Is pay-by-the-hour advice over the telephone the next big thing?

A few years ago, almost all financial advisers around the world charged clients a percentage of their invested assets. Nowadays there’s a whole range of charging models, including retainers, fixed fees and subscription fees, for consumers to choose from.

In all of those cases, clients are paying for an on-going service. But what about those who only want to pay for advice as and when they need it?

Financial writer and index fund advocate RICK FERRI is one of the most respected financial advisers in America. He recently started his own advice practice, Ferri Investment Solutions, based at his home in Texas, which charges clients by the hour. Consultations are generally held over the telephone or via video link.

In this in-depth interview, Rick explains why, in his opinion, there is a huge and largely unmet demand for hourly advice, and how, over a lifetime, paying for advice on an ad hoc basis can save clients a fortune.

Rick, you’re probably best known as an advocate of low-cost index funds, so it makes sense to start there. Despite all the evidence that active fund management is generally not worth paying for, most advisers around the world still tend to recommend it. Why do you think that is?

Advisers may have had their “a-ha moment”, they may have realised that this is the way to go, but they have a problem, in a business sense, with admitting it to their clients and going in that direction. I think a lot of advisers are afraid of telling their clients that they were wrong. And if they can get over that and say that they’ve had an epiphany and that, through their learning or their own analysis, they’ve come to this decision to move to low-cost, passive investing, they’re afraid that clients will say, “Well, what do I need you for if all you’re going to do is buy a few index funds?”

I’ll tell you from experience, that just doesn’t happen. If clients trust the advisers and, and the advisers go to the clients and say, “We’re going to move to passive investing because that’s what I believe in now,” almost all the clients will do it. It’s a problem with advisers. They have to get over that.

It’s much easier, though, isn’t it, if you’ve been recommending low-cost index funds all along?

Yes. About ten years ago, I was sitting on a panel at an ETF conference down in Florida, with probably one of the most famous advisers in the US at that time. It was a panel on active versus passive, and this guy — he was very well-known, but I won’t mention any names — was on the active side. But at the end of the panel, he turned to me and whispered, “If I could do it all over again, I’d do it your way.”

Do you think this is becoming a generational thing, with younger advisers recommending passive and older advisers sticking with active?

We have a saying here in the US that there’s a lot of advisers who are just trying to get to retirement, so they can sell their practice and move on, because it’s too difficult for them to make the change. And it’s too difficult for them to change their fees too, which is another revolution that’s occurring.

But how are those advisers going to sell their firms if they’re built on a dying business model?

Of course, it’s going to be “buyer beware”. Whoever the adviser is who’s going to come in and buy their book of business has to look at what that book of business looks like and make a determination of the future revenues that they can get from that with, maybe, a different fee model and a different investment philosophy. It just all comes down to evaluation of the business and what someone’s willing to pay for it. So, there is a market there.

The seller’s the one who always thinks their firm is worth so much money. The buyer’s going to come in and say it’s not really worth that much. So, there are a lot of advisers who are just hanging on with their 1% fee models, and maybe doing some active management, just waiting to retire.

You helped to run a very successful business called Portfolio Solutions. How did that come about?

I was disenchanted after a few years in the brokerage industry because there was this “high-cost product sales” thing going on. I had achieved my CFA and received my Masters of Science in Finance, and I was very disenchanted with how things were going, the high fees, the underperformance. So I decided I would start a low-fee money management company where all we used were low-fee index funds, and then I charged a low fee. So I started this small company out of my living room called Portfolio Solutions, which grew and grew into a large company with many employees.

You later sold that business, and your primary focus now is Ferri Investment Solutions, which provides financial advice as and when people need it, and charging by the hour. What was the thinking behind that?

I decided there were a lot of do-it-yourself investors, and a lot of investors who had been using an adviser but had terminated the relationship for one reason or another — in many cases due to the fees being charged. They still needed guidance, they still needed advice, but they wanted to get it “as needed”.

So I saw an opportunity to launch a business that I could just run on my own as a solo consultant. People could talk with me for an hour, they’d send me their portfolios, I would go over them with the clients, write something up at the end, and then send them on their way. Then they could implement the changes and make their portfolio simpler and easier. There is a huge, huge, huge demand. I can’t emphasise how big the demand is for this type of service.

How much do you charge?

I charge $450 an hour and I have a special offer for new clients — a “portfolio second opinion” for $375. I spend two hours looking over their information, talking on the phone with them, and writing something up at the end. That generally covers most of their questions. It’s a very small amount compared to the amount of fees that they’re currently paying. You can shop around and find an hourly adviser who might be less expensive than me, but the fees that they’re currently paying and the management fees for the funds they have can be in the thousands of dollars.

The business has only been operating for a few weeks, so it’s early days, but how busy have you been?

I had 165 people contact me in the first three weeks and in that time I did 30 hour-and-a-half consultations. My calendar is getting booked quickly. I haven’t done a lot of advertising. So far it’s just been built-up demand from people who’d heard that I’d started doing this.

I’m learning a lot by looking at all these different portfolios. I see a lot of mistakes where people are putting the wrong things in the wrong accounts, and they have too much in one type of account and not enough in another. They’re not utilising all of the resources they have available to them. So there’s a lot of commonalities.

What are clients saying to you about their previous experience of financial advice?

I think that there is a distrust growing out there, from the people I’ve talked with, about advisers in general. Not just the brokerage side, but the AUM side, the people who are charging 1% or more. People just don’t want to pay that much money any more. They know that returns from markets may not be what they were in the past, and why pay 1% per year to have a portfolio of mutual funds managed? People are beginning to realise that’s a lot of money. They’re becoming very fee-conscious — not just regarding their mutual funds, but also how much they’re paying an adviser.

