How to Avoid the Coming Crunch on Advisor Compensation

By Dan Richards

April 8, 2014

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Today concludes my series of articles on the inevitable dislocations in the financial industry in the next decade. Two weeks ago, I outlined important changes in how Americans will invest. Last week, I discussed the impact of a rise in professional standards and a redefinition of what constitutes value.

Here are the two final ways that life will look very different for financial advisors in 10 years: a change in the structure of advisor practices and downward pressure on compensation.

Grow big or go home: rethinking the structure of advisory practices

Advisors who operate today as solo practitioners are like small retailers before the arrival of Walmart, or diners before McDonalds — in other words, endangered species. Even if those corner stores and diners survived and stayed in business, pressure on revenue and margins meant that their owners faced a constant struggle to survive.

Even In a world where you can outsource technology, the future will demand scale – the maxim for future advisors well be, “grow big or go home.” The automation of dental practices provides a relevant role model, as the need to serve patients well, run an efficient practice and optimize revenue means that different members of a dentist’s team perform different tasks. In future, the solo advisor with one assistant will be as obsolete as solo dentists who do their own teeth cleaning and prep work and only have a receptionist to support them.

The good news for advisors looking to build teams is that — given the abject failure of most rookie-advisor training programs — the only route for new advisors will be joining established practices as associates. And as more universities launch undergraduate training programs for financial advisors (much like the co-internship programs you see at many business schools), there will be a larger supply of eager, bright and well-trained talent looking to enter the industry. To take advantage of that, solo advisors need to make a realistic assessment of their ability to get to scale in a reasonable timeframe. If the prospects for expansion are unlikely, they should partner up or join a larger team.

The landscape for advisors looking to acquire practices will change as well. I recently spoke to an advisor who said that given what he can get for his practice, he’s better off working part time and winding down gradually. Even if he loses 10% of clients annually because he’s scaled back to three days a week and takes eight weeks of vacation, he’s still better off financially than if he sold his practice. Setting aside what that says about his client orientation, that kind of lackluster commitment won’t cut it going forward, especially given the heightened regulatory burden You’ll either be in the game or out. Advisors like this one won’t have the option of milking their book and will have to sell their practices instead.

Advisors with a long view of the business need to accept that the minimum level of scale will increase significantly in the period ahead. Some advisors have already expanded their firms to that level, but many need to make a realistic assessment of how to get to the size where they can operate efficiently and avoid the fate of that solo dentist trying to run a practice with just a receptionist.

Are advisors like GM autoworkers?

My final prediction is the most contentious. I expect a significant drop in average compensation for advisors.

Ten years ago, workers on General Motors (GM) assembly lines who clocked a bit of overtime made $120,000, twice what Toyota and Honda paid. Their union had negotiated a “30 and out” clause that allowed workers to retire with fully indexed pensions and health care at age 48 or 50. GM had job banks, where workers with seniority lobbied to get laid off so that they could collect 95% of their salaries indefinitely while not working. Any rational person would have said this was nuts and that it couldn’t continue – and of course we all know how that story ended.

I’m not going to suggest that today’s advisor compensation approaches that level of insanity – but given the education and capital investment required to become a financial advisor, it’s certain that overall levels of compensation will come under severe pressure.  Here’s research from Investment Executive on what advisor compensation looks like today:

Median compensation for
Partner, Financial Advisory Firm $324,000
Advisor who operates solo practice $217,800

Source: Investment News

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