Drop by a Financial Planning Association or NAPFA conference, and you’ll be sure to find Bob Veres, surrounded by a crowd of advisors who want to ask him about a business problem–or others who want to tell Veres how they solved theirs. Indeed, Veres has become a veritable clearinghouse for trends affecting the financial planning industry. A former columnist for Investment Advisor, Veres now holds forth in his monthly newsletter, Inside Information (www.bobveres.com) as well as in email newsletter he zaps out to readers across the country. His constant back-and-forth with advisors provides much of the source material for The Cutting Edge In Financial Services, Veres’ new book on the future of the financial planning profession (National Underwriter Professional Publishing Group). He shared his thoughts on the industry recently with IA Editorial Director William Glasgall. An extended version of this interview can be found at www.investmentadvisor.com.
You’ve said the financial planning profession is entering a new phase of development. What do you mean by that? There are two things to understand about the evolution of the planning profession. The profession goes through what I call professional cycles, which are exactly like normal economic cycles, but are specific to the profession. Just like economic cycles, you have a period of prosperity that gives way to a period of excesses, and then there’s a major shift of some sort which suddenly changes the nature of the game. The profession goes into recession, it sheds the excesses and a lot of people who seemed to be doing quite well are suddenly out of business. The second thing to understand is that the profession changes dramatically during these recessionary periods, where one cycle ends and another begins. All of the evolution seems to be compressed into a very short time period. We are in one of those periods now.
Can you give an example of how that has happened in the past? Look back to the 1980s, when the highest marginal tax rates were 90%. The cycle began in an awful, terrible investment climate, 10 years or more of zero returns from stocks. People weren’t interested in investment advice; they wanted to know how to deal with the confiscatory tax scheme, and it happened that the tax laws at the time favored investment in tangible items like real estate, oil and gas wells, depreciable items like cargo containers. So the profession turned to tax planning as the No. 1 item on its service menu. Eventually, it became easier to specialize in that top-of-the-menu service and abandon full-service financial planning. In the late 1980s, people made a great living by simply asking the question, “Do you like to pay taxes?” If the answer was “no,” they had a sale. And thousands of financial advisors abandoned the full-service financial planning model, and became specialists in asking that one question. That’s how you know a cycle has turned; when it suddenly becomes much more profitable to specialize in the most visible element of the service, and stop doing the hard work of full-service planning.
And then the Tax Reform Act of 1986 came along. Exactly. Tax shelters were no longer economically viable, and of course you had the stock market crash in there as well, and all those people who were specialists were suddenly being sued out of business. My best estimate is that 25% of all planners left the profession between 1988 and 1991. That’s about the same as the death rate in Europe from the Black Plague in the 14th Century. And, of course, that very brief period gave birth to a whole new dynamic in the profession.
Which was assets under management? Notice how fast the change was. After that very brief recessionary period, suddenly the service that had been paying for the entire financial planning engagement–tax shelters–was no longer contributing a nickel to anybody. Professional leaders were suddenly behind the curve, while new faces emerged as leaders of the profession. In the blink of an eye, the profession moved to modern portfolio theory, from commissions and junket trips for producers to fees and fiduciary conduct.
You think we are in a comparable period today? Yes. The next two years are going to see what I call a compression of change, very rapid shifts in the service menu, in how planners are paid, just like every 12 or so years since the profession began. It will be very difficult to keep up with these changes, and the stakes will be enormous.
What will the new phase look like? People who specialized in pure asset management–the most lucrative of the financial planning services, and the service that was at the top of the menu in this last professional cycle–are now getting hurt. It might not be as bad as what happened to the people who specialized in selling tax shelters, but we still don’t know how much further this bear market has to go. The simplest prediction I can make is that people who hung onto the full-service financial planning engagement will have a near 100% survival rate during this professional recession. Those who specialized in asset management services have lower odds of survival. In a couple of years, we’ll be able to look back and see what those odds were this time around.
