Are Financial Advisers Supposed to Get Paid?
For many investment professionals, the seemingly inexorable rise of robo-advisers constitutes an existential threat. The fear is simple and justified: Services now exist that provide investors with a portfolio that fits their expressed risk tolerance and reward inclinations for 0.25% of the assets invested in that portfolio.
That’s comparably a great deal and thus financial advisers offering a similar service are in a tough place.
If we use the example of a financial adviser currently making $75,000 a year, one who splits their fee down the middle with their firm, we can see this pretty clearly. At a 1% fee, this adviser can make a comfortable middle-class income if they spend 60 hours a week talking to 100 or so happy clients with a grand total of $15 million invested with the firm.
If their fee were lowered to 0.25% of assets, the adviser would need to either take on more clients (and provide less service to existing ones) or seek wealthier clients. Either way, their firm would need $60 million in assets instead of $15 million to make the same amount of money. Like, duh, right?
If losing that much in fees worries you, a widely shared blog post should terrify you. Blake Ross, who co-founded Firefox before spending six years at Facebook as director of product, maintains that those already-reduced fees are astronomically high and should be closer to zero. He even accuses Wealthfront, one of the larger robo-advisers, of embodying the same “Wall Street” mentality that many find reprehensible.
So while investment professionals are staring at robo-advisers and wondering how they’ll ever compete on cost, technology folks are looking at robo-advisers and wondering if they can be undercut further. I’ve been saying this for a long time at this point, but free investing is the new free checking. The cost of these services is going to approach and eventually reach zero.
So What Should You Do?
Enterprising Investor is written for professional investors, so it’s tempting to interpret the question above from a business perspective. What should you do if you want to stay competitive?
The thing is that good business comes from good outcomes, so let’s ask the question from a different vantage point. What should you do if you want to give your clients a good outcome?
Blake’s argument is really simple to encapsulate. Many robo-advisers compare their fees to the typical investment adviser’s 1% and argue that they are fantastic. But that’s not necessarily the right benchmark to use. All fees reduce investment return, so what would happen if you didn’t pay any of them?
Well, if you’re able to save $5,000 a year for 50 years and invest it at a constant 6%, you’d be richer.
The more than $300,000 gap between a 1% annual fee and a .25% annual fee is striking, but so is the $125,000 gap between paying a seemingly nominal .25% and nothing. If you paid 1% a year in fees, you’d have an account that is smaller by 28.5%, whereas if you paid just .25%, you’d be behind by just over 8%.
Value after 50 Years of Saving $5,000 Annually
And remember, that’s for an account that receives regular contributions over time. For a lump sum investment, the gap is even larger.
So like, why would you pay fees? The answer you have to give is because the fees are for services that add value, right? So the only question that matters is simple . . .
Value Compared to What?
Blake’s post makes the point that many of the services that Wealthfront and other similar robo-advisers provide are of uncertain or questionable value, and he may well be right. It’s awfully difficult to beat a Vanguard target date retirement fund on cost.
But what is value here? What’s the point of saving money? Managing someone’s money well should be about maximizing their quality of life. It seems quite reductive to distill that down to the size of their bank account in retirement. Everybody wants more money, but it’s not the point of existence. It’s just a means to buy the stuff you need or want.
A mean-variance optimized portfolio, however it’s delivered, is simply not the same as insight into what you will need and might want. It is also not as valuable. If you approach a client with a perfectly customized portfolio but fail to explain the role it will play in their life, they won’t care very much. They might well become a client, but they will miss the point of the exercise and you will have failed both them and yourself.
So don’t neglect the conversations that are really important when you sit down with your clients. Don’t forget to ask them about what they’re doing to live a good life. You should be able to have discussions about the trade-off between spending money now to be happier and saving it for later in a context that is broader than an ending account balance.
If you’re willing and able to have those sorts of conversations with clients, then it’ll be worth paying top dollar for your services. But that assertion only confirms that the product you provide — advice — is worth something. It doesn’t tackle the question of how to charge for it.
That’s somewhat intentional. How do you think we should be charging? Let me know in the comments below.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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27 thoughts on “Are Financial Advisers Supposed to Get Paid?”
As an advisor I feel you are on the right path with adding value to the service(s) we provided. Most advisors have been trained in many areas of financial services to include insurance planning, tax advice, business analysis, and budgeting–not just investments. Robo-advisors would be hard pressed to do all those things for just 25bps a year. I think human advisors should rise to the occasion and start competing on a higher level and offering a full service option to investors and earn the fee we charge!
Many thanks for commenting. I think the constraint on the robo side in providing insurance, tax, business, and budgeting services isn’t so much the fee but the relative youth of many of these services and the approach that the silicon valley mindset takes toward product development. I would expect robo advisers to “nail” investment management before they branch out to provide other services.
