, But Margin Compression Is Real

In talking with RIA owners and particularly RIA operations professionals, the topic of fees often comes up. “What is your standard fee rate? Have you had to lower your fees over time?” are common questions posed from one RIA to another. The value clients place on traditional asset management (“stock picking”) has declined significantly over time. Clients have a myriad of options for purchasing low-cost, well-diversified portfolios through a number of digital solutions or ETFs. Financial advisors who have focused their value proposition solely on their ability to build portfolios and “beat the market” have seen their fee rates plummet in recent years. But the majority of advisors who have focused on a more comprehensive value proposition, who have broadened their service offering beyond simple asset management, have maintained their fee rates, and in some cases, have even managed to raise fees.

By adding additional services to their traditional offering of asset allocation and investment management for liquid assets, advisors have been able to explain to clients that their AUM fee encompasses much more, thus keeping their fee level constant over time. Clients are now receiving access to alternative investments; comprehensive financial planning is now included as part of the AUM fee being charged; many firms are now offering trust and estate planning, bill pay services, insurance reviews and in some cases, RIAs are now processing tax returns on behalf of their clients. There clearly has been downward pressure on fees, with clients asking, “What am I getting for the fee I pay you?” Advisors, in my opinion, have done a great job in articulating the full value of those fees, and thus justifying their worth to their clients.

But not all is rosy in RIA land. While these additional services have kept the average fee rate constant, these new services cost money (CFPs, CPAs, attorneys and licensed insurance agents don’t come cheap!), thus putting downward pressure on profit margins. In addition to increased labor costs, in many cases, these new service offerings require additional technology tools. These services are also tougher to scale than asset allocation models that can be executed through trading and rebalancing software. If an RIA has managed to keep revenue stable by maintaining fee rates but has dramatically increased the cost to serve clients, profit margins will plummet, and the business will be in trouble.

On a recent podcast with Michael Kitces, Mark Tibergien defined “scale” as “revenue growing faster than the firm’s expenses.” Therefore, if these additional services haven’t maintained fee rates and resulted in more clients (more revenue), these additional services will do nothing more than put the RIA out of business. At the same time RIAs add these services, they need to increase their marketing spend to ensure the marketplace is aware of the firm’s additional capabilities. Unfortunately, not every firm is able to increase labor costs and increase marketing costs at the same time, but it is necessary.

With more arrows in their service offering quiver, firms can tell a broader story to attract new clients (and increase the wallet share of existing clients). In many cases, the RIA can attract larger prospects than those clients traditionally serviced by the RIA. Larger, more complex clients will be looking for help with estate planning, bill pay, access to non-traditional asset classes, etc. With these services now part of the marketing efforts of the firm, more prospective clients should now be attracted to it. And once they hire the RIA, with so much of their financial lives being catered to, the assets should be stickier than simple “investment-only” clients.

The only reason we haven’t seen fee compression is because firms have pivoted to offering more services to justify those fees. Without an uptick in the number of clients served and/or the average size of those clients getting larger, thanks to these additional services, RIAs could find themselves in a precarious situation. Business owners must always remember that profit margins are quite literally the bottom line when it comes to their business. Additional services can justify fees to clients, but RIA owners must also justify those services to themselves by tracking their margins. These additional services should be touted loudly in the firm’s marketing campaigns to attract new (and hopefully larger) clients. It’s the compression of margins, and not necessarily fees, that owners should be tracking.

Matt Sonnen is Chief Operating Officer at Coldstream Wealth Management, as well as the creator of the digital consulting platform The COO Society, which educates RIA owners and operations professionals how to build more impactful and profitable enterprises. He is also the host of the popular COO Roundtable podcast.