Virtually all advisors operate with a value proposition built on bettering their clients’ financial future through management of their assets. But trends in the workforce and capital markets will force advisors to rethink those assumptions and, if Richie Lee is right, the planning firm of the future will adapt a four-factor service model that places much greater emphasis on helping clients maximize their human capital.
Lee is a living legend in planning circles, in part because his firm – Lee Financial in Dallas, TX – has consistently been ahead of the professional curve. Lee was fee-only before the term had been coined, and is one of the inventors of the AUM-based business model. He was pooling client assets into nontraditional investment vehicles before hedge funds were popular, and was a consistent advocate of creating viable businesses and internal career paths when the advisory profession was primarily made up of small scattered practices.
Lee’s recommendations are a byproduct of the comprehensive white paper I recently wrote on excellent client service and service standards in the financial planning profession. After sorting through more than 400 very interesting service-related comments from advisors, I managed to isolate six key factors that are important components to offering great service, with dozens of eye-opening examples in each area.
One of them, obviously, is the quality of the professional advice you provide. One advisor commented that you can offer the client's preferred beverage when she walks in the door, and host terrific client appreciation events. But if you're not giving quality financial advice, those other things are irrelevant.
This raised an interesting question: what qualifies as quality financial advice today? The world is changing dramatically: more volatile markets, shifting labor markets (goodbye to lifetime employment, hello to free-agent employees), delayed retirement, a new emphasis on personal fulfillment and less on wealth, and charitable inclinations in the not-unusual case where clients have saved more than they can spend.
Lee has given careful thought to those questions. He is taking off in a new direction, and rethinking the traditional client service model around which the RIA profession has coalesced.
The evolution of the advisory industry
To see where Lee is going, one must recognize some base assumptions that are part of our professional environment. "One of the interesting things about this profession is that most of the people in this business tend to be analytical," he says. "And that means that they aren't as strong on the innovation side as the people you see in other businesses. In the history of the profession, it was all a big experiment because we had no models,,” Lee continues, “and then a few of us became successful, and suddenly we had a service model that everybody was adopting without asking whether it was the best that we could do."
In fact, if you look at the financial services business in a certain way, Lee says, you see that it is eerily similar to the way brokerage firms have operated. The evolution of the profession can be seen as different wirehouse departments or functions finding their way outside of the brokerage structure – basically recreating all the different functions in a wirehouse firm in a broader market outside the firm structure.
Thus:
- People from the brokerage firm's operations group started independent broker-dealers and custodial services like Schwab Institutional, Fidelity Advisor Services and TD Ameritrade Institutional.
- The brokerage firm's retail trading business, which made its money on trading commissions, migrated out into the marketplace and became the discount brokerage firms who advertise that you can trade your way to success.
- The proprietary trading desk that traded for the brokerage firm's own account became the hedge fund industry.
- The in-house mutual funds became the no-load fund industry and ETFs.
- The research department became Morningstar and Lipper.
- The software teams that created trading and client tracking programs became the software industry supporting the RIA world.
And brokers morphed into retail RIA advisors.
"The point is that none of this was a planned thing," says Lee. "And if you look at the services that advisors provide, it is still modeled on the brokerage model – just like the entire support structure that we work with. You're tending client portfolios and giving out analysis that supports your investment decisions."
What could be done differently? Lee suggests that the financial advisory firm today is evolving toward a professional service platform, which basically means that you – the advisor – provide a certain type of advice, and the client has to adapt and plug into that framework. You walk into a brokerage office, and you walk out with investment recommendations. You talk to an advisor and you get portfolio recommendations and sometimes a financial plan.
The alternative, Lee says, is a personal service platform. If you're offering personal service, then it's the advisor's responsibility to plug into what clients need. You have to be the one to adapt, not the client.
This sounds like a simple shift in thinking, but the implications are enormous – and, for many advisors, disturbing. When you adapt your financial expertise to the client's needs, you become involved in the myriad financial decisions that come up in the client's life: buying a car and negotiating the best price; helping clients find the lowest-cost home loan or arranging a line of credit for her business at one of the local lending institutions; arranging for home care for an elderly relative; identifying reputable vendors for home repair, remodeling, auto repair – and a lot of other things that you are probably thinking about because you've faced these challenges in your own life.
The end of managing clients’ assets?
Instead of simply managing the client's assets, Lee says, the financial advisory firm of the future will be managing the client.
What does that mean? Let's start with the obvious. If you can convince a client to save a bit more of his/her income, the result, in terms of terminal wealth, will be dramatically larger than if you can manage to squeeze an extra 1% of return out of the portfolio. On the other hand, if the client saves just a bit less every year, no amount of fancy investment footwork is going to save the portfolio. In this area, at least, small changes in the client's behavior will overwhelm the most heroic efforts on the portfolio management side of the ledger.
So where should the advisor put most of his/her efforts?
Recent research showing flows into and out of funds and markets (Lee cites a JP Morgan study, but he could just as easily have pointed to research by Dalbar or Morningstar) indicates that the average investor gets about half (or less) of the long-term returns offered by the market. Keeping the client steadily invested, and managing the emotions, is immensely more valuable than any incremental above-market returns you might achieve with tactical asset allocation.
