Five industry trends reshaping global financial advice

Edited copy of talk by Michael Kitces, Chief Planning Nerd, Kitces.com

The business model of delivering financial advice is shifting and changing as a function of very long-term trends that have been compounding for the better part of 40 or 50 years.

Technology has interrupted and reshaped business models since the early 1800s, when more technologically advanced weaving looms threatened the livelihoods of professional weavers and kickstarted an economic reconfiguration known today as the Industrial Revolution.

A similar technology revolution has been playing out in the financial advisor world since the 1970s. In summary, technology is enabling a great convergence of industry channels, leading to a crisis of differentiation amongst financial advisors, which in turn is driving a search for new business models and a growing focus on the client experience.

Let’s start with our first industry trend: Technology.

1. Technology

A financial advisor of the 1970’s or 1980’s in the US was a stockbroker. Stockbroking was incredibly lucrative back then because the trading commissions had been fixed by the regulators in the late 1930’s, in response to market abuse and commission gouging.

After about 40 years of this regulation, the US deregulated the stock trading commissions in 1975. Being free to charge any fee for trading for the first time in 40 years, an entrepreneur from Northern California decided to use computers to see if he could put financial advisors out of business. His name was Chuck Schwab. Schwab was followed by Ameritrade shortly after that as well as Scottrade, and the predecessor to Etrade.

The late 1970’s/early 1980’s was a giant boom of start-up tech companies for who's sole goal was to obliterate the human financial advisor at the time - and the computers won. But they didn’t kill the financial advisor – they merely killed the financial advisor business model at the time. Financial advisors went into the mutual fund business, placing clients in professionally managed funds as opposed to selling them stock picks.

But technology interfered again. In the late 1990’s, all financial advisors were paid by the commission load on a mutual fund. Now a tech company offered a zero-commission mutual fund platform on the internet. This was the Schwab OneSource program. Consumers suddenly no longer needed advisors to buy mutual funds.

But financial advisors responded and evolved into the assets under management business. In the US this was typified by the evolution of what we call registered investment advisors (RIAs) – independent licensees who manage a portfolio or clients as part of a holistic advice proposition, and who charge a percentage of the client assets annually as their fee.

This advice model has now become the dominant one in the US, with even product provider-tied advisors rushing to adopt the assets under management business model. This led to the next technology interruption, in the form of automated, technology driven portfolio management tools. The most well-known example of this is the set of direct-to-consumer tools called robo-advisors.

So, the key question to financial advisors today remains the same as it has been since the 1970s: what is the value advisors can add on top of what the technology will increasingly automate? This leads us to our second trend: The great convergence.

2. The great convergence

The first impact of the technology and its ripple effect is on the convergence of the product-led (tied agents) and advice-led (independent financial advisors) business models.

In a continuous cycle all financial advice business models are increasingly playing increasingly in the same space - migrating to the funds under management business model as the product commissions business model is rapidly eradicated. This leads us to the third driver of change for financial advisor business models: the crisis of differentiation for the modern financial advisor.

3. Crisis of differentiation

Modern financial advisors are increasingly finding that superior client service, breadth of financial planning, or depth of client relationships are no longer viable differentiators in a market increasingly overrun with advisors operating on a funds under management business model.

Secondly, the key weakness of the assets under management business model is that prospective clients need to have assets to start with, and need to be willing to delegate the management of that money to a financial advisor – we call them Delegators. However, this ignores a large swathe of younger clients who are still building their wealth, as well as a critical group of older clients who want to participate in the advice process more actively – we call them Validators.

The end result in the US is that we have too few clients with large enough assets for all the financial advisors now converging on the assets under management business model. This is forcing financial advisors towards the fourth trend: searching for new business models.

4. The search for new business models

The search is on for financial advisor business models that can work for Validator clients as well as clients who are asset-poor but income-rich.

In a fee-for-service model several interesting options are currently being explored, ranging from selling hours, selling contracted client outputs, or charging a client a retainer fee as a percentage of the client’s income. There is no clear winner yet.

5. Client experience

Which brings us to the last industry trend – how clients are experiencing the process of buying financial advice. Much research work into this topic in the US arrives at the same conclusion. That receiving financial advice from an advisor feels like a combination of a math class, marriage therapy and a dental exam. Confusing, stressful and uncomfortable.

Linked to the search for new business models and the crisis of differentiation, advisors are increasingly looking at remodelling the client experience of the advice process by utilising trend number one: technology.

A recent example of how technology changed client experience can be seen in the travel agent industry over the past fifteen years. Technology revolutionised travel in many ways, but one of the biggest impacts of travel blogs, Airbnb and online flight bookings has been a reduction in the number of employed travel agents in the US. But the smaller number of travel agents left are doing four times more travel plans than they did ten years ago. How can this be?

The travel agents who survived were the ones who leaned into the new capabilities that technology enabled – they differentiated away from what the technology automated; booking of flights and accommodation, and into the areas technology had more difficulty automating; individually customised travel and itinerary planning.

Conclusion

Technology has been a driver of change in financial advisor business models since the 1970s. The computers were supposed to kill the financial advisor stockbroker model. Instead, they just changed the model. Then the computers were supposed to kill the financial advisor mutual fund model. Advisors just evolved up the value chain again. Now we talk about technology killing the funds under management model. It is not going to kill the financial advisor. It just drives changes in the value proposition of what advisors do, increasingly driving advisors into providing more holistic financial advice, because portfolio management will become increasingly easy to execute with technology.

The ultimate goal for good advisors is to redesign their business models to sustain their fees and command value premiums in the marketplace due to the value they can add on top of what the technology increasingly automates. They key is leaning into the technology and the opportunities that is represents, as opposed to fighting it.