The Essential Advisor

Building Value in the Investor-Advisor Relationship

Bill Crager, Jay Hummel

• Publisher: Wiley
• Year: 2016
• ISBN:
  9781119260646
• Edition: 1
• Topic: Business
• Subtopic: Wealth Management
• Index: Business

Leverage the financial services evolution to maximize your firm's value

The Essential Advisor presents an insightful handbook for advisors looking to navigate the changing face of financial services. The industry is evolving, consumers are evolving, and many advisors are being left behind as old methods become less and less relevant. This book shows you how to turn this shift into a positive, by positioning your firm to maximize these new opportunities, and deliver the results and experience increasingly expected of financial advisors. You'll learn how to provide the transparency, hands-on interaction, and around-the-clock access today's clients demand, and how to consistently deliver service that robo-advisors cannot duplicate. Emerging technologies do not have to be a threat to your practice—they are tools that represent opportunities to provide greater service to your clients, and smart technology integration will be a hallmark of firms that survive the shift. This guide provides a clear vision of the future of financial services, and an indispensable management framework for maximizing your firm's future value.

Advisors are increasingly confused about what clients are seeking, and clients are equally confused about what advisory firms offer that alternatives cannot. This book helps clear the air on both sides by examining the client's perspective of financial services, and helping advisors better communicate their strengths.

• Articulate the value of your services
• Leverage new technology to complement your practice
• Capitalize on opportunities and maximize your firm's value
• Position your firm to benefit from the changing consumer population

Financial advisors can only grow their businesses if clients know what they do, know how to hire them, and can access them affordably. The Essential Advisor shows you to bring your firm into the future successfully.

Chapter 1
The Evolution of Financial Advice

You can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future.

—Steve Jobs

Advice is essential for people to reach their financial goals and dreams. Technology has made it so much easier for consumers to access information, and it is important for advisors to recognize how this impacts their role—for better and for worse. As consumers think about their changing demands, and as advisors position themselves for the future, both groups must understand how drastically the financial system has evolved. It’s easy to forget that not long ago the financial landscape was very different. For example, we take for granted the number of transactions we can handle on our phones. Even 10 years ago the thought of moving money with the swipe of a finger or depositing a check by taking a picture seemed crazy.

In the broad history of our industry, the 1950s wasn’t that long ago. During that time, when consumers had a few dollars to put away, they opened a savings account. At some savings and loans (S&Ls), the teller wrote down the amount of the deposit in the saver’s bankbook along with any interest that had accrued. In time, computers took over many of these tasks, and the economy started to become more global. In the 1980s and 1990s, banks focused on geographic expansion, entering new markets and building more—and larger—branches. Less than a decade later, the amount of traffic into most retail branches declined sharply. Today, few people visit a brick-and-mortar branch to do their banking. Many banks, especially those with a regional focus, are trying to shutter as many locations as possible, a trend driven largely by the rise of ATM transactions.

The first ATM in the United States appeared sometime in the late 1960s. By 1980, the number of monthly ATM transactions was nearly 100 million. Within 10 years that number grew to almost 500 million transactions per month.¹ This accelerated a strategic change for banking executives. In 20 years, banks went from adding real estate to decreasing real estate—an amazing transformation in a sector that remains the heart of the financial services industry. In the remaining branches, there is also a tighter focus on generating revenue through the sale of specialized products and services that often have higher margins. There are also far fewer tellers than in the past, and it is not uncommon for them to encourage customers to bank online and through mobile channels.

This short trip down memory lane was intentional. Banking is the largest portion of the financial services industry and these rapid changes impacted its employees and clients. In the wake of such significant change to the industry’s biggest sector, it’s reasonable to believe that the wealth management and advisory businesses will face similar disruption in the very near future. Those opportunities and challenges exist today and will accelerate for advisors.

The Roots of Modern Investing

The majority of this book is about the future. Our goal is to present a roadmap for increased success in a period of immense change. In order to do so, we believe it is crucial to examine the past. After all, these events have set up where we are today and represent the building blocks of the future. In the 1950s, most people in the United States shunned investing. Many of them had lived through the Great Depression and wanted no part of the stock market. A number of Americans subscribed to the notion that the stock market was for rich people, and this perception had become a reality. Buying and selling securities was costly, in large part because most brokerage firms charged fixed commissions, which were quite high and typically nonnegotiable. These rates could be 10 percent or more of the transaction amount. In 1952, only 6.5 million Americans, which was about 4.2 percent of the U.S. population, owned stock.²

In the 1970s and 1980s, consumers typically looked to brokers for what they deemed to be financial “advice.” Madison Avenue helped broker-dealers convey that message to consumers through advertising. One of the most famous commercials of all time was for the brokerage firm, E. F. Hutton. In one commercial, wealthy people were filmed as they lounged around a swimming pool at what appears to be a country club or a fancy hotel. A man turns to a woman and asks about her broker’s advice. She answers casually, “Well my broker is E. F. Hutton, and E. F. Hutton says …” Everyone around the pool stops talking, purportedly because they want to hear E. F. Hutton’s financial advice.