Yet most advisory firms have an investment committee and staff who are focused on squeezing those incremental returns out of the portfolio, and nobody other than the advisor who is responsible for helping clients change their behavior. Lee envisions a time in the future when advisory firms will have a psychologist on staff whose job description is facilitating client behavior change from poor habits and self-sabotage to healthy financial habits and self-enhancement.
If we expand the discussion a bit, we see that there are other areas you could focus on that might produce even better outcomes. Lee starts with human capital – the value of a person's skills and career, which can be quantified as the present value of future earnings. If you can help the client make small incremental gains in her ability to harvest her human capital (acquiring the skills to get a better job, starting a business, negotiating a better salary or faster promotion, moving opportunistically from a position with one company to a better one with another), the result will be even more dramatic than shifts in the client's savings rate or investing steadiness in the face of shifting markets.
Lee believes that helping clients with their human capital may be far more valuable going forward than it ever was in the past, as we move out of lifetime employment models and stable careers into a brave new world of value-driven, high-volatility, free-agency employment and entrepreneurship.
Interestingly, Lee makes the case that managing a client's human capital will help the advisor achieve higher portfolio returns. "All the research you see about investors moving their money out of the market during the downturn," says Lee, "tells you that the reason is because people are irrational or emotionally unstable, or not smart enough to know that they should buy low and sell high. What the research doesn't take into account is the fact that moving to the sidelines is often a perfectly rational decision," he adds. "As the volatility of human capital soars, as people don't know whether they're going to be able to keep their job. If they actually lose their job, suddenly the portfolio has to provide the income they need to stay alive. There's nothing crazy about the decision to pull it out of the markets. And," he adds, "they don't get back in until their job situation has stabilized. It has nothing to do with whether they can get back in emotionally; it's a function of their employment and financial situation."
In other words, as advisors recognize how human capital issues impact a client's investment decisions and portfolio returns, they will increasingly divert some of their attention toward their clients' work life. And, of course, just as the employment environment is becoming increasingly complex and chaotic, so too are the markets. So too are the events that impact peoples' lives. If you don't believe this, look at all the black swans flying around your client portfolios: the great recession and the credit crunch, sovereign debt crises in Europe, the tragic tsunami and nuclear disaster in Japan and the uprisings in the Middle East.
Providing advice and service in these other areas of a client's life – savings habits and human capital – will become more important for another reason. Lee asks, rhetorically, if anybody believes that the markets are going to provide the same generous returns going forward as they did during the period when most advisory firms were incubated. He showed me a slide which calculated the S&P 500's cumulative return from 1981 to 2000, after inflation: a remarkable 480.20%. From 2001 to 2006, the cumulative real return was 3.90%.
From 2007 to 2025, the respected economist Woody Brock is projecting a cumulative (real) 28% gain. You can quibble with the projection if you like, but consider the basic conclusion: if clients are going to achieve their financial goals, the money won’t come from outsized stock market returns. More importantly, financial planners and their service models will face increasing pressure to justify their value in the context of more modest market returns.
Defining a new value proposition
The bottom line here is that Lee believes that financial planning firms will have to hook their value proposition to something broader than market returns. At the same time, as they project forward, they will realize that terminal wealth will be built more predictably, and more powerfully, by enhancing their clients' human capital and savings/investing behavior.
If you accept this line of logic (hypothetically, for now), it raises some pretty basic questions: What will that new "managing the client" service look like? How will you describe it? How will you deliver it? And how does that impact the structure and staff of the planning firm of the future?
To formulate this broader value proposition, Lee starts by identifying the most basic things that people value in their lives. Start with human capital, which I've already discussed at some length, so I'll just say that the planner of the future will help clients more effectively harvest revenues from their talents and skill sets by:
- making them more aware of opportunities;
- by lending them professional expertise to, say, start a side business or negotiate their employment contracts; and
- by making sure their clients set aside time and capital to build those talents and skill sets throughout their lives.
Then there's what Lee calls "fulfillment capital," which can be broadly described as "spending money to make you feel good." This can be anything from vacation trips to sending the grandkids to private school to taking up a fulfilling new hobby. For many people, this represents an enormously unplanned area of life; how many of us default to watching TV when we're bored, giving ourselves a convenient but watered-down form of fulfillment when we crave something more dramatic and fun?
Interestingly, this may become the area that clients value most in their planning relationship. If they weren't taking vacations and sipping fine wine in the evening with their spouses before the planning engagement, and they are now that the advisory firm is on retainer, their lives will be enhanced in ways that are far more enjoyable than the unseen accumulation of assets on their quarterly statements. They will be helping clients plan for a more fulfilled life-stage than the traditional retirement, when work is optional, but they may prefer to stay "in the game." This, in turn, could mean the difference between feeling relevant and young, and feeling obsolete and old. It could even mean the difference between a long and a sort lifespan.
Financial capital is Lee’s third category, and this is where most advisors today put the bulk (if not all) of their attention.
Finally, there is what Lee calls "shared capital." "That is the money that you have to give to the government, or money that you can use for philanthropic purposes," he says. "It's money that can be spent to create significance."
