Those of us in the ever-evolving financial services profession always have to be looking around the next corner and over the next hill. Your technology, regulation, best practices and consumer profile are all changing constantly. You have a choice between running breathlessly to evolve with the changes or finding yourself behind, irrelevant and without the resources required to catch up.
But how do you peek around that next corner? After talking with hundreds of advisors and interacting online with thousands more, I’ve identified five ominous challenges the profession will face and trends it will need to adapt to in the coming year.
Regulation: Winning the BI fight
Most of you know that the SEC proposed a new Reg BI disclosure regime this year, which was roundly criticized by the fiduciary advisory community and praised by the brokerage world. The stated goal was to create a clear disclosure statement that would address the biggest complaint that the SEC was receiving: Consumers had no idea who was regulated as a fiduciary under SEC oversight versus under the FINRA system. What does a “suitability” standard even mean, anyway, and how is that different from a “fiduciary” standard?
The commission’s “solution” was to introduce a new disclosure form, which included a new standard for brokerage firms (meaning, broadly, wirehouses and dually-registered advisors affiliated with independent broker-dealers) – and to call it a “best interest” (BI) standard.
The fact that the brokerage firms were cheering should give you a clue as to how effective this disclosure arrangement was likely to be. I was not the only person to note, in my comment letter to the SEC, that the “best interest” standard defined in SEC Proposal 34-83062 was no different (and even borrowed much of the same language) from FINRA’s website’s definition of “suitability.” The SEC was just rebranding the same (sales) relationship with consumers in language that would be more attractive to the consumer. In fact, polls suggested that consumers preferred to work with somebody who was allegedly working in their “best interest” over somebody operating under the confusing “fiduciary” standard.
Bigger picture, the whole disclosure proposal was loaded with jargon, and shied away from declarative language that would make clear who did and did not owe a full duty of care to consumers.
The SEC asked the RAND Corporation to do a consumer study of the proposals, and after reading that study over a few times, the bottom line is that the SEC is going to have a hard time defending the disclosures it has proposed. It didn’t really clarify anything, based on results from focus group participants.
So how can you “win” the Reg BI debate? Not by convincing the SEC that it should suddenly veer into a new course, and require all the brokerage firms to adhere to a fiduciary standard. Given the lobbying power of the brokerage industry, that tactic will fail. But consider what will happen in the coming year. We’re going to see a lot of very public debate about the standards that advisors and brokers are held to – which is exactly what the brokerage industry doesn’t want. The SEC will offer an amended proposal, which will once again have the brokerage industry’s fingerprints all over it, the press will criticize it, and the fiduciary advisor profession will point out that they serve clients in their best interests and wonder aloud why the brokerage industry can’t abandon its sales culture and join the fiduciary club.
Action plan recommendation
The “winner” in these public debates – as we learned from the DOL proposal – is the firms that pledge unequivocally, without any tricky disclosures, to put the consumer’s interests first. Offer yourself up to the local press as an authority on what the brokerage firms describe as the terrible hardships of trying to live under a fiduciary standard – and tell them that it’s actually pretty easy.
The Committee for the Fiduciary Standard has, on its website, one of the most effective marketing tools I’ve ever seen: the fiduciary oath. You can sign up as a committed firm, and offer the oath to your prospective clients, with your signature, and tell the prospect (who is probably aware of the “best interest” controversy) to take the oath across the street and ask that wirehouse broker who is bidding for their business to sign his or her copy.
The publicity around “best interests” and Reg BI will be amplified by the next trend.
The markets: The bear as friend or foe
Full disclosure here: I replaced the crystal ball in my office with an Alexa, which I found has equally fallible predictive abilities. I cannot predict when the next market downturn will come or if, indeed, it already has. Nobody can.
But a storm is gathering in the investment markets. U.S. equities are historically expensive, to the point where even Warren Buffett isn’t buying. The U.S. national debt is soaring, and many state and local pension plans are so underfunded that some form of bankruptcy or messy restructuring seems like an inevitability. We are engaging in reckless trade wars with friend and foe alike that are disrupting supply chains and dampening corporate profits. The economy is due for a recession. Corporate America has run up historic debt levels, and the ratings agencies have been reluctant to downgrade.