I totally agree that financial advisers should be rising to the occasion, but I don’t think it’s enough to simply provide a greater breadth of services at the traditional 1% fee. The important thing to remember is that anything that can be described as a workflow is something that a computer can do. So the processes that we use to provide each of the services that robo advisers don’t can and will be automated.
So I agree with you that there is presently a significant gap in the services that are provided, but I don’t believe that’s a durable competitive advantage. Workflows will not fuel competitive advantage the way client preference will. My question to you is straightforward: can you combine these services in a way that makes your clients actually want to use them (as opposed to feeling like they have to)?
You’ve hit the nail on the head. I strongly believe that proof beyond a reasonable doubt, and “what’s in for me” are the 2 necessary agents for change.
I think conversations like this can help fuel that type of change in the industry. Your question is a valid one, so often I end up starting the conversation with “what’s most important to you?”
Many thanks Dominique! That’s a good approach, but I still wonder about asset-based fees. If you couldn’t charge for your services that way, how would you?
Let’s take this off line, I’m interested in discussing it further. message me in LinkedIn.
Definitely. I’ll ping you next week.
First, feel free to respond and post to me, but forgive not leaving last name. I did not want to have to go through a process of compliance pre-approval, as my firm requires when i post publicly, using my full name.
Should you want to follow up or get my information, respond with such and I will reach you via your Twitter.
I am an adviser, primarily fee-based, but over the last year, transitioning my practice to FLAT fee for planning/consulting based on time spent, pegged to an hourly fee.
As I make the current move, and even as I moved from commissions to fee-based 12 years ago, there has always been one theme as it related to compensation: what exactly is my value and how should I express that to clients.
Your points are valid and your advice prescient, especially in light of the recent DOL Fiduciary Rule debate (between the DOL and Financial Services Institute).
My one thought while reading your piece is that there should be a stronger point made as it relates to the value an adviser brings to a client and the quantification that may justify more than just an asset-based fee to them.
Yes, cost ‘friction’ to portfolios is material and between that and tax drag, that is low hanging fruit to add to long-term returns.
However, what are your thoughts as to the value of the following human advice and feedback not available from the non self-aware computer or index fund?
Some examples: matching a client’s values or aspirations to financial products or solutions, guidance as life events evolve, expertise of a Socratic discussion on which investment or approach to take (ie long term care insurance versus simply saving $, Social Security taken prior to full retirement age, “should I loan my adult child $100k to invest in a tavern with his college friend,”) or finally, the long term GAIN experienced the by advice we provided that helped the client avoid a mistake that may have caused a permanent loss of capital, or worse.
As the saying goes: your true cost is the price you pay less the value received.
Once again, my goal is in seeing a balanced conversation (not necessarily here, but anywhere it relates to financial services industry) on the value the ethical adviser may add and certainly less emphasis on what something simply costs.
Once again, thanks, Will, for a well written and thoughtful conversation.
Great post, Will. There’s been downward pressure on fees for several years now, and frankly I’m surprised it’s taken this long to get close to zero. I think the future financial advisor/fee model will look something like this:
0% fee for anyone under 30 or with a portfolio under 100k
.25% fee for people aged 30-50 or with a portfolio between 100k and 500k
.5% fee for people aged 50+ or with a portfolio above 500k
1% fee for portfolios above 1 million
The added services that justify a higher fee (such as tax and estate planning) don’t really come into play unless an investor is near retirement or has a reasonably high net-worth. The vast majority of Americans should have easy access to free or nearly free financial advice, with the option to pay more for specific add-on services.
The elephant in the room is what happens if 90% of U.S. investors all have capital committed to the same handful of index funds? Does that make the market, and therefore everyone’s investment portfolios, safer or more volatile?
I don’t think the investor with $1 million would be too excited about paying a 1% fee if he knows he can spread his assets around to multiple advisers and pay only 0.25%. Also, the DoJ might have a problem with an advisory fee that penalizes/targets the elderly…as would AARP…and my grandpappy.
Great points — I think Dmitriy’s big concept is that fees should be zero under a certain threshold and rise commensurately with services provided. I responded in more depth to him, but wanted to thank you for reading too!
Cheers and all best —
Thanks for the kind words. I’ll return them — great thoughts. I agree with you that folks with less than 100k shouldn’t pay fees, and I’m actually in the middle of laying out the reason why right now. I’m not sure about raising an asset based fee as the assets in the account rise — as Michael notes below I bet folks would find a way around that. Age based fees are tough too, since they don’t necessarily relate to the services that are provided even though they’re likely to. Folks nearing the retirement age need more advice.
