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You are my friends and clients. I have great respect for the work you do and appreciate the value you add to the lives of your clients. That’s why it’s painful for me to see so many of you headed for trouble by denying the obvious trend in fee compression.
When I raise issues about your business model, some comment they “are not losing sleep” over the future because investors “will always need the guidance of a human advisor.” Sentiments of this nature recall this famous quote attributed to Upton Sinclair, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
Pressure on fees will accelerate
A recent article in Morningstar by John Rekenthaler noted the impact of robo-advisors and made this observation: “On average, over time, robo portfolios will beat those created by human advisors by about 75 basis points per year.”
Many investors now understand the difficulty of attempting to “beat the market.” They also appreciate the effect costs and fees, including those charged by advisors, have on reducing returns.
Rekenthaler claimed the financial services industry will follow the lead of mutual funds in reducing fees “up to a point.” Wealthy clients, and those with complex issues, will be willing to pay more for professional advice. However, even these clients will “push for steeper volume discounts.”
Rekenthaler concluded, “robo-advisors have only just begun. They will not conquer all, but they will expand greatly over the next couple of decades.”
If he is right (and I believe he is), the market for your services is going to shrink dramatically, and those clients who continue to use your services are likely to impose demands for lower fees.
This conclusion is buttressed by a report from PwC. It found 30% of consumers plan to increase usage of “non-traditional” (i.e., “robo”) financial services providers. Only 39% planned to continue using traditional advisors.
Paolo Sironi, an IBM thought leader with Watson Financial Services, predicted more fee compression in a recent talk at the Advicent innovation Summit, as reported by a blog post in Financial Advisor Magazine. Sironi said advisors will be servicing more clients as margins continue to decline due to the “commoditization of investment management.”
As a consequence, he predicted market forces will compel advisors to switch to an hourly rate “because the value of advice is trending away from the product the client buys.”
If you’re not losing sleep over these developments, you should be.
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Competition for clients will be more intense
I get many requests from readers of my books for financial advice. While I can’t provide advice tailored for them, I typically provide the following options:
- Do it yourself, using low-management-fee index funds. I refer them to this blog by Jonathan Clements, which sets forth options for putting together a globally diversified portfolio with a weighted average annual expense ratio of 0.05%.
- Use a fee-only financial planner from the Garrett Network who doesn’t manage money or sell products. These planners will provide a comprehensive financial plan and will assist clients in implementing their investment recommendations, using low-cost fund families like Vanguard. They have a one-time fee for the plan (ranging from $2,500 to $5,000) and a reduced fee for yearly updates. Their cost is significantly lower than the AUM-based fees charged by traditional advisors.
- Use a fully automated robo-advisor like Wealthfront or Betterment. Fees are generally 0.25% of assets.
- Use a hybrid service from a major fund family like Charles Schwab, Fidelity or Vanguard. These services provide access to qualified advisors. Fees are 0.30% or less.
- Use a traditional advisory firm. I generally recommend one firm that does everything in-house (including tax preparation and estate planning), one firm that does tax preparation but not estate planning in-house and one firm that coordinates with tax and estate planning professionals.
Because most people who contact me have assets under $1 million, almost all of them choose options 1-4. Many of them elect to invest themselves.
Some high-net-worth prospects use a compound interest calculator and compute the value of investing the advisory fee at a conservative rate of return over a decade or more. When they see how much this might cost them, they often decide to use the financial planner or hybrid service option. One investor told me he could "buy his daughter a home" for the difference between doing it himself and paying an advisory fee.
In every instance when they have chosen the traditional advisory firm, they have been able to negotiate a lower fee than the one initially quoted.
A plan of action
My plan of action is simple: Lower your fees. I’m not advocating any particular fee model. Consider following the lead of mutual funds. They kept AUM-based fees, but lowered the percentages.
Don’t be fooled by the “race to the bottom” argument. Vanguard “raced to the bottom” and it has over $4 trillion in assets in its mutual fund business.
Your services may be worth more than the 0.30% charged by Vanguard’s hybrid service. But how much more? Many of you charge 200%-300% more. That isn’t sustainable.
The writer William Gibson said, “The future is already here. It’s just not evenly distributed.”
Prospects are savvier. A business model built on serving clients who don’t realize alternatives are readily available at a lower price won’t survive.
Dan Solin is a New York Times best-selling author of the Smartest series of books. His latest book is The Smartest Sales Book You'll Ever Read. His sales coaching practice has expanded to include advisory firms throughout the world. Dan is no longer affiliated with any advisory firm.
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You are my friends and clients. I have great respect for the work you do and appreciate the value you add to the lives of your clients. That’s why it’s painful for me to see so many of you headed for trouble by denying the obvious trend in fee compression.
