21 – The advantages and disadvantages of time based fees
The main advantage of time based fees is their simplicity. Calculating the fee is a simple matter of recording the amount of time required for a client file and multiplying that time by the hourly rate.
Where clients require a firm estimate of costs beforehand, the adviser will need to determine the number of hours that are likely to be worked on a client’s behalf. There is, of course, a danger that the adviser will get their estimate wrong. It is not a big danger, though. Experienced advisers tend to become quite accurate in predicting how long a task or tasks will take. They also learn to deliberately overestimate the amount of time to be taken. If the actual time taken is less, this lets the adviser give the client some ‘good news:’ their fee is less than was initially quoted.
A further advantage of time based fees is that clients are typically familiar with this form of billing. Lawyers and accountants use this type of system. So do plumbers and electricians.
There is a further advantage flowing from the fact that professional groups, such as lawyers and accountants, typically use time based fees. A common criticism of financial planners has long been that commission-based remuneration systems have more in common with sales people than professionals. Time based billing is the standard for professional services.
Another advantage of time based fees is that they can reduce the chance of an adviser making a loss on a given piece of work. For example, an adviser may calculate that it costs them $100 per hour to provide a professional service. They will (hopefully!) set their hourly rate some way above this figure. This ensures that the adviser is making a profit for a given piece of time spent on a client file.
Finally, time-based fees can also place a limit on the extent of an adviser’s responsibility to a client. When a client pays via an alternative payment system, especially an FUM-based fee paid on an ongoing basis, there is no real ‘end’ to the adviser’s responsibility to act. This may not be the case with time-based billing.
For example, where an adviser quotes for ten hours work in setting out and establishing an investment strategy, and then provides the advice and puts the investments in place, the adviser can send the client an invoice for the ten hours work. Once paid, the contract has been completed.
The main disadvantage of time based fees is that they are limited: there are only so many hours available. It is of course possible for a financial adviser to work longer hours. It is also possible – although absolutely unethical – for a financial adviser to charge for more hours than they actually worked. It is difficult for a client to know precisely how many hours an adviser spent on a task: the client is not there when the adviser does all the work.
Notwithstanding these compromises, the basic limitation of time based fees is unavoidable: the only way to earn more income is to work more hours.
Limited time can also discourage advisers from completing other professional tasks for which no client can be directly billed. This can include things like training and practice development. This can lead to advisers finding themselves fully occupied working in their business such that there is no time available to work on their business. (This is, of course, the phase made most famous by Michael Gerber, of the E-Myth series of books).
A common criticism of time based fees is that they discourage efficiency. The faster an adviser completes a task, the less he or she gets paid. There is little incentive to do things more efficiently. Why run when you get paid more to walk?
Related to this is the fact that some clients may be put off contacting their adviser for fear of incurring a time based fee for doing so. This will be particularly the case for any clients who have ever previously needed legal advice: stories abound of clients choosing not to contact their lawyer (often to the client’s detriment) for fear of being charged in six minute increments for doing so.
A further criticism of time based fees is that they can make it difficult for an adviser to be properly paid for completing some tasks needed to assist a client. Many clients object, for example, to paying their adviser a fee to read previous statements of advice or speak with other professionals such as accountants, et cetera. They can argue that this is ‘background work’ that the adviser should do on his or her own account.