THE NEW FINANCIAL ADVISORY PRACTICE Transferring Power and Knowledge Back to Advisors and their Clients

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1 12/3/2008 THE NEW FINANCIAL ADVISORY PRACTICE Transferring Power and Knowledge Back to Advisors and their Clients Matt Busick, MBA, CFP Kira S. King, Ph.D.

2 Introduction The field of financial planning is currently struggling with several biases and regulations that ultimately give large brokerage firms more power than either financial planners or their clients. This results in a variety of inequities that prevent financial advisors from developing expertise and devoting sufficient time to their clients, and ultimately limits clients access to high quality, affordable financial advice. In essence, large brokerage firms seeking to increase profits through the sale of financial products have dominated the industry, and dictate how financial planners provide services. The end result is that clients pay high prices for limited service that fails to put their needs first. Constraints for Financial Planners To understand why clients are being shortchanged, we have to examine the challenges that financial planners are facing. Currently, financial advisors are struggling with limited opportunities for non-sales based education, increasing demands to provide a broad range of services, limited time to provide client service, and biased pay structures that limit their productivity and objectivity. 1. Limited Training Opportunities: Both established financial advisors and newcomers to the field have limited opportunities to gain non-sales based training. For newcomers, since there are so few on-the-job mentorship opportunities from mid and senior level advisors, most new recruits rely upon company sponsored training programs (Eckblad, 2006). However, the quid-proquo that most companies set in place (and intentionally downplay) requires new advisors to sell enough services during their training period to cover the cost of their development. Requiring newcomers to sell before they are properly trained or fully aware of how their skills match up to the requirements of the job can be disastrous for the new advisor and detrimental to their clients. In fact, Field (2006) suggests that it may take as many as five years of experience before a financial advisor has the appropriate skills and knowledge to begin developing new clients. Additionally, since most financial advisors are encouraged to become a one-stop shop, their opportunities to specialize in a single area of 2008 River Glen Wealth Counselors Page 2 of 10

3 interest to them are very limited. Result: The result is that financial advisors may be better at selling products than on analyzing what their clients really need to protect and improve their financial health. 2. Increased Service Requirements: Due to societal trends and the repeal of the Glass-Steagall Act during 1999, financial advisors are currently being challenged to provide a wide variety of services, including investment suggestions, insurance planning, estate and tax planning, health care planning, and wealth transfer techniques (Drucker, 2004; French, 2007; Gresham, 2007). In fact, financial service companies (including banks, investment brokerages, insurance companies, etc.) have been merging into larger conglomerates capable of offering their clients one stop shopping experiences. To ensure that the new suite of financial products could be sold to consumers, these companies converted the role of stock broker (Stone, 2005) to that of financial advisor, requiring advisors to acquire multiple licenses. The problem for advisors is that they are now required to provide so many different types of services that they often develop shallow expertise in a variety of areas, instead of deep experience in any specific area. Result: The result is that many advisors know just a little about a lot of areas but are not experts in any of them. 3. Insufficient Time with Clients: Due to a variety of human resource issues, advisors don t spend enough time servicing existing clients (Tibergien and Pomering, 2005). In fact, most financial advisors (no matter what size of their firm) spend only between 35% and 38% of their time with their clients (Moss Adams LLP, 2006). The rest of the time they are recruiting new clients, or managing back-office tasks like deciding which mutual funds to use in their client s accounts. Result: The result is that many advisors spend more time on sales and administration details than on actually meeting with clients and reviewing their financial plans. 4. Biased Pay Structures: As many as 93% of advisors (Burns, 2008) even independent brokers are affiliated with large firms that compensate them for selling products. Whenever an advisor is paid for selling a product, their advice is automatically tainted by the fact that they are motivated to sell a specific 2008 River Glen Wealth Counselors Page 3 of 10

4 product. Therefore, their advice is biased. While some advisors refuse to accept commissions, they do charge a 1 or 2 percent asset under management fee. This seems to be simpler and unbiased, but it can de-motivate advisors from providing high quality advice. That is, since advisors will receive a percentage of their clients assets even if the investments lose money, what motivation is there to ensure the investments grow? Result: both commissions and asset under management fee structures can bias advisors from putting their client s needs first. Constraints for Clients These constraints for advisors ultimately reach the client, preventing them from accessing affordable, high quality financial services that put their needs first. The result, as explained below, is that clients have limited opportunities to receive unbiased financial advice that is comprehensive and affordable. 1. Unbiased Advice: People have few opportunities to receive sound financial advice that is free from a sales-related bias. As depicted in the following scenarios, many consumers pay for financial advice by purchasing products that generate commissions for their advisors: Imagine yourself as a first-time homebuyer who can only afford a 10 percent down payment on a new home. How do you decide which type of loan is right for you? Typically you visit with a bank s loan officer, who introduces you to the features and benefits of various loans and ultimately positions one as best for you. When you agree to adopt the recommended loan, the loan officer receives a commission from the company issuing the loan. You are an expectant mother worried you may not have enough life insurance. How do you determine an appropriate amount of insurance to buy given your situation and goals? Moreover, what type of coverage is right for you? As a first step, most people seek out a life insurance agent. The insurance agent helps you determine the right death benefit amount and policy type. When you ultimately buy the policy the agent is paid a commission by the insurance company issuing the policy River Glen Wealth Counselors Page 4 of 10

