Charging fee to clients is a fairly new concept in India and as such there is not much precedence on the right way to do it. As such, a lot of RIAs are trying different methods of charging fee to clients. I want to caution them here that if they don’t get it right in the beginning, it will hurt later.

Initially, most clients start small and as such charging an AUM based fee to them won’t yield much. Therefore, many RIAs propose to charge a fixed annual fee to them, say Rs.5,000/- or Rs.25,000/- annually.  This is not a good idea. Once a client is used to paying a fixed fee, it will be extremely difficult to raise the fee in the proportion to growth of her portfolio size. For eg. a client’s portfolio can become 100x over 20 years but it will be difficult to raise fixed fee to 100x level. Even raising the fee to 25x will be not be easy.  Since an advisor can’t have huge number of clients, his/her growth will become limited by charging a fixed fee.

The business model of an RIA should be such that they grow with the growth of the client. The only way to achieve this is to charge AUM based fee, much similar to the way AMCs charge their fee. It should be a % of assets or can be profit sharing (subject to regulations and client’s comfort).

Some advisors may debate as to why a client who started with 10 lacs and who grows to 20 crores portfolio in 15 years time should pay an AUM based  fee of 15-20 lacs per year since advise is mostly passive and it only takes one or two meetings a year to manage such portfolios. Well, the justification of charging a fee based on AUM is not about the time spent or the efforts made. It is justified due to trust established and the quality of advice provided.  A good analogy can be a surgeon who charges his fee based on his expertise rather than number of hours it requires to perform the surgery. If the advisor himself/herself is not convinced about his value addition, then he/ she can never grow in this profession. Growth is not about how much assets you manage but how much fee you generate on that asset.

Hourly based fee or financial plan writing fee is also not a great idea. While it can give a kick to an advisor, it won’t help in the long term. These are not sustainable models.

So, even if the AUM based fee is small in the first few years, it is still worth it as future fees will more than offset the low initial rewards. Since the differential won’t be huge on yearly basis, even the clients will be mentally prepared about paying an increased AUM based fee with the increase in their portfolio. It will become a norm. Unless we take some fundamental decisions in the beginning about our practice, we might end up having a great book but unsustainable income. Link your growth with the growth of clients. That’s sustainable because there is no doubt that clients will grow.