There’s nothing special about offering financial advice—and that’s part of the challenge for advisors, said Michael Kitces, partner in Pinnacle Advisory Group, an RIA based in Columbia, Md.

Just as clients have difficulty distinguishing between fiduciary advisors and brokerage representatives, they will have difficulty telling the difference between all of the various entities purporting to offer them financial planning, said Kitces in “Where Is Financial Advice Headed Next: Experts Explore Five Critical Trends,” a discussion on Thursday at BNY Mellon Pershing’s 2019 INSITE conference in Phoenix.

“I think we’re quickly entering a transition phase where financial planning and wealth management will no longer be enough to differentiate you,” he said. “Everyone says they do it. No client knows, no client can tell, after the fact. They’re usually there with their advisor and it’s a pain to change advisors.”

Not only can clients not differentiate between one form of financial planning and another, but firms are starting to have difficulty distinguishing themselves from one another, said Kitces.

For example, in the past when Pinnacle Advisory would compete for clients in the Washington, D.C. region, Kitces and his partners would often be the only fiduciary advisors offering holistic financial planning services in the field—and would win “80 percent” of the business they competed for.

“We used to win 80 percent of the business we went out for, and now we’re winning one-in-three clients because we’re one out of three firms competing for their business,” said Kitces. “That’s a coin toss. We’ve lost that differentiating edge.”

To some extent, Pinnacle and its competitors can draw small, nuanced distinctions between themselves along investment philosophies and specializations like tax and estate planning, but not all of these differences are meaningful to clients, he said.

Instead, the most successful financial planning firms of the next 20 years will be the ones who concentrate on very specific niches and develop specializations to holistically serve these customers, he said.

“When everyone else says we do financial planning, now the way to differentiate is to say we do financial planning specialized for doctors,” said Kitces.

Kitces cited the example of a planner in the Midwest who specializes in bass fishermen and prospects from high-level professionals who have to allocate multimillion-dollar tournament awards and endorsement deals. 

Technology As The Driver

Many of the changes occurring in the financial services industry have been driven by technology. While automation does threaten some incumbent players in the industry, Kitces said that the impacts of technological change have usually been more “subtle and pervasive” than any displacement that might be caused by things like robo-advisors.

Technology has been commoditizing financial services for decades, said Kitces. Fifty years ago, most advisors were really stock brokers who were paid for arranging trades, but that business model was displaced in the 1970s by discount brokerages who used technology to place orders for investors. Advisors responded by going into the mutual fund distribution business, connecting investors with the most talented and skilled—and the luckiest—stock pickers. Their compensation was mostly in the form of commissions, he said.

“Then the internet showed up, and online providers made a market where you could buy a mutual fund at low cost,” said Kitces. “Technology started offering zero commission funds in a world where every financial advisor was paid entirely by commissions. Technology eventually won that battle as well. We’re 20 years into that cycle and commissions are still ratcheting down—and now mutual funds themselves are ratcheting down.”

Advisors moved from the mutual fund distribution business towards asset allocation. Until recent years, the software that made accurate and tax efficient rebalancing possible was only available to advisors and financial institutions, but roboadvisors have changed that, said Kitces.

“I didn’t view robo-advisors as a disruptive threat,” said Kitces. “They just took rebalancing software and offered it directly to consumers. The only people who want to buy something like that are the same people who want to be responsible for managing their finances themselves.”

Kitces argues that robo-advisors have helped financial planners by introducing technology that makes their jobs easier, especially streamlined onboarding and account opening processes. However, the costs and other barriers to accessing investing and asset allocation services have dropped considerably, requiring advisors to turn to financial planning as their primary value proposition.

Referrals Break Down

Technology is also disrupting financial advisors’ main source of new business: peer-generated referrals.

This is mainly because not as many people are asking family and friends for advice on their finances. Instead, many are turning to the internet, just as they do when they have a health problem or any other issue that needs to be solved, Kitces said.

“We built our business historically by referrals,” said Kitces. “You’ll see referral-based growth is going to start to break down. The more you want to move up-market, the harder it’s going to be.”