Philanthropic planning sits at the top of the Maslow hierarchy, but how many clients sit down with an advisor and plan out the changes they want to make in the world around them, and the causes they want to promote, and the smartest financial way to do it? The client meeting can explore different causes, the advisor can research different charitable organizations and propose the most tax-efficient ways to make donations, and suddenly shared capital is deployed more intentionally than responding to the solicitation letter from the child's university.
Together, these different segments define a new four-factor service model for financial professionals. "Human capital is about success," says Lee. "Fulfillment is about fun and pleasure. Financial capital is about security. And shared capital is about significance, about making a difference in the world." You can define the third wave financial planner as a professional who will help clients raise their "utility function" in all four of these dimensions.
The four-factor service model
The four-factor service model will be more complicated than simply adding new services, however, because all four of these aspects of a person's life are interrelated, and all of them compete for a person's time and attention. Lee points out that we have a name for a person who maximizes his/her utility function in the human capital area at the expense of everything else: a workaholic. A person who maximizes pleasure and fun at the expense of human capital might be considered a slacker, underachiever or spendthrift. A person who focuses totally on the portfolio and accumulation of wealth is sometimes called a miser. Changes in one utility function affect all the others.
"You have to look at all four of these areas at the same time," says Lee. "Financial planning will be used in a way that applies to those four areas, to maximize the total utility across all of them so that individuals and families can get more out of life in a more meaningful way."
This broader model helps explain some persistent anomalies in today's financial planning profession. Why does the planning service seem relevant to only a small segment of the population? (Because it focuses on assets, and only a small segment have significant or complicated portfolios.)
Why has the life planning movement been slow to catch on in the planning profession? (It is offered outside of the broader context of assets and planned giving.)
Lee is still exploring how to deliver on this four-factor service model, but he notes that the profession has many of the components in place already. There are advisors who specialize in philanthropic planning, and even a national organization – Advisors in Philanthropy – with its own (very good) annual conference. The life planning (or financial life planning) movement is continually refining its approach to maximizing the fun and pleasure utility function for planning clients. Most of traditional financial planning focuses on the portfolio return "factor," and we are becoming more sophisticated by the year. A few advisors are already providing advice designed to increase the return on a client’s human capital; the list includes Mike Haubrich in Racine, WI and Elizabeth Jetton in Atlanta, GA.
The problem is that, today, all of these tend to be regarded as specialized or niche services by advisors who are following a professional (rather than personal) service model. If delivered at all, these services are delivered in isolation, rather than components of a holistic advice model that evaluates all four in the context of each other.
If Lee is right, they will be integrated, expanded, explored and improved as planning's third wave works its way through the profession. A 2023 conference might have a full track on human capital-related services, and another on planned giving integrated with tax planning. Life planning sessions will focus on clients who are overbalanced toward their work lives or portfolios.
There's one question that I still haven't addressed: What kind of firm would deliver this four-factor planning service? Lee says that in a world that is becoming increasingly chaotic, unpredictable and full of black swans, flexibility is paramount. He expects the smaller, more nimble independent planning firms to have more adaptability than the larger institutions. Independent planners will have to guard against developing an entrenched belief structure.
Lee quotes from Eric Beinhocker's The Origin of Wealth, which says that "The majority of value migration winners in the last decade have been newcomers, not incumbents." Will that be true of the financial services profession too? Will today's planning firms be rendered irrelevant by newer advisory firms that embrace the four-factor model?
The planning firm of the future, in Lee's view, will tap into its employees' commitment and capacity to learn, at all levels of the organization – it will be, in effect, a "learning organization" first and foremost, so that everybody is constantly looking for ways to understand more, and become more valuable to a broader range of potential clients. It will offer the services that clients need, and that menu will be much broader that the "future needs analysis and portfolio management" service package that advisors offer, on a take-it-or-leave-it basis today.
The planning firm of the future
Lee talks about systems thinking; pattern recognition; personal mastery and lifelong learning; constantly reexamining our mental models and continuous adaptation; the ability to achieve shared vision about goals, values, missions; team learning; constantly refining the talent that is needed to deliver the value that you bring to a client's life. Each of these is a day-long discussion in itself, but the point is that planning firms of the future will have to be more dynamic and, frankly, more interesting to work for than they are today if they hope to master this four-factor planning model.
If Lee is right, we are experiencing a dramatic change in our definition of client service. My client services white paper identified a number of nontraditional types of advice that advisors are already providing for their clients, and provided evidence that this transition from a professional to a personal service delivery model is already invisibly underway.
As always, this period of dramatic change in the profession will raise some practices up and leave others beached in irrelevancy. As always, the outcome – the difference between the winners and the losers of these powerful new trends – will be determined by foresight and adaptability.
Lee has provided a generous dose of the former. The rest is up to you.
Bob Veres'sInside Informationservice is the best practice management, marketing, client service resource for financial services professionals. Check out his blog or subscribe to get the Fee Samples report at: www.bobveres.com. Or check out his Insider's Forum Conference (September 17-19 in Dallas) at www.insidersforum.com.
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