Weekend Reading For Financial Planners (December 9-10)

New Cerulli Study Shows Investors Are Increasingly Willing To Pay For Advice In Spite Of DIY Advancements

(Brooke Southall | RIABiz)

In the days prior to the internet, the process of investing involved a lot of friction, since buying or selling investments meant picking up a phone and calling a broker to place an order. And when it came to deciding what to invest in, investors typically needed to rely either on the advice of their broker, or what limited publicly-available investment research tools were available at the time (e.g., the back pages of the Wall Street Journal or Investor's Business Daily). However, as the internet era dawned, it spawned a new breed of discount online brokerage firms like E*Trade, Ameritrade, and Scottrade that made it easier for investors to buy and sell stocks, bonds, and options on their own – or as the signature E*Trade ads of the time implied, investing was now so easy a baby could do it. At the same time, platforms like Morningstar and Yahoo! Finance arose to provide investment research and evaluation tools far beyond what had ever been available to individual investors. All of which seemed to herald a new age of DIY investing which would threaten the role of active money managers and mutual funds, since in theory anyone with a computer now had the tools available to effectively manage their own portfolios.

The reality since those early Internet days, however, has been a far cry from the promise of the original discount brokerage providers. Because despite having the tools to research and trade on their own, it seems the majority of people still largely want to be advised on what to invest in, preferring to rely on a professional's expertise rather than do all of the work themselves. And beyond just advice about the investments themselves, there's also been a rising demand for guidance on how to plan and save for financial goals, from retirement to children's college savings, as well as for help with tax planning, risk management, and estate planning. So as the discount brokerage firms struggled amid competitive pressure and fee compression, and ultimately endured a wave of consolidation as E*Trade, Scottrade, and Ameritrade were all acquired by larger competitors, the remaining brokerage firms like Fidelity and Charles Schwab began to increasingly lean into the advice space (both by offering custody services to independent RIAs and by launching their own in-house RIAs) as it became clear that the future of investing wasn't all about DIY investors calling their own shots.

Which makes it notable that this week a new research report from Cerulli and the Securities Industry and Financial Markets Association (SIFMA) has found a significant increase in investors' willingness to pay for financial advice over the past 15 years. According to the study, the proportion of investors who work with an advisor has increased from 35% to 47% from 2009-2022, while over the same time period the proportion who consider themselves "self-directed" has decreased from 41% to 27%, showing that despite the abundance of DIY tools, the demand for hands-on financial advice has only increased.

The steady demand for advice highlights the reality that as financial decisions and challenges have gotten more complicated over time, consumers have recognized the value of a professional who can advise them holistically – which is why, for instance, the robo-advisors that have arisen over the last 15 years have struggled to gain mass adoption despite offering investment "advice" at a far lower cost than a human advisor, and most investors are quite willing to pay a human advisor who can give them the advice they actually need. Ultimately, despite the challenges that advisors face in finding clients and scaling advice, there's hope in the fact that the market for financial advice is still growing as more and more investors recognize the value of what a trusted advisor can do for them.

Welcome To The Jungle: Mark Hurley Says The Party's Over For Wealth Management

(Diana Britton | Wealth Management)

For the wealth management industry, the decade of the 2010s started out with a lot of uncertainty. Many firms were still recovering from the recent global financial crisis, which had resulted in plummeting asset values and subsequently lower revenues for AUM-based advisors. At the same time, the rise of robo-advisors, as well as the foray of mega-brokerage firms like Vanguard and Charles Schwab into developing their own in-house advisory services, raised fears about whether independent advisory firms would have their existence threatened by fee compression and being squeezed out by larger competitors.

As the decade went on, however, the mood largely shifted from fear and uncertainty to increasing confidence. Rather than being pressured to lower fees, many advisors found themselves able to increase their fees by offering more services to an increasingly specialized client base. At the same time, a long bull market quickly reversed the losses of the global financial crisis and led to a decade of nearly uninterrupted asset growth. These factors combined to result in double-digit growth in firm revenues and profits, which was more than enough to overcome the comparatively paltry low-single-digit organic client growth that firms experienced over the same time. On top of all that, an extended period of historically low interest rates led to a wave of private equity-funded Mergers & Acquisitions (M&A) activity, allowing the founders of many independent advisory firms to exit at increasingly high valuations.

