Here’s a rare guide to how you can transform subjective performance bonuses into incentives to achieve specific, measurable metrics.
Steven Kaye, CEO of AEPG Wealth Strategies in Warren, N.J., and AEPG Director of Strategic Planning, Operations and Compliance Chris Schiffer, have been on a journey that is familiar to most advisors running midsize to large firms. “Employees are the number one asset for most of us,” says Schiffer, “and that is certainly true at our firm. About half of our total revenues go to compensation, so that is certainly an area to pay close attention to.”
Moreover, he adds, “there is a shortage of talent in the profession, and more competition is looming. So it’s very important to get the compensation formula right.”
Schiffer and Kaye shared their company’s journey to an objective, measurable compensation formula at our 2018 Insider’s Forum conference at the Hotel Del Coronado in San Diego, CA last September, and it was an eye-opener for many attendees. Schiffer noted that most advisory firms rely on the crudest of measures for evaluating the fairness of their staff compensation: the big picture benchmarking studies. These, he said, will tell you the total compensation that other firms are paying for different positions, sometimes broken down by size of firm and years of experience. But what about the structure? How much of that is salary, how much is bonus, and by what metrics are the bonuses calculated?
“People are curious about the structure,” says Schiffer. “The general agreement in our audience was that there should be more data around structure, since there are so many ways to carve up compensation.”
Commissions in drag
Kaye and Schiffer began their presentation by highlighting a single issue that had been a burr under their saddle for years—and which can be an important consideration as advisory firms look to expand the marketing skills of their next generation of advisors. How do you fit sales and marketing into your bonus structure?
AEPG’s original solution was to pay percentage incentives to advisors for the new business they generated—what Schiffer described as “commissions in drag.” Their formula was 30% of these new revenues in the first year, 20% in the second year, and 10% in the third. The advantages, Schiffer pointed out, were similar to the purely commission structure that you find at many brokerage firms.
“If you’re paying com-missions, the pro argument is that all the incentives are built-in,” Schiffer told the audience. “You bring in new business and you’re compensated for it. If you don’t, there’s no compensation.”
But the con argument is kind of important. A commission structure doesn’t always align the interests of the advisor with the firm—or especially the client.
Beyond that, AEPG was running into the often-difficult question of who had actually sourced each new client. “It was the first time in my history that we ever had friction with compensation,” said Kaye. “Was our pension guy the first person to talk with that prospect, or did the planner do the work of bringing him in as a client? We felt like we had to eliminate who sourced the client from the compensation arrangement.”
How is this issue being addressed in the profession today? In a survey that AEPG conducted with the Inside Information community, the presenters found that few advisory firms are providing any additional compensation at all to advisors or staff who source new business—even though roughly half expect their advisors to be business developers. “We feel like the profession may be swinging too far in the opposite direction, away from a commission-like arrangement,” said Kaye. “We think that there should be a happy medium.”
Is there a way to reward staff for bringing in new clients without developing a commission-like structure? AEPG’s solution, which might not be for everyone, is to make the business development role explicit for advisors, and to put an expectation of new business into the bonus formula. Each advisor is different, but a senior advisor might be expected to bringing in $30,000 of new annual revenue each year—and if that goal is achieved, he or she would receive the full percentage of the bonus allotted to that metric. If not, then there might be a partial bonus. If the advisor doubled the metric, then this portion of the annual bonus might be doubled.
To avoid conflicts over who sourced the business, everyone who touched prospects in the process of converting them to clients—assuming the touches were meaningful—received credit for the new business.
While they were at it, Kaye and Schiffer also added a cross-selling expectation to the formula. AEPG manages company 401(k) plans as well as providing fee-only planning for individuals. If an advisor’s individual client is a business owner, and the company 401(k) plan moves over to AEPG for management, those revenues are counted toward an annual bonus.
The bigger picture here is that the bonus part of compensation can be more scientific and specific than what you typically see at most of today’s advisory firms. One of the most interesting results of Kaye’s and Schiffer’s survey was that few planning firms are using measurable metrics when determining staff bonuses. The typical bonus system seems to be almost totally at the discretion of management, rather than tied to goals that the employees understand at the beginning of the year, and work toward for the next 12 months. As a result, bonuses can seem arbitrary, and fail to incent the very specific behaviors that are needed to drive the company forward in terms of client service and growth.
Notable not only in the survey of Inside Information readers, but also in the most recent Schwab survey, is that only about a quarter of advisory firms are tying compensation to revenue or productivity measures. Wouldn’t it be better to reward advisors who were, by the metrics, more productive than their peers?
After going through some intensive consulting with David DeVoe at DeVoe & Company, AEPG began to granularize its compensation formula. Among the considerations it now uses for both base and incentive compensation are: how many actual dollars of revenue is this particular advisor responsible for? How many clients is this advisor managing relationships with? How do those metrics compare with the benchmarking studies and industry-wide data?
“We are not sitting down with the planner and saying, we are paying you 26.5% of the revenue you’re driving,” Kaye told the group. “That is for management to measure, and we now have bands. It might be a $20,000 wide band before anything moves.”