This means that there needs to be some other way to charge for the value-added services that you rightly note are more important as you get richer and older. I’m not entirely sure where the line should be drawn between things that cost extra and things that come with the free, but tax and estate planning seem like the sorts of things that should have standalone cost.
To your elephant, I’m not necessarily sure that the natural result of concentration in index funds would even be observable. Since active managers net out to the market, we already hold an aggregate exposure that is the same as what we’d have if we all held the same cap-weighted index fund.
I’m also not sure that a free investment account necessarily implies a passive one. There’s no particular reason that active products can’t be free for small investors too. They do cost more to deliver than passive products, but costs are falling in general. A fee structure that’s “free till you get rich” might be a good way to build a stable investor base for a newly established active firm.
Thanks as always for reading!
The dictionary describes a commission as a “percentage of a quantifiable sum”. So what is the quantifiable sum of an abstract service like advice. Might be why the national trend is if advisors ever charged commission in 80%/ 20% are diminishing commission or doing away with it.
“I agree with you that folks with less than 100k shouldn’t pay fees….”
Investors who do not want to pay commissions / fees can go directly to Vanguard Brokerage. It’s already free. They don’t even charge transaction fees, plus there are no minimum asset requirements for Vanguard ETF’s. In addition, those Vanguard ETF’s carry very low expense ratios…averaging 0.05% to 0.15%.
But if investors want advice, that entails time, risk, education, licensing, insurance, experience, software, hardware, liability, electricity, brick, mortar…. none of these are free.
The cost of advice does need to come down, in my opinion, but free? I don’t see it.
Right, I don’t think there should be strict requirements that say once you reach this age or income level your fees go up. Rather, I meant that fees would average out around the levels I proposed. I’m sure there’ll be people who want more hands-on service and are willing to pay more in fees, just as there’ll be people who are comfortable with a more hands-off approach. But the industry standard of a flat full-service fee for everyone regardless of circumstances needs to change.
Great article raising great questions that time will answer.
I am no longer interested in managing money. I belong to CFALA and joined to be a better analyst of financial situations. The movement is towards managing for a fee rather that developing astuteness in financial analysis. The organization is changing direction into financial management.
My answer is from a behavioral finance perspective, and lies with the relationship between advisor and client. That is tantamount. If the relationship becomes either meaningless or lies on 0.25% of a fee, then the profession is in trouble.
Several years ago, I spoke to a health insurance executive about the importance of the doctor patient relationship and the trust between them. His answer was that the insurance industry was committed to destroying this relationship and replacing it with the patient/insurance company relationship. I didn’t see it then, but insurance has accomplished this by contractually eliminating the doctor’s relationship. And patients, well or ill, have to trust the insurance company because the doctor on the relationship is only a name on a list right now and is easily replaced, by maybe the low bidder.
So there is a lesson, and the organization of financial professionals may need an organization specific to preservation of the advisor client relationship. You can get the advice for free on the internet. But you will always need someone to tell you to get into or out of any specific market. That’s where the value will be, especially as investing becomes more global, volatile and political.
This tactic has been around for a while, from dividing a husband and wife on a micro scale. And Brokers have used it to lock in clients, in case an advisor wanted to branch out, on his or her own. Now, rolling this tactic out on a macro level, could be detrimental to any relationship. At we’re talking about it.
I’ll return your kind compliment: great thoughts! Many thanks for reading.
I think the problem that you’re talking about is fundamentally one of recognition. Very few people on the street will talk about how their adviser/client relationship has transformed their lives.
Financial advice is not a fundamentally viral product. It somehow manages to have even less buzz than going to the dentist or doctor. And the people who buy it (at least the individuals) are perhaps even less able to tell the difference between a good and bad practitioner. Just as perniciously, they aren’t necessarily able to tell the difference between a “good enough” practitioner and the one they should really be working with.
There are also fit issues that need to be considered. Like, is personal advice really right for everyone? Would I rather talk to the same person throughout my life or someone with expertise in whatever situation I find myself in?
In any case, it’s not a simple issue. I’m looking forward to expanding it more in the coming weeks. Many thanks for reading!
Yes financial advisors DO get paid everyday on wall street.
Financial planner.com indicates 3 types of payments including salary..
Those who snivel about fees are those who have a sense of entitlement for something for nothing
People have an emotional attachment to their money. While robo-advisers offer compelling advantages, they can never truly compete on an emotional level. That’s not to say robo-advisers won’t change the way advice is delivered, or the cost of that advice…we’re already seeing it happen. But investors will always respond to human interaction better than they will to an automated email.
Traditional advisers will adapt to the new technology, just like they did with online trading. I see the robo-adviser revolution as an opportunity, not just for investors, but for traditional advisers as well. Maybe the new model is a hybrid, where small independent advisers can partner with robo-adviser platforms instead of those costly alternatives. The money and time savings can be redirected toward acquiring even more clients and strengthening existing relationships.
