For financial advisors whose clients have seen years of hard-earned savings evaporate in the last 18 months, there's some — okay, very little — comfort in knowing there were few places to hide. The popping of the credit bubble (and the real estate buying panic) took down nearly every asset class with it. You might try to sell your clients on how unprecedented this trouncing was — a Black Swan event, really. No one could have foreseen this kind of pain, right?
Not surprisingly, many clients may openly question your investing prowess — and the fee you charge for sharing it. The story of one high-net worth retiree we know — we'll call him Jack — serves to illustrate this point. Jack, in short, is ready to give up on his long-time advisor. At age 65, after 40 years of toil, the former Xerox executive checked out of the workforce for good in the middle of 2007. He and his wife, a teacher at a grade school near their home in the suburbs of Boston, had amassed an impressive multi-million-dollar nest egg; the couple was looking forward to traveling (a private sailboat cruise with friends in the fjords of Scandinavia was slated for this year) and spending more time with their four grown children and their young families. All in, Jack's situation was enviable: The only debt he carried was a modest $220,000 mortgage balance on a 30-year fixed loan at 5.6 percent. He purchased his home in 1994 for roughly $500,000; it was valued recently at more than $900,000.
When he retired, Jack and his wife were set — the hard work and discipline of saving having paid off. Then came the historic decline in global capital markets and the arrival of what the newsletter writer and author James Grant has called “The Great Recession.” Today, Jack's total nest egg is 35 percent smaller than it was a year-and-a-half ago. He's spooked — very. He's frustrated and angry. And one of the primary targets of his frustration and anger is his financial advisor. In particular Jack is angry at having paid an annual 1 percent asset management fee in the ten years since hiring the advisor.
For what? He wonders. “Excluding my contributions and without accounting for inflation, my portfolio has grown by 0.121 percent over the last ten years,” says Jack. Paying 1 percent a year on a multi-million dollar portfolio to watch it shrink (after inflation) over a decade is a sour pill to swallow. “I'm planning the divorce. That's where I am right now,” he says.
It's safe to say the vast majority of financial advisors have (or had) at least one disgruntled client like Jack in their book. According to a recent study by Prince & Associates, a research firm that plums the hearts and minds of high-net-worth clients, 15 percent of the wealthy left their financial advisors in 2008 and 70 percent took at least some of their assets out of the advisor's hands. In short, the “value proposition” of every financial advisor is being reviewed by clients. What services do you provide, how much do you charge, and is your service worth it?
I Am Alpha
If you are like most FAs, you probably charge 1 to 2 percent on assets. According to a compensation study conducted by Registered Rep., and sponsored by Cambridge Associates, 62 percent of advisor respondents charged a 1 percent fee in 2008 while 23 percent charged 2 percent. Additionally, 73 percent of respondents said their fee in 2008 hadn't changed from 2007.
What do your clients get in return for that fee? It may not be what you think. Research conducted in the fourth quarter of 2008 by Cerulli Associates, together with the FPA and IMCA, reveals that what an advisor says he offers and what he actually provides aren't always in synch. Here's how advisor respondents perceived themselves: financial planners (59 percent), investment planners (23 percent), wealth managers (15 percent) and money managers (1.2 percent). And here's what Cerulli thought about them after evaluating their businesses: financial planners (43 percent), investment planners (45 percent), wealth managers (10 percent) and money managers (1.2 percent). In other words, fewer of you do financial planning and wealth management than you think.
Do you know where you fit? Do your clients? Right now, advisors must be especially clear with clients and prospects about how exactly they earn their keep. The bottom line is that the wealth management industry, with its plethora of designations and titles, is under intense scrutiny. Clients like Jack want reassurance that they're not paying their advisors for services they don't use, or aren't receiving. After all, who needs an advisor to lose them 35 percent or more by going long the S&P 500? Most clients can get that kind of service for free with an ETF.
“It's been way too easy for former stockbrokers to gather assets and dump them somewhere and call themselves wealth managers,” says Bill Bachrach, founder of advisor coaching firm Bill Bachrach & Associates. “If asset management is all you do and you can't point to some other way you make or save money for clients, you have nowhere to hide when performance goes south.” Indeed, if you have been marketing yourself an investment planner or manager (“I'll make you money”), you are probably playing defense right now. Investment performance is a big piece of any advisor's value proposition, Bachrach says, “but for 1 percent you can do a whole lot more.” The good advisors are doing a whole lot more, he says, citing one example of an advisor he knows who, within weeks of taking on a new client, renegotiated that client's property and casualty insurance. The move saved his client $10,000 annually — more than he charges for one year in fees.
Disclosure Is Key
Structuring your fees intelligently and explaining them to clients is also essential. The advisor mentioned above made what now could be characterized as a business-saving change to his fee structure years ago, according to Bachrach. He added a “minimum fee” as a safety net to his 1 percent. If client assets drop to a certain level, a minimum $8,000 fee kicks in. Contrary to what your clients might initially think of this arrangement, it's good for them too. Instead of forcing you to frantically resize your business from boom to bust and back — laying off staff and fretting over business costs — a minimum fee protects an advisor's revenue and allows him to stay focused on clients when they are demanding even more of his time.