This, of course, has the advantage of reducing overhead (and staff income) for an AUM-compensated firm during market downturns. As client portfolios go into a temporary decline, so, too, might salary or bonus compensation that is based on the advisor’s client revenues.
Meanwhile, the 26.5% number offers a decent estimate of how much of an advisor’s managed revenue he or she should be paid. “If you pay a planner 40% or more,” says Kaye, “it becomes hard to pay junior planners, deep support and the overhead to create a good work environment. If you pay less,” he adds, “you are not really providing the incentives.”
AEPG advisors are currently being benchmarked to a target of managing between 80 and 100 clients each, although that can fluctuate depending on the complexity of individual clients. Kaye admitted that this number is high by industry standards, but it works at AEPG because the support teams are larger than the profession’s average. “We found that our advisors can be more productive because we’re bringing on junior financial planners or associate planners to handle some of the more basic work,” he says. “Plus the junior planners are learning about the planning work, and we get two sets of eyes looking at each plan.”
Planners are not only compared with benchmark productivity metrics that are found in the various studies; they’re also benchmarked with each other. To achieve their bonuses, AEPG sets performance goals for new revenue generated, prospect meetings they achieve every six months, and a specific number of meetings with local centers of influence.
Of course, there are other parts to the bonus formula, including ratings on how the advisor or staff person functions as a member of his/her teams. Interestingly, in the survey that Kaye and Schiffer conducted, “teamwork” received the most emphasis and was the most-referenced metric in determining staff bonuses. “But it’s also the hardest to measure,” Schiffer noted, “which means it has a very large discretionary element to it.”
Finally, there are individualized criteria. AEPG happens to be converting its asset management system to Tamarac, so mastering Tamarac, and converting workflows to the new software, are part of the next round of bonuses. Achieving specific software masteries is frequently included in bonus considerations—which takes some of the subjectivity out of the calculation. The staff person can either demonstrate mastery of the software, and be incorporating the workflows into his routine, or not.
At the end of the presentation, Kaye and Schiffer said that some of the art in compensation design is, biggest picture, what percentage of the overall compensation should be discretionary and how much of it is base salary. Some of the performance metrics can be used to determine a stable base salary, and some for a fluctuating bonus every 6 or 12 months. AEPG has instituted a first-of-the-year performance review to set the goals for the year, and another review meeting at midyear to evaluate progress toward them. “Four items—client service, technical expertise, teamwork and business development—are in everybody’s review,” says Schiffer.
Of course, transitioning from one compensation structure to another is a challenge—and the conversation can uncover unexpected areas of staff discontent. “I’ve been doing compensation and performance reviews for years,” said Schiffer, “and the people who I thought I was going to have an issue with, I generally didn’t. And the people I believe have been treated very fairly, oddly enough, those are the people I had a problem with.”
The company implemented two policies that calmed the waters. First, they made sure that nobody’s compensation moved very far in either direction in the first year. And, second, there was an effort to keep the overall compensation in line (actually a bit above) the overall big picture figures taken from the benchmarking surveys.
Beyond that, Schiffer responded to staff apprehension directly. “They’d ask these questions, and I would say, ‘did you feel like you were paid fairly last year, salary and bonus?’ And they would say yes. I would say, what about the year before? Again, yes. So I said: ‘What makes you think we’re going to be less fair this time around? We’re trying to come up with something better.’ And I said what I believe for all of us in the profession: ‘whatever it is, compensation must be competitive.’”
Of course, bonuses are only one component of an attractive work environment. In the increasingly competitive race for talent, Schiffer and Kaye said that it’s important to pay attention to the other elements of a great place to work. The list includes flexible work schedules, personal development and growth opportunities, a comfortable office and work environment, and co-workers you enjoy working with.
As part of the package, which doesn’t fall under compensation, AEPG purchased standing desks for everybody in the office, so people could be more mobile during the day. The firm has instituted flexible work hours and work-at-home policies, and provides excellent health and retirement benefits. There are birthday parties in the kitchen, a group bowling day, holiday parties and free golf lessons for everybody.
“Participating in the “best places to work” surveys helps with these things,” says Kaye. “We started participating in the “Best Places to Work in New Jersey” program five years ago, and last year we were rated number 15. The process was very informative for us; they did a deep dive into our benefits and also did a survey of our employees directly, which gave us good feedback.”
The firm ranked number 38 in Investment News’s most recent “Best Places to Work” survey. “When you’re recruiting,” says Kaye, “we discovered that young people pay close attention to those surveys, so it becomes a big boost if you’re on those lists.”
I’m sure most of you have heard or read Mark Tibergien’s admonition that you want your compensation to provide incentives to do the things you want to happen in your office, and often those incentives become misaligned with your strategic goals and corporate objectives. The Kay/Schiffer presentation was unusually important because it actually led the audience toward creating a compensation formula that is more objective and more effective than the subjective bonus formula you see at many advisory firms. You are constantly reading about how these compensation plans should be better, more precise, more effective. But this presentation was a rare example of somebody putting meat on those tired old bones, and the audience came away with a lot of practical ideas that would help address Tibergien’s concerns.