Are You Oblivious To Fee Compression?

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You are my friends and clients. I have great respect for the work you do and appreciate the value you add to the lives of your clients. That’s why it’s painful for me to see so many of you headed for trouble by denying the obvious trend in fee compression.

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When I raise issues about your business model, some comment they “are not losing sleep” over the future because investors “will always need the guidance of a human advisor.” Sentiments of this nature recall this famous quote attributed to Upton Sinclair, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

Pressure on fees will accelerate

A recent article in Morningstar by John Rekenthaler noted the impact of robo-advisors and made this observation: “On average, over time, robo portfolios will beat those created by human advisors by about 75 basis points per year.”

Many investors now understand the difficulty of attempting to “beat the market.” They also appreciate the effect costs and fees, including those charged by advisors, have on reducing returns.

Rekenthaler claimed the financial services industry will follow the lead of mutual funds in reducing fees “up to a point.” Wealthy clients, and those with complex issues, will be willing to pay more for professional advice. However, even these clients will “push for steeper volume discounts.”

Rekenthaler concluded, “robo-advisors have only just begun. They will not conquer all, but they will expand greatly over the next couple of decades.”

If he is right (and I believe he is), the market for your services is going to shrink dramatically, and those clients who continue to use your services are likely to impose demands for lower fees.

This conclusion is buttressed by a report from PwC. It found 30% of consumers plan to increase usage of “non-traditional” (i.e., “robo”) financial services providers. Only 39% planned to continue using traditional advisors.

If you’re not losing sleep over these developments, you should be.

Competition for clients will be more intense

I get many requests from readers of my books for financial advice. While I can’t provide advice tailored for them, I typically provide the following options:

1. Do it yourself, using low-management-fee index funds. I refer them to this blog by Jonathan Clements, which sets forth options for putting together a globally diversified portfolio with a weighted average annual expense ratio of 0.05%.
2. Use a fee-only financial planner from the Garrett Network who doesn’t manage money or sell products. These planners will provide a comprehensive financial plan and will assist clients in implementing their investment recommendations, using low-cost fund families like Vanguard. They have a one-time fee for the plan (ranging from $2500 to $5000) and a reduced fee for yearly updates. Their cost is significantly lower than the AUM-based fees charged by traditional advisors.
3. Use a fully automated robo-advisor like Wealthfront or Betterment. Fees are generally 0.25% of assets.
4. Use a hybrid service from a major fund family like Charles Schwab, Fidelity or Vanguard. These services provide access to qualified advisors. Fees are 0.30% or less.
5. Use a traditional advisory firm. I generally recommend one firm that does everything in-house (including tax preparation and estate planning), one firm that does tax preparation but not estate planning in-house and one firm that coordinates with tax and estate planning professionals.

By Dan Solin, read the full article here.