Kitces On Financial Advice’s Future

December 21, 2017

Michael KitcesThe times, they are a-changin', Bob Dylan once sang. The same could be said about the financial advisory business as 2017 concludes, says Michael Kitces, partner and director of wealth management for Columbia, Maryland-based Pinnacle Advisory Group.

Kitces' blog, Nerd's Eye View, is a widely followed educational resource for financial advisors, attracting some 200,000 unique visitors per month. On it, Kitces tackles the complexities of running an advisory business in his signature dense, deep-dive style, with topics ranging from tax planning to trust-building and everything in between.

He is also co-founder of the XY Planning Network, an industry organization deisgned to support and connect hundreds of fee-only advisors who work primarily with Gen X and Gen Y clients.

Kitces will be speaking at the upcoming 2018 Inside ETFs conference. sat down with Kitces to talk about the trends he sees changing the advisory business, as well as how advisors can adapt to survive. How have Gen X [birth year mid/late 1960s to 1980] and Gen Y [birth year 1980 to late 1990s/2000 (also known as millennials)] clients been underserved or overlooked by the traditional money management model, even as these generations become a bigger part of the market with each passing year?

Michael Kitces: The industry has become so fixated on one particular kind of business—which decreasingly has been about managing money and instead charging for assets under management—that we've unwittingly concentrated into a business model that excludes the overwhelming majority of Gen X and Gen Y. They have financial questions, too, and they want to pay for financial advice. But they can't pay for it by handing over a portfolio to manage, because they just don’t have one yet.

At the XY Planning Network (XYPN), we champion a different business model: financial planning for an ongoing, monthly subscription fee. That opens up a huge market of consumers who want to—and can—pay for financial advice, once it fits their own situation. It also resonates with a large number of financial advisors—particularly those in their 20s, 30s and 40s—who want to serve their peers and couldn’t do so before, constrained to a model that didn’t work for young people. What is it about a subscription model that works so well for Gen X and Gen Y investors?

Kitces: There's a simple math to it. Lots of people live paycheck to paycheck, but still want financial advice. So saying [to them], “You should pay me $1,200 for a plan this year” is burdensome. Paying $100 on an ongoing basis is just more bite-sized and manageable. It's easier to handle within your household cash flow. Do you think advisors who choose not to move to a subscription model will eventually be left out?

Kitces: I wouldn't necessarily say that. There's still immense wealth in portfolios that engage the AUM model, and even when the people who have them pass away, they're likely to give it to someone else. I don’t think that goes anywhere.

But probably only 15-25% of the population has liquid financial assets in the dollar amounts needed to sustain a financial advisor, which means all roughly 300,000 of we financial advisors are competing for the same 15%.

Part of why we’re seeing so much growth in XYPN is that most of our advisors have no competition. They're not competing against 299,999 other advisors for the same clients—the doctor who makes great income who really wants to pay for a financial advisor. But because they have $250,000 in student loan debt instead of a $250,000 portfolio, no one will talk to him [but us]. Let's talk investor education, because we often hear about advisors who think they're communicating one thing to clients, but investors actually hear something quite different. Have you seen this kind of communication mismatch?

Kitces: Yes! We’re so prone to our jargon and we don’t even realize it. Take "smart beta." What on earth does that even mean to a consumer? They don't even know what "beta" is in the first place, much less how to distinguish smart beta versus dumb beta.

Almost everything we do when we describe portfolios and how we design them is full of jargon that most consumers don’t understand. But intelligent consumers will just go online and look it up. Anybody who believes we can have super-secret information no one else has in the age of the Internet is only deluding themselves.

Your worst-case scenario isn't just that investors don’t understand what you're talking about; it's that they pull out their smartphone, find an advisor who actually explains it properly, and then does business with them instead. You're literally driving clients to competitors who explain things better. Being an advisor today means using and understanding fintech. As someone who watches this space very closely, where are you seeing fintech deliver on its disruptive promise, if at all?

Kitces: Frankly, I don’t think we've seen any in the current cycle of fintech. Really? Not even robo advisories?

Kitces: Robo advisors have 0.03% of market share after six years. All robos combined have taken in less money than Vanguard does in two weeks. So what about Vanguard's robo advisory, Personal Advisor Services?

Kitces: That's not a robo. Vanguard hired 600 CFPs [certified financial planners] to deliver financial planning advice. If they're robo advisors, then you're a robo journalist, because this meeting right now is using a telephone.

I do think, though, that one of the few disruptive events in our industry over the past five years is Vanguard's decision to go into financial advice. But that’s not a technology disruption. The disruptive part is that they hired 600 humans in two years to service $100 billion. In 10 years, do you think Vanguard will be one of only two issuers left standing, as that story in Bloomberg claimed?

Kitces: No, I think the nature of business cycles is that large firms get larger, then eventually they get too large. That opens the door for new entrants to come in and try to disrupt. If there's one thing I'm comfortable counting on, it’s that competition will continue to thrive.

Frankly, I think the growth of Vanguard and Black Rock—and of ETFs more broadly—has been somewhat misconstrued. I don’t think we’re seeing the death of active management, but the death of bad active managers. We're seeing a winnowing of bad managers and bad funds. There's something like 200 S&P 500 Index funds out there. Why would you need 200? It’s the same index!

So half of what we’re seeing is outflow from low-quality funds. Technically, that's not even disruption, really, just vicious competition. And platforms like yours and others made it really easy for consumers to understand which were the good funds and which were bad—and lo and behold, the bad ones are now having outflows. In that case, I suppose the internet was really the most disruptive fintech?

Kitces: Yes. Overwhelmingly, the primary reason we’re seeing the explosion of ETFs and the decline of mutual funds is the internet. It just took a while to play out. Looking back on your career, what's the one thing you think has remained constant?

Kitces: That money is complex and people don’t make good decisions with it. It’s like our brains were not built to handle money problems. We've dubbed this "behavioral finance," but I think that's an overly narrow grade marker, because our dysfunctions around money are much broader than just the dumb things we do in our portfolios.

We make bad career decisions, bad business decisions, bad spending decisions. We screw this up in all sorts of ways. We’re not very good at navigating ourselves, and we need help. But where will we get that help, going forward?  You can easily put your money in a robo now. You can get quick, solid asset allocation and at least market-matching return. So what room is left for financial advisors to still provide value to their clients?

Kitces: Well, we add value for our clients in every single thing that has to do with their money, except for asset allocation. It's equivalent to asking, "What's left in investing once there's an S&P 500 fund?" There are still a lot of other decisions: spending, cash flow, retirement, estate planning, ensuring your future, debt … the list just goes on and on.

If you dial the clock back 30 or 40 years, everybody in the investment business got paid to sell stocks. But now most advisors don’t even actually know how their orders get executed. We just click the box and the technology does it.

So if I fast-forward another 10 or 20 years, I think what’ll stay the same is that people will still have dysfunctions around money. What changes is that all portfolios are literally a three-second click of a button.

There's a lot of stuff to get paid for still. But it ain't the things we get paid for today.

Contact Lara Crigger at [email protected]

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