If the services of a financial adviser are limited to asset allocation services comparable to that of the robos, then they will experience fee compression.
However, anyone with practical experience knows that financial and investment planning with individuals is more about psychology and human behavior than about numbers.
Without a personal relationship with a quality adviser, individuals make choices based on over-optimism in bull markets and over-pessimism in bear markets. They buy at the top and sell at the bottom. They invest either too aggressively or too conservatively. They miscalculate the cost of taxes. They think they will live forever when discussing life insurance and that they they won’t live very long when discussing longevity insurance. They are mostly in complete denial about future medical and long term care expenses in retirement. They deplete retirement funds to give money to and pay for education for their kids. They overspend with their consumer and real property purchases. They underestimate their spending habits. They rarely revisit their debt amortization and costs. They buy cars based on monthly payments. They buy vacation homes and rvs when they would be better off renting than owning. They are subject to the whims of the things they read and watch on the Internet and cable TV. Etc., etc., etc.
A financial adviser who also addresses all the above psychological and behavioral issues more than earns their 1%. They create tax alpha, behavioral alpha, budgeting alpha, etc., etc. far in excess of their 1%. They do not experience fee compression.
Some good discussion above; a new angle to add to the discussion:
I am very interested to see what happens to Robos after a significant market correction. Robos don’t know their clients beyond a risk tolerance questionnaire. Unsophisticated clients may invest too aggressively and unwittingly participate in the full downside of the inevitable downward market cycles we experience from time to time.
Part of the reason investment advisers must charge a fee based on AUM is because liability grows as assets grow.
A few thoughts, rambling perhaps.
It would be bewildering if individuals who spent a lifetime building a nest egg moved en masse toward a robo solution that applies a few back-of-the-envelope calculations and ends up buying SPY anyway. This money they have is their entire life; I can’t imagine they will treat it with callous regard. It’s the job of the advisor to explain in great detail the client’s holdings, the risks, the plan. To answer the phone. To answer the same question three different ways until understanding is reached. Hold their hand through the process, the same as a physician should hold your hand if you fall ill. How many individuals polled agree with the statement, “I’m satisfied with the WebMD diagnosis I received after answering 5 questions?”
With this in mind, I agree with Mr. Ross: why would I pay someone to buy SPY for me? Why should I pay extra for a boiler plate 10 year term?
The CEO of Betterment said they’d employ 1 advisor for 10,000 clients. Clearly, service is an afterthought; this is the independent advisor’s edge. The edge is in providing an understanding, in providing a confidence.
All excellent points, Arthur.
Also, regarding “The CEO of Betterment said they’d employ 1 advisor for 10,000 clients.”….
I wonder how genuine that statement/forecast really is, considering Betterment is marketing a wrap program to independent financial advisers through Betterment Institutional. Not that their platform can’t handle it, I’m sure it can once the client is acquired. But they’re using traditional advisers to acquire those new clients and manage those relationships. They’re obviously not counting them in their 1:10,000 ratio.
This suggests robo-advisers have marketing limitations, and that’s where even offering a “zero fee” won’t be able to help them. Investors need people, and people cost money.
I didn’t know about that, thanks for pointing that out. I think a white-labeled solution for independents definitely fits, and actually may be a huge positive for RIAs to compete at a grander scale.
I think the idea of simply a fee for time (consulting) or a fee for assets under management may not ever be the right answer. If the problem has multiple dimensions and multiple sources of conflict then the solution probably has to be multi-pronged. I believe we need to have three compenents to the fee discussion:
1 – Fees for safekeeping/oversight (10bp)
2 – Fees for communication/insight ($50-200 per hour) typically 5-10 hours/yr
3 – Fees for value add (10% of return greater than benchmark, with highwater mark)
Vast majority of assets in $500k to $2.5 million and 60% Equity(SP500)/40% bonds (Barclays Agg). Level of person speaking to client could vary based on complexity.
For a $1 million with 4 meetings, $1000 asset based fee plus a $1000 time based fee and with value add of 1%, yields another $1000 for total of 30bp. These numbers may need to be tailored to accomodate a each advisory practice.
Robos provide automated, passive money management services for substantially reduced fees. Fee reductions are achieved by eliminating expensive investment professionals and relationships with traditional financial advisors. If you were a prudent, rational investor how much would you be willing to pay for a relationship with a financial advisor? Is the relationship worth 50 bps, 75 bps? What happens when investors need some serious hand-holding in material down markets? Will a barrage of Robo emails be an effective substitute for an advisor who listens to investor concerns and takes action to minimize losses.