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2017 Career Guide: Financial Services Explained

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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. 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 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: taking 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, here are 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.

Contracts as Products

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 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. 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 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.

While Ford has a one-time conflict with its customers over the price of its cars, 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.

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, the $100,000 would have grown to $1 million or thereabouts (don’t hold me to those numbers).

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.
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.

Levels of Independence

About 10 years ago or so, the National Association of Professional Financial Advisors (NAPFA) was facing a crisis. Its public relations campaign to promote the benefits of fee-only advice had been so successful that financial advisors of all stripes were claiming to be fee-only, regardless of their actual status. The common explanation in the brokerage world and among many financial planners was “when I’m charging fees, I’m fee-only; when I’m charging commissions, I’m not.” Even the CFP Board was found to be in on this deception; Financial Planning magazine’s Ann Marsh revealed in 2013 that hundreds of brokers had listed themselves as “fee-only” on the Board’s “Find a CFP” website.

In response, NAPFA was considering changing its focus from “fee-only” to “fiduciary” advice, and asked a number of industry observers what we thought of the idea. (The NAPFA folks proved to be ahead of the curve when four years later, the Dodd-Frank Act popularized the concept of fiduciary advice; more recently, the Department of Labor made it a national conversation with its Conflict of Interest rule regarding the fiduciary status of advisors while giving retirement advice.) At the time, I told the NAPFA board that I thought the concept of a “fiduciary” was both too legal sounding and too complicated for most investors to grasp. Instead I suggested the term “independent advisor” to differentiate sources of truly client-centered advice.

While NAPFA did not take my suggestion, they did heed my advice (and undoubtedly that of many others) and passed on the fiduciary nomenclature. In the years since that meeting, a majority of brokers have embraced managing assets for a fee, making them fiduciaries when advising on client portfolios, but not fiduciaries when selling the investments that go into those portfolios. They have been able to co-opt this term in marketing and speaking to confused clients, just as they did “fee-only.”

That’s why I still believe that “independent advisor” is the best description to market truly client-centered advice. However, like most things in financial services “independence” isn’t quite as simple as one might think. To be clear, we’re talking about advisors’ financial independence from employers or other firms. As it turns out, some advisors are more financially independent than others. Here’s a breakdown of advisor independence, along with a breakdown of how client-centered advice can be affected at each level.

Employee Advisors. At the bottom of the independence scale are brokers at the large brokerage firms: Merrill Lynch, Morgan Stanley, Wells Fargo Financial Advisors, UBS. The brokers at these firms are W-2 employees, so there’s no confusion about whom they are working for. Their salaries, bonuses, forgivable loans, promotions, offices, staff support, entertainment allowances, client referrals and payout percentages (the portion that they get to keep of the revenues that their clients generate, which typically range between 25% and 50%) are all controlled by their employer.

Since the primary business of these firms is underwriting (creating) securities such as stocks and bonds, and investment vehicles such as mutual funds and hedge funds for outside client companies, the primary mission of their brokers is to sell these securities to investors. Consequently, these brokerage firms have considerable amount of influence over what — and how much of it — their advisors recommend to their clients.

Independent Broker-Dealer Advisors. On the next level of independence are advisors who affiliate with so-called “independent broker-dealers.” These BDs are called “independent” for two reasons.

First, unlike the big Wall Street firms, they don’t underwrite securities to be sold. Instead, they are simply conduits for their clients to buy and sell securities. The second reason is that instead of being employees, these brokers own their own advisory businesses.

They affiliate with their BD for regulatory oversight and for back-office services and technology that they couldn’t afford on their own. The BD can still exert some degree of control over their affiliated advisors: primarily by determining their payout percentages, which typically range from 40% to 90%. On $1 million in annual commissions and AUM fees, that’s a difference of between $400,000 and $900,000.

Even though these independent BDs don’t underwrite investments, they do have financial arrangements to market the products of mutual funds and other investment firms, all of which can render the advice of their affiliated advisors less than financially independent.

Registered Independent Advisors. Finally, at the top of the independence spectrum, we have registered independent advisory firms. These firms are advisor-owned RIA firms that derive their revenues solely from charging a fee on their assets under management (AUM) or flat retainer fees paid by their clients. Their clients have accounts at custodial firms such as TD Ameritrade or Schwab. These firms and their advisors are full-time fiduciaries under the ’40 Act, without affiliations with other financial services firms.

Industry observer Michael Kitces has pointed out that some of the custodial firms do offer technology support and other services at reduced costs to some of these firms, which can create conflicts of interest. Yet the dollar amounts of these perks appear to be quite small, and most RIA firms today work with multiple custodial platforms to get their clients the best pricing while reducing any outside influence.

As a result of this range of financial independence in the advisory world, and the confusion it might cause among investors should the notion of “independent advice” gain the same success that “fee-only” and “fiduciary” have achieved, it will be important for truly independent advisors to clearly differentiate themselves in a meaningful way.
I suspect that this can be accomplished more easily and effectively by RIAs than advisors at the other two levels. How? By simply stating that these financially independent advisory firms do not take revenues from any source other than their clients. Period.


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