Technology, be it in the form of robo advisors or digital tools, have forever changed the traditional financial advisor landscape. Michael Kitces, partner and director of research for Pinnacle Advisory Group, who also publishes the financial planning industry blog “Nerd's Eye View,” offers here a glimpse into what’s at stake for advisors out there who want to survive—and thrive—in the digital age. Kitces will be a speaker at the upcoming Inside ETFs conference next month.
ETF.com: You’ll be speaking at Inside ETFs about the future of investment advice in the digital age. Can you give me a preview of your core message?
Michael Kitces: The core message is that the introduction of technology and robo advisors into the landscape is not the end of financial advisors any more than the internet was in the late 1990s, when similarly we said, “Well, we've got E-Trade now, why do you need a financial advisor anymore?”
The internet didn't replace financial advisors. The internet became the platform that all financial advisors used to build their business. We're going to find over 10 to 15 years that the exact same phenomenon is about to happen with robo advisors—they're not actually a threat to financial advisors and what they do, but they are going to commoditize a core aspect of what financial advisors do and get paid for, which is basic asset allocation services.
The pressure that introduces for advisors, simply put, is that we have to step up and move up beyond what we've done historically. Robo advisors aren't necessarily here to disrupt or eliminate financial advisors, but this is one of those inflection points where you have to move up the value chain and offer more, or you’ll be put out of business by a robo platform.
ETF.com: Does every financial advisor today need some sort of robo-advice solution or a digital element of their practice?
Kitces: Yes and no. If you’re doing asset allocation by hand with an Excel spreadsheet, your business will be dead in five years or less. Now, what you have to replace that with isn't necessarily a robo tool. What you can replace that with is automated rebalancing software, which is basically what robo advisors do. But the truth is, financial advisors have had rebalancing software to automate this for 12 years. The first one came out in 2004.
So what's the difference between a robo advisor and a financial advisor that uses automated rebalancing software? My answer would be, nothing; there is no difference. It's a difference in terms, it's not a difference in substance.
Do advisors need to adopt robo platforms? My answer would be, no. But you need to use technology that does what robo platforms do. The reality is, advisors have had technology to do what robo advisors do for a decade. We just didn't adopt it. Today using none is not an option.
ETF.com: Is this all about better client experience? Is it about cost? If you're an investor, are you really going to know if your advisor has cool software in the back office, as opposed to doing things the old way?
Kitces: No. The difference is, if you ever want to get another client for the rest of your life, doing what you've done for the past 20 years won't cut it. And you can see that across the entire advisory landscape right now.
If you look at all of the industry benchmarking studies, growth for financial advisors is grinding to a halt in the aggregate. We're getting to a point now where there aren't very many clients left who are unattached, and if you want to grow, you have to actually get people off an advisor from someone else. Or you have to show why you're more valuable than a robo advisor at 25-35 basis points.
ETF.com: If you're an advisor, where do you start? What's your first step to join the digital wave? How do you reinvent your value proposition?
Kitces: You buy automated rebalancing and trading software, and you stop using spreadsheets. That's it. That's No. 1.
No. 2 is, either use or find a custodial or advisory platform that lets you onboard your clients without paperwork, i.e., you create the system to do the onboarding process digitally. The point of that is if you want to grow, slapping people with 37 pages of printed forms they have to sign is not exciting to anybody.
ETF.com: Have you seen any new and interesting, innovative practice management tools? What has caught your attention?
Kitces: Honestly, not much. This isn't complex, innovative stuff. This is about adopting the technology that's out there. Imagine it's 1997. Your job is to be a stockbroker who gets paid $100 a trade to sell a stock.
Then E-Trade shows up. If you keep doing stock trading for $100 a trade when E-Trade does it for $20 a trade, your business is dead. Your opportunity is to adopt an online discount technology platform to do stock trading for $20 as well.
So step one is, you can't sell for $100 what E-Trade sells for $20. The second issue is, you need to do something more valuable on top of the $20 so you not only replicate what E-Trade does, but you offer value to keep the client.
What we all did 15 years ago in order to do that was we became asset allocators. We said, “You can buy a stock online, but I'll create you a diversified asset-allocated portfolio.” That was our value-add on top of stock trading and why clients should do business with us instead of E-Trade. It worked quite well.
We're at a very similar inflection point here, where ultimately if you were still doing stock trading by calling the trade in, you have no chance of competing in today's environment.