But as financial industry (and now cybersecurity) serial entrepreneur Mark Hurley writes in a new whitepaper, Welcome to the Jungle: The Next Phase of the Evolution of the Wealth Management Industry, the climate for financial advisors is likely to become much less inviting in a world of higher interest rates and private equity-backed investments in RIA firms. As Hurley writes, as the decade of "easy money" from low interest rates comes to a close, firms will need to increasingly focus on creating scale and boosting their organic growth to efficiently bring in younger clients that will remain with the firm for decades. Additionally, he predicts that with the abundance of private equity capital funding many of the largest firms, the atmosphere of the industry will shift from one of congeniality to one of cutthroat competition as professionalized managers act aggressively to squeeze competitors' margins and hoard talent.

Notably, though, this doesn't necessarily mean that "all" advisory firms must merge and consolidate for scale. In the end, Hurley predicts 3 types of firms that will emerge in the coming decade: the "mega-firms" (30-50 firms with $500B+ in AUM) operating as diversified financial services companies in direct competition with national players like Schwab and Fidelity; the "specialist" firms, that may grow to $10s of billions of AUM offering a premium offering to a specialized niche clientele; and the generalists, which Hurley analogizes to bookkeepers, that do mostly perfunctory work for clients that generates less in fees and profitability and results in little enterprise value.   

Ultimately, while it does seem clear that higher interest rates and PE investment in advisory firms will have large scale effects on the wealth management industry, the question remains of what exactly those effects will be, and if the environment will really turn out as hostile as Hurley predicts. What does seem true is that, as Hurley writes, firms that can capture the rising generation of Millennial and Gen X clients (who at this point, far outnumber the Baby Boomer generation that preceded them) have an immense opportunity ahead of them to attract clients who will remain with them for a multi-decade time horizon – provided that they can effectively attract and serve those clients to capture their true lifetime value.

RIAs Are Hiring, But Most Are Also Investing In Existing Staff, Schwab Finds

(Emile Hallez | InvestmentNews)

One of the broad themes to emerge in the advisory industry so far in the 2020s has been the competition for talent. As firms seek to grow and scale (while at the same time considering how to replace founders and senior advisors approaching retirement), the value of advisors who can bring in new business and serve clients effectively has greatly increased.

The demand for top talent is reflected in Charles Schwab's most recent RIA Compensation Report, released as an addendum to its annual Benchmarking Study, which shows that recruiting new staff to increase the firm's skill set and capacity is the #2 priority among the firms surveyed, ranking just behind acquiring new clients through referrals. Additionally, the overwhelming majority of firms surveyed both hired staff over the last year (77%) and plan to hire more staff in the year ahead (75%).

To that end, firms are increasingly deploying more tools to attract and retain talent. Starting with simply more compensation (with the median firm increasing their cash compensation by 17% since 2022), but also including other incentives such as equity ownership, flexible remote work policies, and improved benefits such as parental leave policies. Additionally, firms are increasingly seeking to document their value to their employees in the form of a written "Employee Value Proposition" (EVP), a statement of the offerings that a firm provides to its staff that includes both quantitative benefits such as salaries and performance-based compensation, equity ownership, and coaching/mentorship opportunities; but also more qualitative benefits such as a defined company mission or culture statement, commitments to an inclusive work environment, and career path and growth opportunities.

Which ultimately highlights the reality that, while money is often the deciding factor for an employee in deciding whether to join one firm over another, employees are more likely to stick with a firm for the long term if they can see themselves happy, fulfilled, and advancing in their career with that employer. If the firm can articulate what it provides to its employees – and more importantly, if it can follow through on those promises – it might be more likely to hold onto talent who might otherwise stay only until another offer comes along with a higher salary or bonus potential.

The RIA Industry Is Headed Into A War For Talent

(Daniel Gil | Citywire RIA)

Over the years, the primary concern of advisory firms has been how to attract clients to grow revenue and profitability. Which made sense in an industry comprised largely of firms still being run by their founders: With the firm founder being the main person in charge of bringing in new business and maintaining client relationships, the need was simply to find new clients for the firm to serve. However, with many of those original firm founders now approaching retirement, there's an increasing need for younger advisors to replace the firm founder's role in bringing in and serving clients – and as many firms have found, hiring an advisor to service clients well is hard enough, but it really isn't easy to find a new advisor who can sit down and fill the original firm founder's business development role on Day 1.

The issue isn't necessarily a shortage of young people who are interested in financial planning careers, though. With 375 CFP Board registered financial planning programs, thousands of aspiring planners are coming into the industry every year, ranging from fresh college graduates to career changers with decades of work experience. Rather, the challenge is finding advisors who can bring in new business and continue to grow the firm to the extent that the original founder was able to. And with a reported 72% washout rate among rookie advisors (as many struggle in sales or support roles with few planning-focused entry-level roles existing in the industry), the number of advisors who come into (and stay in) the industry barely outpaces those who leave due to attrition or retirement, with total advisor headcount only growing by 2,579 in 2022 according to recent research by Cerulli.

