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Financial Services Explained, Pt. 1: The Cost of Everything

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From the emergence of the independent retail financial advisory industry in the early 1970s to about the mid-1990s, just about every independent advisor in the country was either a former stockbroker or an insurance agent (along with a few renegade lawyers and accountants). And virtually all them went independent because of their inside knowledge of, and experiences with, the financial services industry. Despite the fact that these advisors usually took a significant decrease in compensation, they believed that they could better serve their clients in their own businesses.

But that career dynamic changed in the 1990s. With the industry’s transition from primarily commission sales to primarily fee-based asset management, independent firms began to grow beyond “mom and pop” shops, into much larger businesses. These were businesses that needed to hire increasing numbers of young advisors—fresh out of financial planning or business schools—to keep up with their growing numbers of clients.

Of course, this trend has continued to the present day, with ever-larger advisory businesses hiring newly minted advisors as fast as their schools can pump them out. In my view, this influx of professionally trained young advisors has had a major impact on the independent/financial planning industry: talking it to new levels of professionalism, client service, and business management. 

With one exception: lacking the older generation’s direct experiences with large financial services companies, this new generation of advisors tends to lack a real understanding of how the financial services industry actually works. That makes it difficult for them to help their clients navigate the essential benefits of financial services while avoiding its many pitfalls. To fill that void, in this and future blogs, I’ll offer some observations about the workings of the financial services industry—and how advisors both young and old can help their clients benefit from it.

To my mind, the most important thing about the financial services industry is that it’s very different from any other industry that you or your clients are likely to come in contact with.

As a basis for comparison, let’s take the auto industry. Its product is cars and trucks, and its revenues come from selling those products. When we go to buy a car, we all know the dealer wants to sell the car for as much as it can, and we’d like to get it for as little as we can. But more importantly, what we really want is a vehicle that we can drive around, and if we make a deal for whatever price, that’s exactly what we’ll get.

While financial services companies also call what they sell ‘products,’ they really aren’t products at all: they are contracts. From checking accounts, to mutual funds, to homeowner’s insurance, to annuities, they are contracts that read this way. If you give us your money now, at some point in the future we’ll give you some money back, usually more than you put in. But how much more money you get back will depend on the terms of the contract.

So to start with, you don’t get to take the benefit home: just a promise of some benefit in the future. More importantly, the money that the financial services company ‘makes’ isn’t like the $35,000 you fork over for a Chevy Silverado. You don’t see the benefit up front, and you may never see it at all. I’ve seen variable annuities that had more levels of fees and expenses than I thought possible.

The point here is that while Ford has a one-time conflict with its customers over the price of its cars, that we can all plainly see, a financial services company that’s holding a pile of our money has a conflict every day. The more of that money they can move into their own accounts, they more money they’ll make, the happier their owners will be, and the bigger their salaries and bonuses.

On the other side of the equation, most investors are clueless about the time value of money and the power of compounding. I know this because as part of a talk I used to give to groups of investors, I’d ask them this question: If you gave me $100,000 and in 30 years I gave you back $200,000 would you be happy? My listeners always said “Yes!” Even though at some reasonable rate of growth rate, the $100k would have grown to $1 million or thereabouts (don’t hold me to those numbers). But you get the picture: high expenses can greatly erode client portfolios without investors being the wiser. 

Now, in fairness, most financial services companies are very scrupulous about the money they take out of client accounts. But there are powerful financial incentives to push the limits and some companies succumb. Often, these “excessive” fees are disclosed, but not always: for instance, remember the cases of broker-dealers in recent years that conveniently “forgot” to waive their commissions on retirement and charitable accounts, totaling millions of dollars. 

The takeaway is that there’s really only one “product” in financial services: your clients’ money. And there isn’t one client in 1,000 who is savvy enough to even understand that, let alone determine whether what they pay is fair.

Not surprisingly, the suitability standard that most brokers operate under does not require them to consider the investors’ ‘costs’ in their recommendations. But as a professional financial advisor, it’s one of your most important functions.


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