AdvicePay Financial Advisor Community Blog

How Fee-For-Service Billing Keeps Clients Fully Invested For the Market Recovery

August 26, 2022 By Bill Winterberg, CFP®
Bill Winterberg, CFP®

Stock market declines are a part of the long-term investing process, and unfortunately, nobody can consistently predict when and by how much the next significant drawdown will be. 

Financial professionals encourage long-term investors with prudent advice to remain focused on the long term and resist reacting impulsively to day-to-day market volatility, helping investors avoid selling when the market is low and subsequently buying higher after a market recovery.

However, investment portfolios from which ongoing investment advice fees are debited could be forced to sell investments during the middle of a market decline in order to raise sufficient cash to cover their fees. Not only does this action result in the sale of a portion of long-term investments when prices are low, but it also sustains a small but non-trivial level of cash drag to the portfolio’s overall performance, as a percentage of the portfolio’s balance is typically held in cash to pay for ongoing investment management fees.

Both investors and financial professionals want to keep long-term portfolios fully invested at all times, allowing the entire portfolio balance to benefit from the market’s eventual recovery and subsequent appreciation over a long-term time horizon. One solution aligned with this long-term investment principle is to implement fee-for-service billing paid for by using accounts and assets that are separate from an investor’s long-term investment portfolio, and this is a solution that financial professionals can implement with AdvicePay.

Sell Low, Buy High?

One of the more well-known adages in investing is “buy low, sell high,” where investors take advantage of short-term declines in the stock market to purchase additional investments, hold the investments for decades, and eventually sell them after multiple periods of significant growth and appreciation.

When financial professionals deduct ongoing investment advisory fees from client portfolios, cash allocations can often be insufficient to cover the advisory fees, especially in portfolios where dividends are not received in cash or there are no regular cash contributions added by clients into the portfolio. Therefore, advisors will sell a portion of the portfolio’s investments to raise cash to pay investment management fees. However, if the need to raise cash occurs during the middle of a recession and a bear market, the advisor’s activity contradicts the “buy low, sell high” adage by selling investments during a period when they are low!

Investments that are sold to raise cash to pay fees are rarely, if ever, reinvested back into the portfolio. As a result, the portfolio does not fully participate in the subsequent recovery and bull market phase of the investment cycle, decreasing the portfolio’s future total returns and lowering the odds of meeting clients’ anticipated financial outcomes.

As an alternative, financial advisors can adopt fee-for-service billing models, where fees are paid with client cash flow or assets outside of long-term investment accounts, and avoid selling investments during the depths of a bear market.

Costs of Cash Drag

In a July 2022 informal poll on LinkedIn by Michael Kitces, the majority of over 1,000 advisor respondents indicated that they maintain between 1% and 2% of client portfolio allocations in cash in order to pay for ongoing investment management fees. This allocation to cash introduces cash drag to the portfolio, which is another way the portfolio’s long-term total returns are decreased, especially for investors who plan to remain invested over three or four decades.

In addition, cash has the lowest expected returns of all investment assets, with brick-and-mortar banks paying interest around a meager 0.05% per year. Money market funds have higher seven-day SEC yields than cash, currently yielding around 1.5% to 2.0% as of early August 2022. But with the year-over-year inflation rate for the United States exceeding 9% for the period ending June 2022, cash is rapidly losing its purchasing power, causing savers to experience a real negative return on cash!

Finally, most investors that hold mutual funds and ETFs already have a few percentage points of their portfolio allocated to cash, simply due to the cash holdings inside the funds they already own. According to Morningstar, Inc., across the universe of U.S. equity funds, the average cash weighting of the holdings in mutual funds is around 3.2%. Maintaining an additional one to two percent of the portfolio’s balance in cash set aside to pay fees could increase the entire portfolio’s total cash allocation by 30 to 60%.

