• / Free eNewsletters & Magazine
  • / My Account
Home>Practice Management>Practice Builder>Designing Variable Compensation for Your Team

Related Content

  1. Videos
  2. Articles
  1. Bucket Portfolios for Retirement Income: Step by Step

    Morningstar's Christine Benz walks investors through the basics of setting up and maintaining a 'bucket' retirement portfolio, including some of her favorite funds for retirees.

  2. Our Favorite Funds for Retirement Portfolios

    Christine Benz's bucket portfolios for retirees focus on simplicity, diversification, and low costs.

  3. How to Fund a Long Retirement

    With mortality improvements, investors planning for a long retirement should consider an annuity, delaying Social Security, and being more aggressive with their portfolio.

  4. For Labor Day, Make Workplace Benefits Work for You

    Employees can maximize their benefits by investigating HSAs, free or cheap 401(k) advice, insurance, and other perks.

Designing Variable Compensation for Your Team

A variable compensation plan can reward and incentivize while also transferring some salary risk to employees.

Helen Modly, CFP, CPWA and Sandra Atkins, CPA/PFS, 09/15/2016

Advisory firms on average have embraced the concept of adding some form of variable/incentive compensation for their advisors, as well as staff. The primary purpose is to reward and incentivize individual performance, and a well-designed plan can also shift some of the compensation risk to your employees.

The largest expense, by far, for most firms is salary cost. This was historically pretty much a fixed annual expense for firms that don't silo clients by advisor (the "eat only what you kill" model). However, in 2009 many of these firms realized how vulnerable their revenue stream is to a severe or prolonged market drop. Eliminating staff is one response and reducing salaries is another, but those are very difficult and never well received

Over the years, as documented by the annual People and Pay reports provided by FA Insight, the average firm now keeps fixed salaries at a reasonable level and instead layers on variable compensation to reach the desired total compensation level. Variable compensation can be anything from a fully discretionary bonus to a bonus calculated by individual performance to a bonus derived from firmwide performance on one or more specific objectives. Although all these can be designed to reward and incentivize, they can also transfer some of the salary risk to employees. Industry averages are 10% of compensation being variable for associate advisors and 20% or more for senior/lead advisors.

What Would a New Business Incentive Plan Look Like?
Firms where every client is a client of the firm and not solely belonging to one advisor have some challenges in designing incentive plans. A new business bonus can't just be, "If you bring in this much in new assets, you will get this much in a bonus." How would you handle prospects who just call in from the cold saying they found the firm in an online search? Who gets credit for assets that come as a referral to the firm, rather than a referral to one advisor?

One strategy is to calculate revenue from new clients and divvy it up among the advisors, operations, marketing, and any other staff responsible for generating, closing, and onboarding new clients. You must be willing to share some of the financial information of your firm in order to provide transparency and actually motivate the desired behaviors.

It is important that the team members who share in the bonus pool have some form of influence over the results. For instance, most employees have no control over the expenditures of the firm, so profitability is not a good basis for incentive compensation. In addition, management might not want to share information with the staff regarding the firm profits. On the other hand, it's likely that advisors and support staff can estimate the fees billed on new client assets. The advisors, and possibly other support personnel, are responsible for bringing in new business, so receiving a quarterly incentive based upon the fees collected from new clients can bring some urgency for all of them to initiate, close, and successfully onboard new business in a timely fashion.

Why Include Staff in a New Business Incentive Plan?
Initially you would think that this should be an incentive for lead advisors who are out shaking the trees for new business. The truth is that the lead advisors can close all the business they want, but there must be a support team in place to prepare and process the applications, do the planning, make the trades, and handle all the other tasks involved in seamlessly onboarding a new client. Otherwise your lead advisors remain involved in the process too long or clients aren't serviced properly, jeopardizing the new relationship. The responsibility for providing outstanding service to clients belongs to all firm staff who "touch" the client.

What Would an Incentive Plan Based Upon Client Retention Look Like?
A plan based on actual fees collected from existing clients would provide an incentive for advisors and other staff to help service and retain clients.