You pick the trigger. And remember that in the last downturn, the accelerating factor was reckless Wall Street speculation using derivative investments which, astonishingly, still have yet to be adequately defused by the regulators. Who knows what bets are being made, on what, if interest rates or the dollar or some other factor were to shift two standard deviations from the model?
This is a long way of saying that I would not be at all surprised if we finally experience the long-awaited bear market in 2019. And here’s the punch line: The next blowup, like the last, will benefit some parties and disadvantage others.
Most broadly, the independent RIA community will benefit in its competition with Wall Street. If the bear market accelerates into next year, it will happen right in the middle of a very public debate where the SEC is trying to explain how it came up with a “best interest” definition that is identical with “suitability,” and the press will not be fooled about who benefits from the ensuing confusion. You will once again be hearing brokerage firms arguing, in comment letters, that it really isn’t in the best interests of consumers to require brokers to act in their best interests – and nobody has a lot of patience with this argument when they’re losing money in their portfolios.
If the blowup includes risky derivatives sold to unsuspecting customers, more bailouts and Congressional hearings, then the brokerage world will have to travel though a fresh series of nasty scandals involving firms not named Lehman Brothers. Brokers who depend on the brand for marketing will see their wirehouse brand as a net negative and the breakaway exodus from Wall Street will accelerate. That will create recruiting opportunities for independent advisory firms.
Within the advisory community, there will be winners and losers as well. The losers will be firms that never quite shifted their value proposition from investments to planning. Their client relationships will be the most easily dislodged (Why am I paying my advisor so much when I’m losing money every quarter?), creating a huge marketing opportunity for the firms whose value proposition is largely or entirely based on financial planning. Those firms will be holding clients’ hands, re-running retirement projections quarterly instead of annually, and hosting new prospects who want a second opinion about their advisory relationship.
Action plan recommendation
If you haven’t already, bring your clients in for a full, comprehensive financial plan and talk to them about what they want to do with their money – and potential ways to get to those goals. If you already lead with planning as your value proposition, go one step further and allow your clients to revisit their financial plan in a collaborative session in your office. Let them take the mouse and work through their own bargain with the future: perhaps retiring later in order to afford a stretch goal, perhaps scaling back some of their goals to be able to afford others. Make the plan theirs.
And in all cases, show them the impact that a bear market could have on their financial situation, and discuss alternatives – now, rather than trying to catch up on this conversation when the blood is running in the streets.
Revenue models: The shift away from the AUM-revenue model
The next bear market, whenever it comes, will be a tipping point for a major shift in how financial advisory firms are paid. Today, a lot of advisors are looking at flat quarterly fees, and may even be charging them for younger clients who have not yet acquired wealth. But they’re reluctant to put their relationships with longstanding clients to the test by making their fees visible during a discussion about shifting the revenue model.
When advisory firms go through a bear market, their workload increases dramatically – and if they’re compensated via an AUM-revenue model, their top-line revenues will decline by anywhere from 15% to 30%. Does that make any sense from a business standpoint? If there is a bear market, I expect the trend toward flat fees to accelerate in its aftermath.
But whether or not the markets turn down, 2019 is the year when many advisory firms realize that a growing number of their potential clients – Gen X and Millennials – prefer to pay flat fees. The younger people I talk with don’t believe that you (or anyone else) can deliver above-market returns, so who are you to charge based on a percentage of their total assets?
Last time I checked, those people (and not the aging baby boomer clients) are the profession’s clients of the future.
And finally, as many advisory firms are trying to recruit talent to replace the aging advisors in the firm, they are discovering that the most talented younger advisors want to provide planning services to their not-yet-wealthy peers. They want the firm they work with to have a flat-fee option that would be attractive to Gen X and Millennial clients. If that isn’t an option, they’ll look elsewhere – and some firms will enjoy more recruiting success than others.
Action plan recommendation
The question I’m always asked is: How do you make the transition? My best recommendation is to start with your least-profitable clients.
