Online brokers may be bigger threat to financial advisors than they realize, study says

Financial advisors are asleep at the switch about what constitutes one of the gravest threats to their business – online brokerage firms, according to a new study by the Aite Group.

Online brokers are the most likely of all channels to take clients away from financial advisors and they are also among the more difficult competitors to pry assets away from, according to a report originally released in December entitled: “The Direct Business Ambush: Advisors Not Seeing the Threat.”

When the 402 advisors who participated in the study were asked what kind of firms they lose the most business to, online brokerage firms were chosen 23% of the time — the most frequently chosen category. It was followed by regional brokerage firms, independent RIAs, traditional banks, wirehouses and “other” with 22%, 17%, 13%, 13%, and 6% of the responses respectively.

Charles “Chip” Roame, managing director of Tiburon [Calif.] Strategic Advisors, has long warned the advisory community that online brokers are a major threat to their businesses.

Little value in financial advisors

“I am glad someone gets it and admits the truth, so kudos to the study,” he says. “There is a segment of consumers, bigger than nearly every advisor-centric person believes, that prefers to do things themselves, trusts few, and/or sees little value in financial advisors.

“I think (online brokerages) are becoming a bigger threat because: 1.) they are further improving their offers and 2.) the financial advisors have not been able to prove they added any value the last few years.”

The online brokerages are hardly shy about helping investors come to these conclusions with their unrelenting advertising campaigns, says Adam Honoré,research director of the capital markets group for Aite Group of Boston and author of the study.

“The pseudo-cartoons of Charles Schwab, talking infants of E*Trade, “Law and Order” celebrities of TD Ameritrade and Roger Riney flying in his helicopter for Scottrade are all promoting the same theme: Investors do as well if not better than their advisors but without the added cost,” he writes in the study’s introduction.

Messages like these are effective enough that they need to actively countered but the vast majority of advisors are content to ignore them, according to Honoré.

Advertising onslaught

“Despite the advertising onslaught by discount brokers, a recessed market, routine news on fraudulent money managers and brand tarnishing by the largest firms on Wall Street, nearly 70% of financial advisors see online brokers as being no threat to their business,” the researcher writes in the study.

“Advisors need to wake up to the reality of the threat and…combat the messaging coming from these firms,” he writes.

The online broker that is perceived as the biggest threat by the advisors in the study was E*Trade, which was picked by 25% of the survey participants followed closely by Charles Schwab & Co. with 23% and Fidelity Investments at 22%.

Skeptical about the threat

Matthew McGinness, principal of Best Practice Research in San Diego, is skeptical about the threat posed by online brokers. “The question is: how big are the assets?” he asks.

The advisors that McGinness speaks to say that often the assets lost to online brokers are low-balance clients who were high maintenance, hence undesirable. These clients were chafing at giving up control of their investments to a third party all along.

But Roame believes that there are plenty of self-directed accounts held by high net worth investors.

“Self-service is alive and well, and has many more wealthy clients than anyone who is advisor-centric wants to believe,” he says.

Inherently challenged

Based on his experience as a researcher, Philip Palaveev, president of Fusion Advisor Network, says that studies tracking where assets go based on what advisors say are inherently challenged because they don’t necessarily know where they end up. “Clients don’t call to say: I’m going somewhere else,” he says.

The study does offer food for thought when it comes to something advisors are able to track more accurately: where assets come from. Online brokers are among the hardest firms to win assets from, according to the study.

Asked which firms they gain the most assets from, survey participants named regional broker-dealers 23% of the time. This was followed by traditional banks, wirehouses, online brokerage firms, RIAs, credit unions and other with 22%, 21%,14%, 12%, 5% and 2% of the responses respectively.

Roame believes that there’s another reason why advisors are oblivious to where their lost assets end up.

Can’t handle the truth

“FA-centric people do not want to see these firms as a threat because they then need to admit that maybe they are not adding so much value if it can be replicated by a online tool or a lower end rep,” he says. “I’d love to see evidence that these smart wirehouses or even RIAs are better at picking funds than Schwab’s select list. I’d guess it about the same. And one is free! See the truth.”

Asked what online brokerage attribute is the biggest threat, 69% of participants in the Aite Group study said price, followed by technology at 16%.

But Roame says that price and technology are only part of the explanation for online brokerage success. The other factor is quality.

“These online brokers are a threat to advisors because they often have good offers, and those offers often have a good price point,” he says. “Schwab’s in-office consultations, T. Rowe Price’s online tools, Vanguard’s $500 financial plans, Fido’s telephone-based mutual fund wrap program, TD Ameritrade’s online ETF wrap program, are all logical products for certain groups of clients.”