The fees generated by most advisory firms are determined by the value of their AUM quarterly. AUM is influenced by several factors, some of which you can't control, such as the amount of client withdrawals and the performance of the market.

One activity you can control, in addition to the new business activity you maintain, is the level of service you provide to retain your existing clients. If your staff knows that they will receive compensation based on the fees collected by the company, and those fees will be higher if all the clients are kept happy, then you have another basis for incentive pay.

Client retention should be the responsibility of the entire firm--from the receptionist who greets clients to the entire team of advisors and client support personnel. If a client has a bad experience anywhere in his or her interface with the firm, the relationship could be at risk, so it becomes everyone's responsibility to take care of clients. This is most evident in situations where the clients are clients of the firm--even though the primary client interface may be with one advisor or team.

The amount of incentive pay can depend on your annual revenues, the number of advisors and staff who participate in the plan, and how you determine each person's share of the pool. One of the first decisions is what percentage of revenue are your willing to share? Will owner/advisors be included? Will years of service affect the payout? How will the payout differ based upon the roles or job descriptions? Then you must test the plan under varying conditions: severe down market, frothy up market, significant client withdrawals, significant deposits by existing clients, addition or loss of advisor/staff members. In all cases, does the plan pay enough to actually influence behavior? Does it remain close to your desired percentage of variable compensation? Can you afford it?

Sample Plans
Are any number of factors could be included in an incentive plan. The tricky part is to find the balance between a generous enough incentive to actually influence behavior and a reasonable amount that the firm can afford. You also need to understand the ratio between the variable and fixed components of salaries.

When you first offer a plan, it should be with disclaimers to your employees that you may have to "tweak" the numbers based on the growth of the firm assets and the number of employees. For instance, the percentage award for each level of incentive may have to decrease as the firm grows and there are more employees to share in the bonus. Setting an expectation that the plan will be reviewed annually is not unreasonable, as long as you communicate any issues and concerns clearly.

There also has to be a heightened level of transparency regarding the firm's financial experience. This doesn't mean an open-book policy, but you will have to allow employees to see and understand how the bonus awards are calculated.

New Business Plan. A new revenue plan could be based upon a percentage of the revenue collected in the prior quarter from new client assets. New clients are clients who have not reached their fifth billing cycle. Each employee, depending upon his or her role, would get a percentage of the new client fees. For example, senior or lead advisors might get 5% of the pool. Associate advisors would get 3%, service or support advisors 2%, and non-professional staff would get 1%. Your overall cost depends upon the number of staff and their roles as well as the percentages you assign to each category. Even in down market years, your team will be rewarded for the activities associated with developing and bringing in new business.

Retention Plan. This plan could be based upon a percentage of revenue from existing clients for the past four quarterly billing cycles and paid at the end of the year. It would exclude any revenue from clients who had not had their fifth billing cycle. In this plan, your team is rewarded for retention, but they also share in revenue loss due to market conditions or client withdrawals, which are not under your control. The pool in this plan is distributed by role and years of service, with senior/lead advisors over five years taking the lion's share, and newer team members and non-professional staff sharing a smaller piece.

The retention plan is a smaller percentage on a much larger fee base, since it is an annual calculation on all AUM except the new business. In this case, advisors with more years of service are favored, but all employees participate. The rationale is that advisors who have been at the firm longer had more influence growing the existing book of clients. You can easily adjust the qualifying employees and percentages based on the composition of your own firm.

Other Bonus Programs
Although the incentive programs discussed in this article may be sufficient variable compensation for most employees, there will always be those star performers who need additional recognition. You can add an additional layer into your overall compensation plan to allow for other primarily discretionary bonuses to reward exceptional performance. 

Helen Modly, CFP, CPWA, is President of Focus Wealth Management, Ltd., and a practicing wealth advisor. She is a member of NAPFA and Chair of the board for the National Capital Area chapter of FPA. She can be reached at info@focus-wealth.com.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

©2017 Morningstar Advisor. All right reserved.