5 You find yourself in the enviable position of being able to invest money every month. How do you decide where to invest? Generally speaking you see a stock broker, more commonly referred to these days as a financial advisor. The broker interviews you to determine key factors such as your time frame and risk tolerance, and eventually offers a mutual fund as your best option. When you invest in the recommended mutual fund, the fund company pays the broker a commission In each case, you receive financial advice from a professional. Is it clear, however, if you are receiving unbiased advice from a financial advisor who is bound by a fiduciary obligation to you, a paying customer, or if you are receiving advice from a sales representative whose first and highest obligation is to sell a financial product? Undoubtedly, financial product sales representatives offer advice as part of the sales process. But to what extent is their advice tainted by their desire to drive a purchase decision that will ultimately benefit their personal bottom line? What if the best advice is for a consumer to buy nothing? Or, what if a consumer s best solution involves purchasing a product that generates a lower commission than an alternate choice? Will the advisor push an inferior solution in order to generate a higher commission? What if the best solution for the consumer involves a product the sales rep doesn t sell? Will the sales rep do the right thing and refer you to someone who sells what you need? 2. Comprehensive and Coordinated Advice: Many clients are struggling to get comprehensive financial advice across a variety of disciplines, such as tax and estate planning, investment management, insurance planning, health care planning, and wealth transfer technique. Clients may receive this advice from a one-stop shop; however, the professionals providing the advice may not have sufficient, in-depth knowledge of any area. Or, they may go to separate specialists, but fail to coordinate their individual advice. Also, many clients have a difficult time finding advisors who can spend sufficient time meeting with them or following up on their financial recommendations. This occurs because advisors typically have many clients and few professionals to assist them. As a result, 2008 River Glen Wealth Counselors Page 5 of 10

6 many clients fail to receive the attention they require for truly high quality financial planning. Wouldn t consumers be better served by a model where a financial counselor has the ability to ensure that all of the advice is functioning as a system, rather than through a model that has isolated, and sometimes oppositional, components? 3. Advisory Services for a Fair Price: Most clients are confused by how they re being charged for financial services. According to Phillip Palaveev a senior manager of Moss Adams, the field of financial planning has...some of the most convoluted pricing ever invented (Mucciolo, 2007). While clients are not necessarily searching for a bargain, what they do want is clear communication about how they are paying for services and the perception that they are getting a good value for these charges (Mucciolo, 2007). When advisors fail to consistently explain their fee structure in a way that satisfies their clients, they may lose their clients trust and even their business. In fact, only between 30 and 50% of investors state that they understand or are satisfied with their advisors fee structures (Mucciolo, 2007; Touryalai, 2007). If clients truly understood what they were paying, we believe they would be dissatisfied, which is why we believe many advisors fail to fully explain the charges. For example, a 1% fee for assets under management may not sound unreasonable to a client, unless they calculate exactly how much money this is. For example, for a million dollar portfolio that is a $10,000 annual fee. While this is a hefty fee by itself, there may be other fees on top of this that many clients are not aware of including commissions and hidden management feels. The Solution We need to redistribute power within the field and thereby create a more democratic financial planning community that provides advisors and their clients with more control and opportunities to protect financial health. To begin, we need to lift barriers that financial advisors are facing so that they can truly put their clients needs first. This includes: 2008 River Glen Wealth Counselors Page 6 of 10