Ultimately, the takeaway for advisory firms is that increasing competition for talent will likely increase the cost of hiring experienced advisors away from other firms. Which in turn will, for many firms, make it a more attractive route to invest into training and developing newer advisors in-house instead. As while a new advisor may not be ready to bring in new business and take the lead on relationships on the first day, putting in the effort to train them on the firm's culture, philosophy, and processes can ultimately result an advisor who can eventually help to fill the gap left by a departing founder or senior advisor. And in practice, advisory firms can generate a favorable ROI from newer advisors in just a few years, even without business development, but simply leveraging their ability to provide increasing levels of service to existing clients (freeing up others who are good at business development to do more). 

Of course, there is some risk in the advisor being lured away by another firm, but advisors who experience upward career progression tend to reward the firm's investment in their advisory career by sticking around (it's firms that aren't growing and creating career opportunities for younger advisors that experience the most turnover). And even with some degree of turnover, the difference between the cost of hiring inexperienced advisors and offering them experience and training over time, versus competing (and paying) for experienced advisors, might still make it worth the firm's while… at least, if they're ready to invest into training and developing (lower-cost) talent over time!

In Rare Public Appearance, PE Buyers Say They See Plenty Of Open Road For RIA Deals

(Ian Wenik | Citywire RIA)

After a frenzied few years of merger and acquisition activity in the RIA industry amid record low interest rates in the late 2010s, the conventional wisdom has been that the tide would turn once interest rates increased and funding – often in the firm of outside investment from private equity firms – became harder to come by. But in 2022 and 2023, as interest rates have indeed swung upwards and have reached their highest levels since 2001, M&A activity has encountered only a minor slowdown in terms of total deal volume (while the average deal size is actually expected to increase again in 2023). And once again, much of this activity is being led by interest from PE investors.

PE firms tend not to comment publicly on their plans, generally preferring to let the deals themselves do the talking. However, at a recent panel on alternative investing, several PE investors, including Milton Berlinski of Reverence Capital Partners, Fayez Muhtadie of Stone Point Capital, and David Winokur of Clayton, Dubilier & Rice, indicated that they continue to see a promising future for M&A activity in the RIA industry, with Winokur stating that the industry isn't likely to become "overconsolidated" for another 35 years, due to the sheer rate of new firms being formed that provides a steady supply of fresh potential targets for acquisition.

Even though it seems likely that PE-driven M&A activity will continue to roll along, however, there are still questions about whether the pace of acquisitions will continue as quickly as it has in the recent past, or whether the sky-high valuations achieved by selling firms (often exceeding 20x earnings) will prove sustainable. Ultimately, as firms on both the buying and selling sides learn more about the realities of consolidating firm staff, cultures, and client bases, merger partners might become more selective in order to ensure that there is a good fit between firms. Which might make for a slower overall pace of deals, but higher-quality deals on average as investors seek to get the most value for their dollars.

RIAs Are Getting Lots Of Offers To Sell Minority Stakes, But Should They Take Them?

(Charles Paikert | Barron's)

Traditionally, an external sale of a financial advisory firm means selling 100% of its ownership, either all at once or in installments over time but usually with the goal of a full transition. However, not every seller necessarily wants to sell all, or even a majority, of their firm: They may be looking for additional capital to hire, or otherwise invest in ways to scale growth, or simply want to "take some chips off the table", but they don't want to give up the control they have over firm direction and strategy (and the ability to still participate in the upside of continued growth).

To this end, a growing group of (PE and other) investors have begun taking minority stakes in advisory firms, with the number of minority deals rising from just 2 back in 2014, to 23 in 2022, and 14 through the first 3 quarters of this year.

Minority deals make sense for both sides to some degree: Firm owners get access to capital that they can spend on hiring, technology, or even acquiring (pieces or all of) other firms, while investors get a slice of the healthy cash flows generated by the typical advisory firm. The caveat, however, is that an outside investor almost always wants to have some voice in how the company is run, even if they aren't the controlling shareholder. Minority owners might ask for representation in company decisions (e.g., a Board seat, for an advisory firm that's never even had a Board of Directors before), and other restrictions like the right to buy additional shares of the RIA before any other outside investors can do so. It's important, then, for RIA owners to do due diligence on potential minority owners in regards to their own investor goals, capital structure, and plans for long-term ownership (or not). For instance, if an investor's exit strategy is an eventual IPO, that would be useful knowledge for a firm owner with no interest in running a publicly-traded firm, and investors that have a 10+ year time horizon and want ongoing cash flows will push management towards different choices than those who plan to exit for an appreciated value in just 3-5 years!