Advisors have to differentiate into more specific niches to make themselves searchable, Kitces said. While it’s unlikely that any independent advisor will be able to establish a high position in Google’s search results for “financial advisor,” it’s more likely that they can rank highly in search for “bass fishing financial advisor,” he said.

“In a world where most of us can have a successful business with 50 to 100 clients per advisor, you can get amazingly narrow focused,” said Kitces. “There are wide niches with thousands of clients as an opportunity, but you can build a multi-multi-billion-dollar firm off of a narrow niche with a couple of thousand of people in it. I think this is where this route starts taking us.”

Multiple Revenue Models

While investor and advisor views around business models and fees are changing, Kitces does not believe that there is any threat to the AUM model itself.

The problem, as Kitces sees it, is that there may not be enough clients interested in the AUM model to go around, especially as more wirehouse and independent broker-dealer firms shift away from the traditional commission-based model and expand their AUM model offerings.

Kitces estimates that 5 percent to 7 percent of an advisor’s potential clientele will be suitable for an AUM model.

“How many clients have $1 million that’s not tied up in their 401(k) and are delegators?” said Kitces. “Somewhere around seven million households out of the 120 million in the U.S. actually have money, liquidity and a delegator mentality. For rich people who like to delegate, I think the AUM model is going to work fine.”

Some traditional clients, particularly older clients from the baby boomer and silent generations, may balk if faced with a flat fee for financial planning. Planning has typically been offered alongside the investment management services they’re used to paying a percentage of their AUM for. In other words, many of these clients have lived unaware that there is a significant price tag on the planning services they have been receiving—or any cost at all.

While some advisors have started offering fee-for-service, subscription or retainer models, like those in the XY Planning Network that was co-founded by Kitces, others are plotting out a middle ground between the AUM fee and the flat fee, most commonly using a percentage of annual income or some blend between a percentage of income and assets under management.

Margin Compression, Not Fee Compression

Along the same lines, Kitces doesn’t see any sign of fee compression among advisors, citing informal BNY Mellon Pershing research that showed advisors were more likely to raise fees than lower them. Not even the advent of robo-advisors, many of which charge 30 basis points or less for asset allocation, has driven lower fees among advisors.

Instead, advisors have tried to maintain their fees while offering more services to justify charging clients a higher rate.

“It’s not a fee compression problem, it’s a margin compression problem,” said Kitces. “We’re seeing margin compression. The average has come down. A lot of firms are having trouble holding 25 to 30 percent margins. They’re bringing on more staff to offer more services and more people are doing more things. They’re hiring more sophisticated staff, they have to hire people who have CFPs, and it puts pressure on our margins. We’re seeing all that play out now.”

Kitces argued that going deeper into niche specializations and automating more services will help advisors fight the impacts of margin compression. Automation means more efficient mid- and back-office operations. Specialization means more efficient, repeatable planning processes, as the process for any one client will be similar to the process of all of an advisor’s clients if they are appropriately specialized.

Creating A Planning Experience

Advisors will also have to focus on the client experience, said Kitces.

“Client experience is not better client service, and it’s not better technology for our clients,” said Kitces. “Those are features—things we do—but that’s not what defines a unique client experience. What defines a unique client experience is something that a client does and engages in that you stage for them—that they go through and have some kind of transformative experience or process.”

Kitces points to Build-A-Bear as an example of selling an experience. A teddy bear costs $10 or so from an average retailer or online, but customers at Build-A-Bear pay up to $220 for a bear that they have to build themselves—because people will “pay at a whole different level for experience,” he said.

Build-A-Bear customers get to choose the color, texture, clothing and other elements of their bear. Though there are staff on hand to assist customers, they primarily serve as guides. Most of the work and the creative process is done by the customers themselves.

“If the client is going to pay you five times the normal fee to sit and make their own plan in your office, how would you stage a ‘build-a-plan’ experience and charge five times the fee?” said Kitces. “That has nothing to do with the expertise.

“We want to be in the business of building plan experiences,” said Kitces. “Clients are steering the experience. We’re guiding them through the process. Build-A-Plan for a young couple would revolve mostly around cash flow and figuring out where their money is going. For a retiree, it would be to help them find a vision of what retirement looks like.”