Advertising campaigns like E. F. Hutton’s were built on the premise that a brokerage firm could give investors tips on what securities products to buy. Since that campaign, the firm has disappeared through a series of acquisitions involving Smith Barney, Morgan Stanley, and Citigroup. (E. F. Hutton’s grandson has launched a new, unrelated company under the old name.) But many people remember the slogan that made E. F. Hutton famous, “When E. F. Hutton talks, people listen.” Money magazine describes, on its website, how effective the campaign was during the bull market that began in 1982:

This was a powerful image during the bull market that started in 1982. After the lost decade of the 1970s, investors were getting excited about stocks again. The Hutton ad suggested that only through a broker could you gain an investing edge.

In some ways, the suggestion was ironic—coming just ahead of the massive insider trading scandals of the late 1980s, when dozens of Wall Street players, including Ivan Boesky and Michael Milken, were found to have skirted the rules for their own advantage. So much for the broker edge, which in those cases anyway was about illegal stock tips sometimes in exchange for suitcases full of cash.³

During that same era, Smith Barney launched an equally memorable ad campaign. Distinguished actor John Houseman voiced the immortal slogan: “Smith Barney. They make money the old-fashioned way: They earn it.” It’s worth revisiting these advertisements because they capture what the world of financial advice was like in the 1970s and 1980s. And they also reflect how consumers perceived it. These campaigns strongly tied financial advisors to the wealthy classes, and perpetuated the mystique of investment firms. That approach was quite different from what you see today in television commercials for established firms, and in taxi-cab ads for new players like Wealthfront and Betterment.

Firms also operate much differently now. Up until the late 1980s, if you were a broker, you attended a daily research call where stock ideas were discussed. These research calls gave brokers ideas for how to help their clients buy and sell securities. Brokers were allowed to promote only those stocks on which there was research coverage. There’s a debate as to why this happened. Some would argue it was to manage risk, as recommended securities should be tracked, but others with a more jaded view argue it was to push the securities with higher commissions or with companies with financial ties to the brokerage firm. The investment business was largely product focused. It was an era when brokers pushed stocks touted by research analysts.

Regulatory and Tax Changes Spur Evolution

In 1975, the Securities and Exchange Commission (SEC) made an important decision that laid the path for the financial world as we know it today. Fixed commissions were abolished. Up until what is known as “May Day,” brokerage firms charged commissions based on a schedule published by the New York Stock Exchange. The commission was calculated off a grid based on the number of shares traded. Brokerage firms, therefore, could not compete with each other on price. The new regulations created a situation where commissions could now be negotiated. This decision opened the way for discount brokers, and eventually led to the online trading craze of the 1990s. Fueled by enhanced technology, online trading allowed people to cheaply buy their favorite stocks on their own, without a broker, for the first time.

The next change came in 1978, three years after fixed commissions were abolished. A major change to the tax code opened the door to an entirely new financial services sector. Congress added Section 401, under which Item K allowed companies to offer their employees an additional benefit, now known as the 401(k) retirement savings plan. 401(k)s and similar defined contribution plans helped turn employees from spenders into savers—and investors.

401(k) retirement savings plans took off in the 1980s around the same time that companies began to sunset traditional pensions. The vast majority of defined contribution plans were offered by larger companies as one of the benefits to retain employees and also encourage saving. A key inducement was the employer match, a 401(k) contribution made by the employer at no cost to the employee.

Despite the potential benefits of 401(k) plans, they also presented employers with new challenges. Most companies had no idea how to determine which investments should go into these plans, so they turned to 401(k) record-keeping firms to administer their plans. Most of these firms were units of large mutual fund companies so, not surprisingly, the investment menu consisted of a good range of mutual funds. (The default option was the money market fund, much like today’s default option would be a target date fund.) This represented a key building block for the future because the 401(k) business supported the enormous growth of the mutual fund industry.

Meanwhile, wirehouse firms began to more clearly separate business development from managing money. During the 1980s, firms encouraged their account executives to gather new business and increase clients’ investments, while professional money managers tended to client portfolios. This shift emerged from the belief that individuals would benefit from the investment professionals’ expertise, and that client-facing advisors could better serve customers by focusing more time on their existing clients. Without the burden of managing every client portfolio, advisors could also work on business development.

So marked the beginning of fee-based management and managed accounts. On the heels of the existence of managed accounts came professional gatekeepers who decided which asset managers qualified to be on a securities firm’s platform. The good gatekeepers protected clients because the decision to put an asset manager on or off the platform was based on performance. One could argue there were also bad gatekeepers who selected asset managers onto the platform based more on revenue share agreements than what was good for the clients. The debate on good versus bad gatekeepers remains to this day and the managed accounts business has blossomed into a $4 trillion industry.

A Small Shift to Advice

As we will discuss in depth later in the book, we believe financial planning and coaching will be a key building block of advisor value in the future. When we speak at conferences and industry events, it seems like some people think this is a fundamental change that happened overnight. It’s not. The industry has actually been shifting this way for decades. For comparison, consider a musician who has been writing songs and playing in clubs for years. When she finally gets a hit song, she is viewed as an overnight sensation. In reality, however, the musician is being noticed for the first time after years of playing the same kind ...