I’m getting a lot of people contacting me after they’ve terminated their adviser relationship, saying to me, “I have this portfolio. How do I consolidate it? How do I make it manageable, so I can manage it going forward with just a little bit of advice?” I think there’s a big market. This is the next wave of financial consulting, I believe.

Do you find that an hour or two is long enough to sort out what can be quite a complicated situation?

I ask them to take very good notes so that I don’t have to spend another hour writing up my own notes. But I try to keep it down to an hour and a half. It takes me about 15 minutes to look over all the information beforehand. The meeting could even last 30 minutes, depending on how complicated it is, or it could last an hour, so at the end I’ve got extra time to write a few notes about the things we’ve talked about.

Out of the consultations I’ve done so far, that was enough time to take care of it for more than 90% of them. There have been a couple where I needed to spend longer because it was more complicated. I tell them, during the call, that if they want me to spend more time writing up each individual account and get very specific, it might be another hour or two at $450 an hour. I leave it up to them, though.

Do you recommend that your clients come back to you in, say, two or five years’ time?

I don’t recommend that they do anything other than just take the advice that I’ve given them on that particular day. I basically say, “If you need me in the future, just get on my calendar and schedule another hour. I’ve got all your information. Just schedule an hour and we can talk about whatever you need to talk about.” I leave it completely up to them. If what I’ve given them is good and they never contact me again, that’s fine. But if they want to get in contact with me again later, that’s fine as well.

It seems as though what you’re offering is essentially investment advice rather than a broader, goals-based financial planning proposition. Is that right?

I think that a client’s the goals and what they want their money to do for them is all part of the investment advice process. If you’re talking about what type of health insurance they should carry, or what type of trust they might establish for a child who has special needs, things like that, I wouldn’t deal with those. I’d send them on to somebody who is a specialist in that area.

But questions like “Do I have enough money to retire?” and “How much do I need to retire?” are investment-related questions and they fall under the advice that I give. It’s pretty broad but it doesn’t get into other areas that a planner might. For that I would send clients on to a service here called Advice-Only Financial that can find a financial planner to suit their specific needs.

In your view, then, why are hourly fees better for the client?

I call it a decoupling of the adviser fee. It’s a decoupling of the size of the client’s portfolio from the advice you’re giving them. I just don’t see why you should charge a person with $50 million more than you would charge someone with $500,000. It might be more complicated because they have more money, so it might take a bit more time. But it doesn’t take ten or 50 times the amount of time. So I want to better align the advice portion with the actual work that’s being done.

Then, the second part of this is the management, the implementation. And either the clients can do it themselves, or they can hire a firm to implement the plan that the adviser comes up with. Here is where I’m trying to shake up the industry again. Normally when you see an adviser, they’ll say, “We’ll do the plan, and then we’ll implement it.” Well, here you have an outside adviser doing the plan and, when it comes to the implementation of that plan, the client can go to an adviser and say, “We already have the plan. All we need you to do is implement it, maintain it, rebalance it once in a while, tax manage, cash manage, do the things that you do as an asset manager. And we will pay you a small, annual fee of perhaps a quarter of a per cent per year to do that.”

So again, it’s a decoupling of this adviser-money manager model. You’re separating the advice part, charging for that, and then giving the management portion to an adviser with a low fee so that they can implement it through the systems they already have. It just reduces the costs for the client.

The advice profession globally seems to be moving away, albeit very slowly, from the old ad valorem fee model. It's often said that d valorem discriminates against wealthier clients, but at least it enables the less well-off to access advice as well.

Yes. The problem is, however, that once an adviser has been in business for a while, they don’t want smaller clients. It might work initially for an adviser who has just started, and who will take any business. But, after a while, an adviser will realise that they can’t do the smaller clients because there’s not enough money in that. They need to make a certain minimum amount — say $2,500 dollars a year — to break even on a client, and if a client doesn’t have enough assets, you just can’t take them as a client. That’s just the reality of the adviser business. As you get more successful, you only want big clients because that’s where the margins are.

It’s always been a problem, what you do with the smaller clients. This is where companies like the robo-advisers have come along and said that they can service them. I think that’s a good model. In the next generation, I think that’s how the advice will be dispensed — through robo. But that’s the next generation. Right now, we’re in the phase where this transition is just beginning.

What about the subscription fee model? We’re starting to see more of that in Europe. Is it the same in the US?

Sure, we have the XY Planning Network who have started a subscription service. They’re part of Michael Kitces’ and Alan Moore’s group. Depending on the complexity of a client’s situation, it’s maybe between $150 and $300 a month, and you have full access to an adviser. So that’s another way of addressing the demographics of the younger client, who doesn’t have that much money — just pay a monthly fee.

Finally, Rick, advice firms in the US are now having to compete with big adviser networks offered by firms like Vanguard and Charles Schwab. What do you make of those?

I think Vanguard’s doing a great job of showing the world that you don’t have to pay a lot of money for advice. Here in the US, they charge 0.3% of assets under management to talk with anyone who has, I believe, $50,000 or more. And that’s great. I guess the disadvantage of being with Vanguard is that they will only recommend Vanguard funds. As you say, Charles Schwab just started a similar service where they’re charging $300 upfront and then $30 a month, and that’s fine too.

90% of investment management rules are pretty standard, and what I tell my clients is pretty standard. Total stock market index funds, total bond market funds — these are not exotic, difficult, complex solutions. So to show the world, as Vanguard has, and Schwab has, that advice doesn’t have to be expensive is a good thing.