7 Revising the payment structures to remove the commission-based sales bias. Creating non-sales based training opportunities that foster the development of highly skilled financial experts. Building teams of experts and internship programs that allow advisors to focus on their primary skill set, instead of trying to be everything to everyone. This will not only increase the quality of financial advice, but also the amount of time each client receives with their advisors. Creating collaborative teams of financial experts who coordinate their services. This will ensure that clients are receiving strategic advice that encompasses their entire set of circumstances. Encouraging the development of research and learning communities that build new knowledge in the field and thereby bring innovative strategies to clients. Conclusion The financial planning industry is a relatively new field that has exhibited an imbalance of power. Both financial planners and their clients have been hampered by the power of large brokerage firms that have dominated the industry. These brokerage firms have dictated how financial planners receive training, how they are paid, and how they provide services to their clients. The result is that many advisors have struggled with minimal, sales-based training, with the demands of trying to be everything to everyone, with limited time to spend with clients, and with restrictive pay structures. In addition to limiting job satisfaction, these conditions shortchange clients preventing them from being placed at the center of an advisor s practice. In fact, clients have difficulty finding unbiased, integrated financial advice for a fair price. Given recent trends in the market, this is a unique time when we can begin to redistribute the power within the field. To do so, we need to remove commission-based pay structures, create non-sales biased training programs, enable advisors to specialize, build teams of experts who coordinate services, and encourage the development of researching and learning communities River Glen Wealth Counselors Page 7 of 10

8 References Aaker, D. A. (2001). Developing business strategies. New York: John Wiley & Sons, Inc. AARP (2007; May 11). Online extras: Brain aerobics. AARP Bulletin Today. Retrieved on May 23, 2008 from Burns, S. (2008; March 16). Who is your financial advisor working for anyway? Boston Globe. Retrieved on March 29, 2008 from r_working_for_anyway/ Churchill, J. (2008; February 1). Box O Reps. Registered Reps. Retrieved on May 22, 2008 from ml. Courac, K. (2008; April 2). Is cheap now chic? The big-spending ways of the 80s are out as frugality comes into fashion. CBS Evening News with Katie Courac. Retrieved on May 23, 2008 from: Drucker, D. D. (2004;February) Further with fees. Registered Rep. Retrieved on October 29, 2007 from: Eckblad, M. (2006;October). What s the fuss about NexGen? Financial Planning. Retrieved September 26, 2007, from Field, S. (2006; September). Taking the growth plunge. Registered Rep. Available at French, K. (2007; August). RIAs have banner year, face new challenges. Registered Rep. Retrieved on October 29, 2007 from: 2008 River Glen Wealth Counselors Page 8 of 10

9 _Challenges/index.html Green, P. (n.d.). And now, the six-figure scullery. The New York Times. Retrieved on May 23, 2008 from: Gresham, S. D. (2007). Advisor for life: Become the indispensible financial advisor to affluent families. Hoboken, New Jersey: John B. Wiley & Sons, Inc. Katzmire, K. D. (2008). Kala-Rythms and interpersonal style. Retrieved on May 28, 2008 from: LeBlanc, S. (2007; December ). More options, more business. Financial Advisor Magazine. Retrieved on May 22, 2008 from: Longo, T. (2006; November) Is the price right? Financial Planner Magazine. Retrieved on May 22, 2008 from: Los Angeles Times. (2008; April 21). Make 401(k) fees transparent. Retrieved on May 22, 2008 from: 401k21apr21,1, story. McElvaney, S. (2007). Planning your retirement home. Workingcaregiver.com. Retrieved on May 23, 2008 from Moss Adams LLP (2006). Financial performance study of advisory firms. Seattle, WA: Moss Adams LLP. Mucciolo, C. (2007; November 1). Are you charging enough? Registered Rep. Retrieved on April 29, 2008 from O Brien, E. (2008; February 1). Location³. Financial Planning. Retrieved on May 22, 2008 from River Glen Wealth Counselors Page 9 of 10

10 O Connor-Grant, C. (2008; May 7). High net worth survey: More pessimism, fewer advisors. Financial Planning. Retrieved on May 21, 2008 from: Prince, R. A., & Schiff, L. (2008). The middle-class millionaire: The rise of the new rich and how they are changing America. New York: Currency Doubleday. Registered Rep. (2006; March). As cited in Field, A. (2006; Sept 1). Taking the growth plunge. Registered Rep. Retrieved on January 9, 2008 from: Schultz, S. (2008; February 21). 33% of U.S. adults do banking online. Financial Planning. Retrieved on May 23, 2008 from Stone, A. (2005; April 6). Death of a stock salesman. Business Week. Retrieved on January 8, 2008 from: m. Tibergien, M. C., & Pomering, R. (2005). Practice made perfect: The discipline of business management for financial advisers. New York: Bloomberg Press. Touryalai, H. (2007; June 20). Clients to advisors: Let s talk about fees. Registered Rep. Retrieved on April 29, 2008 from s/index.html 2008 River Glen Wealth Counselors Page 10 of 10

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