You know who they are. But to make sure, create a simple spreadsheet that lists each client’s name, vertically down the column, and then in the next column list how much, in aggregate, each client is paying you. Then (next column) guesstimate how many hours a year you spend with this client, in person or on the phone, and in the next column you multiply the number of hours by whatever you believe an hour of your time is worth – $300? $400?
Do the same with your planning associates, multiplying their time by a lesser hourly amount.
Then take all the rest of your overhead for the year, add it up to a total, and divide that amount evenly among all of your clients.
Add up the three expense columns, and subtract that amount from the total fees each client has paid you. Sort based on the profitability or loss number in that final column.
What you’ll find, if you’re a typical advisory firm, is that two-thirds of your clients are unprofitable, based on this simple measure.
To start shifting from AUM to retainer fees, schedule meetings with the clients at the bottom of the spreadsheet, and talk to them about your new revenue model – flat quarterly fees debited out of the client’s account. Propose to raise the fees they pay you to whatever would be profitable on the spreadsheet you just created.
One of two things will happen. They’ll either say that they believe in the value they receive from you, and accept your new flat-fee model, or they’ll ask for your help to find them a more appropriate advisor. You should not fear the latter outcome; it removes an unprofitable client from your books, and opens the door for that time, when the bear market hits, when new, more attractive prospects will come knocking on your door.
Do this all the way up from the bottom of your spreadsheet, and by the time you get halfway through your unprofitable clients, you’ll be pretty good at communicating the value and importance of the flat fee model.
At some point, your eye will stray to the top of the spreadsheet, where there might be one client who is paying much more than the value he or she is receiving. That very important client may be making, mentally, the same calculation that you’ve made on your Excel file. You can rescue the relationship by having a meeting where you propose a reduced, fixed fee, and perhaps re-do the planning work to make sure all the bases are covered.
Once you’re comfortable with charging flat fees, you will discover that there is a world of people who haven’t accumulated a significant retirement portfolio, who need planning advice and are willing to pay for it. This will fuel what may become the biggest growth spurt your firm will ever experience. And it could start as early as next year.
Meanwhile (bonus recommendation), have your younger planners work out a flat-fee revenue and service model for younger consumers. They can start by creating new bonds with the children of your existing clients, and then expand their marketing efforts to not-yet-wealthy members of the community, who will grow into more profitable clients down the road. If you do a net-present-value calculation on the fees they’re paying today, and (raised) fees ongoing for a 20-30 year relationship, you’ll discover that these are great assets for your future advisory practice.
Planning: The fee-only insurance revolution
Today, most fiduciary advisory firms tend to ignore the remarkable innovation that we call risk pooling (smoothing out the outcomes among many policyholders to reduce various life risks). Yes, many of you will recommend a certain amount of term insurance for clients, and some of you will delve into homeowners and car insurance, mostly to get decent coverage in a confusing marketplace.
But advisors have traditionally ignored variable and fixed annuities and the spectrum of cash-value life insurance options for good reason: Whenever they looked under the hood, fees, commissions and lack of transparency slithered out. It was safer and easier to just to close the hood and move on. Of course, there were times when this wasn’t an option – when a client was sold one of these products, and it required some analysis as to whether to keep the contract in force or not. These investigations were seldom pretty, and reinforced your good judgment to leave the whole life/annuity thing alone.
All of that is changing. Today, the U.S. Bureau of Labor Statistics says that the median income for life insurance sales agents is just under $50,000 a year. , while LIMRA’s research has found that 23% of today’s life insurance purchasers buy online, and another 15% are researching online and then buying directly via phone or mail.
The life and annuity companies, seeing the trends away from their traditional agency system toward self-directed purchases, are finally starting to embrace other marketing channels. The first logical place for them to look is the growing “channel” of fiduciary advisors.
Their new interest in advisory firms is already creating a boon for the insurance analysts who work with fee-only advisors. John Ryan at Ryan Insurance Strategy Consultants and Mark Maurer at Low Load Insurance Services suddenly have a wider variety of transparent, no-commission products to recommend in client cases that advisors bring them.