What else? The next lesson these cycles teach us is that the service that mostly paid for the planning engagement in one cycle does not pay for it in the next. When I give speeches around the country, I usually ask how many members of the audience are still making money selling tax shelters. What is frightening is how quickly these transitions happen. If this lesson applies to this cycle, within the next two years planners will not make money primarily on their asset management services. They’ll still provide the service, but it won’t be their source of revenues.
Why? There are two issues to consider here. One is future returns, and how they affect the AUM business model. About a year and a half ago now, I attended a briefing on a summit meeting that had gathered the leading academics who study equity returns. The list included Roger Ibbotson, Jeremy Siegel, Robert Shiller, Robert Arnott, and some people who are known to academics, like Brad Cornell at UCLA, Clifford Asness of AQR Capital Management and Stephen Ross of MIT’s Sloan School of Management. They were there to talk about the equity risk premium, which is another way of saying the rate of return that will be offered by the markets, after-inflation, over the next 15 or 20 years. At the end of the meeting, the organizers asked everybody what they thought the equity risk premium was today–what those future returns would be. The result was an amazing, unprecedented agreement among people who come at this from very different directions. Most of the attendees were clustered around 2%. Jeremy Siegel was the raging bull of the group–at 4%. I think it was Arnott who said the equity risk premium was actually negative. Think about the implications of that. First, if you’re charging 1% of assets under management and the market is delivering 15% or 20% a year, nobody really notices that fee. But suppose the market delivers an average of 2% for a very long period. The client suddenly realizes that he and the advisor are basically sharing the portfolio returns equally. I take my half, you take yours, and I hope you like the asset management services we provide you. That arrangement, I would suggest, may not be sustainable for long.
Are there other considerations? Yes. One is the document most advisors use to communicate their value, on a regular basis, to clients–the quarterly performance statement. The message, which is sent clearly, if nonverbally, is, “my main function is to get you an excellent rate of return on your investments.” If the markets aren’t delivering an excellent rate of return, then chances are you aren’t, either, and clients begin to wonder what they’re paying you for. We’re also beginning to see some structural weaknesses in the way AUM fees are charged. I think we’re approaching the day when somebody, in the consumer press, is going to say out loud, “Anybody who takes 1% a year for managing assets is a thief.” And a lot of advisors are going to have to scramble to show that the fee is really for a lot of other stuff. There’s another structural problem with AUM fees. A planner who subscribes to my newsletter called me up and said, “Bob, I just had the scariest experience of my life. A new prospect came in the door, and he had a $10 million portfolio, and he asked me what I would charge for my full-service planning work. I told him 1% of the assets, more or less. He thought for a minute, and said, ‘Suppose I only came in here with only $5 million.’ I said that my fee is the same. Then the prospect said, ‘Here’s what I’m going to do. I’m going to give you $250,000 to manage and take your 1% fee out of, and I’m going to have a professional money manager handle the rest of it.’ The point, which consumers will catch onto sooner or later, is that it is not 10 times more difficult to offer planning services to a person with $10 million under management than it is to offer those same services to a person with $1 million under management. Ultimately, the AUM compensation structure is destined to break down, which is too bad, because it served us so well for so long.
In the book, you seem to be saying that “life planning” services will be the next top-of-the menu service for financial planners. But what is life planning? Is it career planning? Expenditure planning? Estate planning? Or finding goals and crafting strategies to meet them? It’s all of the above, and more. This takes us back to how you predict these things. Another lesson that seems to be common to all of these professional cycles is that the next big service will be created by the most idealistic and least financially motivated advisors in the business. They’ll try to identify what service their clients really want, and pursue that service even if there is no viable business plan to make it pay your bills. That’s how the asset management service started, and people literally starved for the first few years trying to figure out how to make money at it. The same is true today of the life planners. They don’t have a clear business model, but recognize the importance of the service and want to do a better job of delivering it to clients. If I’m right, a business model will evolve around it and the next professional cycle will be even more rewarding, in money and psychic gratification, than the one we are emerging from.