Online brokers may be bigger threat to financial advisors than they realize, study says
E*Trade, Schwab and Fidelity win assets from advisors and relinquish them grudgingly, according to Aite Group report
Ron A. Rhoades
As the article points out, many persons out there do not believe that “financial advisors” add value. Part of this is due to the perception that financial advisors possess, or should possess, a “crystal ball” as to all (or nearly all) major up and down movements in the stock market. This misperception is due, in large part, to the heavy volume of advertising by the wirehouses, predominately, going all the way back to the days of E.F. Hutton, which tout – either expressly or by implication – the view that outperforming the market is what financial advisors are hired to do. Remember the long line of commercials … “When E.F. Hutton talks, people listen.”
The other part of this lies in far more recent events which many individual consumers experience. They purchased products on the recommendation of their financial consultant, which they later found out were grossly expensive, highly tax-inefficient, or full of risks which were not explained to them. The poor recommendations of so many ill-trained “financial consultants” purporting to provide advice, and/or providing advice which is heavily riddled with conflicts of interest, denigrates the reputation of all personal financial advisors. Therein the fault largely lies with the SEC, in permitting those held only to the far lower standard of suitability to utilize titles (financial consultant, financial advisor, wealth manager, etc.) which denote a relationship of a professional advisory nature – when in fact no such relationship exists. The result is that many unsuspecting individual investors place their trust in “financial advisors” – only to have that trust betrayed. Consumers don’t realize that their are huge distinctions in the standards of conduct governing RIAs vs. BDs, and such consumers – once burned – are unlikely to seek out trusted advisors. This is reflected in the numerous articles appearing in the consumer press which question why – given the many conflicts of exist – a consumer would want to work with ANY financial advisor.
As economist George Akerloff explained in the research which won him a Nobel Prize: “[T]he presence of people who wish to pawn bad wares as good wares tends to drive out the legitimate business. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.” George A. Akerloff, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, The Quarterly Journal of Economics, Vol. 84, No. 3. (Aug., 1970), at p. 495.
Until we get ALL financial advisors held by our regulators to the BONA FIDE fiduciary standard currently applicable under the Advisers Act (and NOT the “new federal fiduciary standard” touted by SIFMA and FINRA – which is NOT a true fiduciary standard, but something far less), the situation will only get worse over time. Good financial advisors will continue to suffer damage to their reputations by those who, pretending to be trusted advisors, act under a far lesser standard. And consumers, unable to discern the difference, will slowly move toward “do-it-yourself” solutions.
This is what is at stake in the “fiduciary debate.” Financial advisors who are willing to be held to higher standards of competency, education, training, and proficiency, and the highest standard of conduct found under the law, seek to promote the profession of financial advice as a TRUE PROFESSION. These proponents realize that if all those who provide financial advisory services / financial planning (and those who hold themselves out as such) are held to a common, bona fide fiduciary standard, the confidence of consumers in such professionals will soar. This in return will fuel greater demand for the professional services.
Those who argue against the application of fiduciary standards to the provision of financial advice are unaware that, by doing so, consumers will slowly move toward “do-it-yourself” solutions (even when they know, or suspect, that in today’s complex financial world they are unlikely to be able to navigate successfully on their own. Consumers would rather make mistakes on their own than have ill-trained poor advisors make those mistakes for them. And – far more important – consumers do not want to see their trust abused. A breach of trust reposed results in a sting just as worse (if not more so) as the hollow, sick feeling one gets when one is the victim of theft.
The failure by our policy makers – Congress, and/or the states, and/or the SEC – to insist upon the application of fiduciary standards of due care and loyalty and utmost good faith – to all relationships in which consumers rightfully place trust in their advisors – will continue to slowly result in the movement of consumers toward the lowest-cost solution, as the article and Professor Akerloff point out.
Peter E. Shenas
Many independent RIA’s custody their assets at the online firms of Schwab and TD Ameritrade. When these firms pull accounts from a wirehouse or independent b/d the assets are shown to be transferred to the online brokers such as Schwab or TD. The losing advisor isn’t usually informed as to whether those assets are being managed by the client directly or as a client of an RIA. I wouldn’t put too much weight in the polling numbers.
You make a fair point but recall also that financial advisors pegged E*Trade as the online broker that takes the most assets. If they handle any RIA custody, it’s fairly minimal.
In the late 70s several top brokers at the old Wheat, First Securities which became Wachovia, now Well Fargo, had a competition to see who added the most value with their recommendations. These were top producers who were very able and very well connected. Everyone was surprised to discover these very able brokers were excellant at developing and managing relationships with well healed clients, but their business accumen in winning clients did not translate into equally excellant portfolio construction and management skills.
Because the industry is geared to product sales not portfolio construction, little value is added. Thus, consumers over time have correctly concluded if little or no value is added why pay for the high cost of a broker or advisor. The observation to be drawn is there is immense pressure on brokers and advisors to add value which is driving the industry toward accountability, transparency and disclosure of fiduciary standing. The industry is still not structured to help advisors to add value through portfolio constructiont but is moving in that direction.
The Wheat experiment coincided with the emergence of the use of outside money managers (managed accounts)at EF Hutton and multi manager portfolio construction best illustrated by Frank Russell from which investment management consulting as we know it has evolved.
Thirty years later we are now at a point where the industry understands it is what advisors do with investment products, or a prudent investment process, that adds value not simply a investment product. Case in point is the DFA investment process generating a postive 50% return over the past lost decade that recorded a negative 9% return. It is process or a CIO function that adds value not product. All that is missing is (1) a prudent investment process tied to statutory documentation to support fiduciary standing (2) a functional division of labor (the advisor, CAO, CIO) to simplify execution, (3) technology to support transparency, portfolio construction and the continuous comprehensive counsel required for fiduciary standing and (4) conflict of interest management.
The wheels of progress turn slowly, but we are drawing near the point where the processes (asset/liabilitystudy, investment policy, portfolio construction and management), technology, functional division of labor and conflict of interest management necessary for brokers and advisors to add value and fulfill their fiduciary obligations will transform the industry in a very positive way which would shift the balance of the scale back toward advisors who are adding value, which is not possible now within the brokerage industry, either “full service” or “discount”.
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