But the insurance industry is also hoping that fee-only advisors, themselves, will become more versed in the complexities of applying fiduciary annuity and life contracts to specific client situations. The clearest example of this trend is the growing number of commission-free, low-cost investment-only variable annuities, guaranteed income products and cash value life products you can find on the DPL Financial Partners website.
The insurance companies will eventually write most of their business through independent, fee-compensated advisors, and 2019 will be remembered as the year that they finally started attracting meaningful attention from this jaded audience. For more than a century, the insurance industry has carved out tax benefits for its various products, and this, combined with the benefits of risk pooling will benefit a growing number of advisor clients in creative ways that we haven’t envisioned yet.
Action plan recommendation
Advisors typically shop for term insurance online or through agents they trust. But it is time for them to look at some of the newfangled true no-load options, where they might get better provisions for converting a policy to permanent life if a client suffers health problems toward the end of a 20-year term schedule, or more options for scaling down the face amount as the need for insurance declines.
As interest rates go up, single-premium immediate and deferred-income annuities (SPIAs and DIAs) become more interesting for advisors who have clients in good health, who they believe will outlive their expected lifespan. Wade Pfau at the American College has done research showing that, for many retired clients, it can be beneficial to replace their bond allocations with annuities that are paying roughly as much per year. If interest rates go up, and as inflation rises, the payment amounts lose value. But at the same time, the client gets protection from longevity risk.
Early adopters in this interesting new marketplace will enjoy an advantage over their peers.
Software: Robo software everywhere
Most of advisors’ existential angst over Wealthfront, Betterment and Personal Capital et al. has faded. But they have settled on an uneasy detente: They will keep managing their largest client portfolios the way they always have, with portfolio management software systems. And they’ll give a robo (probably managed by their custodian) all of their smaller client portfolios to manage, so they can be more efficient and charge lower fees in those relationships.
In the coming year, that accommodation is going to break up, and advisors are going to realize that they can have it all – automated matching of clients to portfolios, automated quarterly rebalancing, partially-automated tax-loss harvesting, online performance statements – not via some outside vendor, but as a part of their own cloud-based software suite. They’ll manage the robo like a staff member.
This in-house robo software is already here. A company called Emotomy provides an online system that offers more features than Wealthfront, which advisors can use to create customized portfolios like they would with their Orion or Black Diamond software. Riskalyze’s integration with Orion Advisor Services offers many of the most-coveted robo features, plus, through Orion’s ASTRO tool, the ability to aggregate individual securities into their own private ETFs that mimic different indices.
More is on the way, with more features. This is an area where artificial intelligence can provide actual tangible benefits to advisors and consumers.
Action plan recommendation
The whole point of the so-called robo revolution is to automate repetitive activities that humans were doing before. That means that advisory firms need to identify all the things their operations staff are doing that can be automated. I believe that 2019 will be the first year when some advisors will "robo" every single client portfolio – and the trend will become the norm as more advisors recognize the efficiencies to be gained.
What would your firm look like if you could automate many of the portfolio accounting activities, when you are no longer creating performance statements (since everything can be posted in your preferred format in client vaults and automatically updated daily), rebalancing and reconciling?
If you could remove staff or re-allocate them to other activities, would that make your firm more profitable? Would you be able to offer planning services, not just to your less-wealthy clients, but to everybody at a lower price-point? Or add new services that distinguish you in the increasingly crowded marketplace?
You already know that the advisory profession has to move quickly to stay on top of new developments, and that means recognizing them in advance. Change is not easy, which is why it’s important to prepare yourself for whatever’s next, rather than trying to react as the changes are sweeping through the profession.
When ask Alexa what the future holds for our profession, I do see a hazy vision. I see a small subset of advisory firms doing a much better job of navigating change, and gaining incremental first-mover advantages.
But of course, this is cheating. Visionary firms always have an advantage, and there’s no reason to think that 2019 will be any different.
Bob Veres' Inside Information service is the best practice management, marketing, client service resource for financial services professionals. Check out his blog at: www.bobveres.com. Or check out his Insider's Forum Conference (for 2019 in Nashville, TN) at www.insidersforum.com.
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