Taking stock of the firm you work for, and the kind of services it allows you to provide, can't hurt either. Not surprisingly, a number of studies have emerged in recent months that evaluate financial service providers. A recent Consumer Reports survey of 9,000 subscribers asking them to rank 17 brokerage firms on customer service in 2008 certainly speaks to clients like Jack. The so-called discount brokers scored higher than their full-service peers. Vanguard and Edward Jones were standouts and other firms like Charles Schwab, Scottrade, Fidelity Investments, TD Ameritrade and T. Rowe Price also had high rankings. The lowest rankings included names, such as Merrill Lynch, Ameriprise Financial and Wachovia Securities.
Philip Palaveev, CEO of Fusion Financial Advisor Network, says clear investment policy statements can also help define the goals, scope and nature of your relationship with clients. But he says industry standardization would also help. Financial planning is relatively well defined because specific parameters have been set by the CFP Board of Standards, and it's also the fastest growing of the industry's disciplines. According to the Cerulli study, 60 percent of advisor respondents said they planned to offer more financial planning services in the coming year. But, unfortunately there's no regulation about what a financial plan should include, just who can offer full-blown financial advice (an RIA advisor). Meanwhile, what is wealth management, for instance? Visit a dozen sites and you'll get a wide range of answers.
Back to Jack
Jack's advisor says on his firm's website that he is a CFP who specializes in “executive financial counseling, wealth management and financial planning for small business owners.” Jack was referred to the advisor in 1996 by another executive at Xerox and he promptly gave the advisor control of 70 percent of his investable assets — his IRA account — and decided to keep his Xerox 401(k) separate. In exchange for the advisor's 1 percent fee, he and his wife get two face-to-face meetings every year in their home, 200 miles from the advisor's office, and quarterly reviews over the phone. Additionally, Jack says he can reach the advisor by phone or email fairly easily. Aside from the initial asset allocation and annual tweaks, he says the advisor has coordinated with his attorney to rework his will, filling it with the necessary trusts, etc.
In fact, there are plenty of services on offer at the advisor's full-service independent financial planning firm. It's just that Jack feels he's had to poke and prod, sometimes sniff them out himself. “He's more the reactive type,” says Jack of his advisor. By that, Jack means he's always available — happy, in fact — to discuss ideas or concerns. But very often Jack is the one initiating, especially regarding his investments, and that has bothered him at crucial points in time when he expected the advisor to take charge. For example, Jack was the one who instructed his advisor to significantly reduce his equity exposure roughly a year before the dotcom bust — a move that he says limited his losses to 25 percent, as opposed to the 40 percent losses suffered by many of his college friends and peers at Xerox.
And it was Jack who took the initiative in this crash, too. When the Dow industrials blew through the 8,500 mark, he started running disaster scenarios in his head — how low can it get before my long-term plans are kaput? Will I have to change my cost-of-living expectations? Since retiring, he hasn't touched the bulk of his assets — the IRA funds the advisor controls. Instead, he's been relying on three sources of income — his Xerox 401(k), which is almost entirely invested in guaranteed investment contracts (GICs) that have consistently paid handsome yields (but are now paying far less), his wife's teaching income, and his Social Security payments.
Jack knew he could live off those three things alone for the next few years and wait out the recession, but he didn't want to push it. So when the Dow hit 8,000, he called his advisor to say he wanted to exchange equities in his IRA for CDs. The advisor told him to hold on. He yielded to his judgment. But he said, “If it gets below 7,000, I'm in trouble.” Eventually it would go below that mark, but at 7,200 Jack, peeved that his worst case scenario was playing out and that his FA had facilitated it, rang the advisor again.“Remember our conversation?” he asked, nervous and irritated. The advisor moved 45 percent of his equity portfolio into cash-equivalents that day. (Of course, since mid-March stocks have been rallying.)
As he mulls over the last ten years, Jack finds more and more to complain about. For instance, Jack researched and bought a long-term care policy on his own. Why didn't he ask the advisor? “I had no idea he would provide that service,” he says.
Undoubtedly, Jack's perception of the advisor's value is powerfully linked to the performance of his portfolio. For ten years, as he puts it, “I was just opening monthly account statements and smiling,” he says. Not anymore. Now he reads his statements thoroughly and he also reads a wide variety of financial literature — newsletters, mutual fund research, financial blogs — things he never considered before. Books by folks like John Bogle have crept onto his bedside table.
So, what's the one reason Jack hasn't fired his advisor yet? The same reason he hired the advisor ten years ago: he doesn't want to manage his own money. “I have even less desire today to be some idiot pulling my hair out over the daily moves of the market,” he says. It's the old doctor analogy — 90 percent of the time you visit you're fine and the doctor sends you home. But it's the other 10 percent of the time that worries us. Presumably, we pay them to know the difference.