Implement Fee-For-Service Billing

With the increased adoption of fee-for-service financial planning and investment management, advisors are able to avoid the drawbacks of forced investment selling to cover fees in the midst of a recession, as well as reduce the long-term effects of cash drag in client portfolios. Fee-for-service billing allows advisors to invoice clients directly for financial services, and clients have the flexibility to compensate their advisor using their payment method of choice… from a bank account outside of their managed portfolio.  

Once a fee-for-service billing agreement is in place, assets allocated in long-term portfolios can remain invested over multiple economic cycles and no longer need to be sold to generate cash needed to pay for fees. And since fees are no longer debited from investment accounts under fee-for-service billing, portfolios no longer need to maintain an allocation of a few percentage points in cash that is reserved to pay for recurring fees, significantly reducing cash drag.

AdvicePay Supports AUM Fees

Just because fees are paid using assets that are not a part of the investment portfolio doesn’t mean that advisors must abandon fee calculations based on a percentage of assets under management. All plans of AdvicePay include a fee calculator tool that advisors can use to calculate fees based on a variety of inputs, including a household’s assets under management or net worth value. Click the links below to view our knowledge base articles on how to set up the AdvicePay fee calculator and how to bill AUM fees on AdvicePay:

Fee Calculator: https://advicepay.helpscoutdocs.com/article/402-using-the-fee-calculator

How to Bill AUM Fees on AdvicePay: https://advicepay.helpscoutdocs.com/article/509-how-to-bill-aum-fees-on-advicepay

Advisors can gather relevant data regarding a client’s assets or net worth and use the information to generate a one-time invoice for the client. The process of creating one-time invoices for clients is not very scalable, so advisors with a growing number of clients paying AUM fees with AdvicePay may want to consider more streamlined approaches to invoice generation.

AdvicePay Professional and Enterprise plans support multiple one-time invoice generation by uploading a CSV-formatted document that contains client email address, invoice description, due date, and total fee amount. Generating invoices through a bulk process is much more scalable, so advisors serving dozens or hundreds of households that pay AUM fees with cash flow or other non-invested assets will benefit from AdvicePay plans that support this feature.

Some AdvicePay users leverage third-party portfolio accounting or billing software to perform detailed fee calculations on assets under management, such as calculating the average daily balance of a portfolio over a specific time period or aggregating accounts among multiple client generations in order to qualify for AUM fee breakpoints. Again, the results of those fee calculations can be exported or copied into a CSV-formatted document for streamlined invoice generation inside AdvicePay (Professional and Enterprise plans only).

Panoramix Integration

One of the most recent AdvicePay integrations was with Panoramix portfolio management and accounting software. Panoramix users can calculate fees for clients using customized fee schedules established in Panoramix, and then automatically send the fee data through the AdvicePay integration to generate invoices that reflect the fee calculations from Panoramix. Not only does this allow clients to pay investment management fees using their payment method of choice, but Panoramix includes the fee transactions in the client’s portfolio activity so that performance reports reflect the true, net-of-fees performance results. 

See the details of the Panoramix integration by reading the press release linked below: https://advicepay.com/news/advicepay-panoramix-integration 

Fee-For-Service Keeps Clients Fully Invested

Long-term investors acknowledge that it is necessary to assume a certain level of risk in a portfolio in order to be rewarded with growth in the value of invested assets over time. Unfortunately, no one knows when the stock market will experience a significant decline, so investors should be prepared to hold their investments for the long term and resist the temptation to sell when asset prices are low. Financial professionals should also support clients’ long-term investment goals by avoiding the sale of investments during market declines in order to raise cash for fees. Implementing AUM billing paid for using assets outside of long-term investment accounts avoids the forced sale of long-term investments during market declines and also decreases the negative impact of cash drag within a long-term portfolio.

To determine how AdvicePay can be used for your firm’s AUM billing, sign up for a free trial using the link below.

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Posted by Bill Winterberg, CFP®

Topics: Compliance, Retainer Model, Practice Management, User Experience, Fee-For-Service, Enterprise