ETF.com: So are investors’ needs from their financial advisors still the same but the expectations are completely different due to technology?
Kitces: Yes and no. The value an advisor can provide above and beyond technology is the same that it's always been. The challenge is, there are a lot of advisors who don't do anything that’s in any way, shape or form more valuable than what a robo advisor does for 25 basis points.
That's not strictly speaking purely of a robo phenomenon, that's just what happens when you're providing the lowest value in the value chain. There's an important distinction between advisors who give comprehensive financial advice and “advisors” who in reality do nothing more than gather assets and move on to the next client. The truth is, people use the word “advisor” for a ludicrously wide range of things and services.
ETF.com: Do you agree that the future of robo advice is customization? And do robos need a human element to do that?
Kitces: I disagree with the premise that the only path to success is customization and that humans have to provide the customization. You can make technology that customizes the portfolio; you don't need a human.
Secondly, that's not why robo advisors are failing in the first place. The thing that makes the human advisor succeed over the robo advisor is not that the human advisor says, “You should have 5% less in SPY [SPDR S&P 500 ETF Trust] and 5% more in international.” That's commoditized.
What's valuable is a human financial advisor who says, “An investment account is a stupid idea for you. Pay down your credit card. Get your student loan debt under control. Then save up money to go back to college and get a better job. And 10 years from now, open your first investment account.”
That's personal advice that has nothing to do with asset allocation. From where we stand right now, no robo advisor knows how to give that advice effectively.
ETF.com: What do “pure” robos have to do differently? Or is that business model not going to succeed over time?
Kitces: It's a model that's not going to succeed over time. It's a model that was never viable.
When we first wrote about robos in 2012, we actually wrote back then that robo advisors are no threat to real financial advisors. It's primarily a do-it-yourselfer solution. And the primary competition for robo advisors would be Schwab and Vanguard, and that they would fail because it's too expensive to get a client.
Four years later, that's exactly what's happened. Schwab and Vanguard were the first two to enter the marketplace. And Wealthfront and Betterment are struggling. And many others have already failed because client acquisition costs made their business model impossible. They fundamentally misunderstood the marketplace problem.
The reason most advisors get paid 1% has nothing to do with the fact that it costs 1% to invest a portfolio. It’s because historically that was the commission we got paid to distribute the investment solution. It's a distribution sales charge; it's not a financial advice charge.
The only way you can undercut a 1% distribution charge for advisors is if you come up with a better way to distribute your investments. That's not what robo advisors did; they had no marketing strategy at all. They had an operational solution, but it wasn't actually an operational problem.
Now you’re seeing robo tools get implemented by human advisors. The difference is that, in the past, you had three staff members and now you have one computer. It replaced the back office of the advisory firm. But it didn’t change what good advisors do.
ETF.com: Are the 1% days over? Will advisors have to learn to live with less or scale their businesses?
Kitces: When we look at the industry research, so far there's no evidence that advisory fees are even declining and that we necessarily have to charge less. Again, robo advisors don't do what we do. Both can coexist.
If you want to be a self-directed asset-allocated portfolio, go to a robo for 0.25%. If you want comprehensive financial planning advice, go to a financial advisor for 1%. You can have both of those. Otherwise, it'd be like, “Why does Tiffany exist? You can buy a ring at Walmart.”
The challenge is that you've got to do more to earn your fee. That's ultimately the transition for at least some advisors that weren't actually doing all that much to add value in the first place.
If you were charging 1% to do nothing more than what a robo does, you've got a problem. And your solution can't be to cut your fees to be comparable to a robo, because no individual financial advisory firm is going to outdo the technology of a venture capital-funded Silicon Valley startup.
ETF.com: Is there any downside to this growing reliance on technology? Anything to be worried about?
Kitces: There are a few things to be worried about. At the high level, cybersecurity continues to be a concern and an issue for every advisor. That’s a new kind of business risk. That's not changing any time soon.
But the biggest challenge for most advisors is simply figuring out what your value is beyond doing an asset allocation. Unfortunately, that's a really hard question for a nontrivial number of advisors who have staked their value proposition on building a diversified asset-allocated portfolio. That's no longer the value it once was.
That thing that we used to hang our hat on can't be the value proposition anymore. At least not at the fees we charge. There are a lot of choices and paths you can go down, but you have to go down one of them, and right now a lot of advisors aren’t even on the path yet.
Contact Cinthia Murphy at [email protected]
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