The key point is that there are almost no truly 'passive' minority investors, which means even if advisory firms keep majority ownership and control, it's still critical to be clear on what exactly the investor's expectations for the partnership look like, and the role they expect to play. And in order to ensure the majority and minority investors' interests align, the seller also needs to be clear on their own goals, so that they can set expectations and advocate for themselves at the negotiating table. Ultimately, as minority investments increase in popularity (and specialized firms begin to pop up specifically to take PE-funded minority stakes in RIAs), it remains to be seen whether the reality of minority ownership truly lives up to the "win-win" scenarios that potential investors pitch to their targets; however, given the number of advisors who still have longer-term time horizons and don't want to sell most or all of their shares to an outside investor, but are interested in some outside capital (for growth or to diversify themselves), it seems likely that interest and discussions around advisory firms taking minority investments will only grow more in the years to come.

Should You T-Bill And Chill?

(Amy Arnott | Morningstar)

For investors who grew accustomed in the 2010s to cash and cash-like investments (like short-term Treasury bills) offering basically zero rate of return, it's been somewhat startling to see the 5%+ yields offered by cash and T-bills over the last year amid the Fed's string of interest rate increases to combat inflation. The effect is all the more stark as inflation has cooled from its peak in early 2022, meaning that cash yields have been running more than 2% higher than inflation (compared to the previous decade when cash most often lost value due to inflation). Which has naturally led some investors to wonder: If you can simply park your money in cash or short-term instruments for what is effectively a risk-free 2% real return, why not just "T-bill and chill"?

Although sitting in cash would have certainly looked good over the last year compared with investing in longer-term Treasuries (which have largely lost value), history provides a mixed outlook on subsequent periods after the outperformance of short-term Treasuries. On the one hand, outperformance of short-term assets is often the result of an inverted yield curve, which tends to herald a recession and can lead to cash and T-bills outperforming stocks over subsequent time periods. On the other hand, when that Treasury outperformance comes during a time when Treasuries also return more than the rate of inflation (as they have over the past year), Treasurys' performance tends to be lower than both stocks and bonds over subsequent periods.

Ultimately, however, with cash and T-bills generally considered to be the ultimate "safe" asset, the most obvious answer is that they simply can't be expected to outperform riskier assets like stocks and longer-term bonds moving forward. Even though they have performed well over the past year, they aren't likely to generate as strong of an inflation-adjusted return looking forward, especially as interest rate cuts look more and more probable in the next 12 months. History has proven time and again that the assets with the highest expected return in the long term involve taking the most risk in the short term, which means that the "free lunch" enjoyed by cash over the last year seems unlikely to continue going forward.

What's Behind Dimensional's ETF Success Story

(Holly Deaton | RIAIntel)

For nearly 40 years after its founding, Dimensional Fund Advisors (DFA) built its reputation as a mutual fund provider on the strength of its factor-based investment strategies based on the Nobel Prize-winning research of Eugene Fama and Kenneth French, as well as the atmosphere of exclusivity it cultivated by distributing its funds only through DFA-approved financial advisors. Which made it surprising when, in 2020, DFA announced its intentions to roll out ETF versions of several of its most popular strategies, making them tradeable on the open market for any investor (retail or professional) who wanted them.

At the time, there were questions about how the loss of exclusivity, which had been a significant part of DFA's brand, would affect the company. Additionally, actively-managed ETFs were relatively rare at the time, since advisors could simply build their own "active" factor-tilted strategy out of a collection of passive ETFs with the help of model portfolios and rebalancing software, leading to questions about whether advisors would pay higher fees for Dimensional's actively-managed ETFs rather than develop their own similar strategies out of cheaper passive ETFs.

On the whole, however, the venture into ETFs appears to have been successful for DFA, garnering over $100 billion in assets to become the largest active ETF issuer in just over 3 years' time. What's less certain is how much of those inflows represent net new growth for Dimensional: since one of its cited reasons for offering ETFs to begin with was to cater to a rising demand for ETFs from advisors, it's possible that a significant amount of DFA's ETF inflows are the result of advisors simply shifting funds from the pre-existing mutual fund wrapper into the ETF.

Still, it's clear that at the very least, dropping its "exclusive" approach hasn't driven significant business away from DFA, and in fact it may have helped to prevent DFA from losing a more sizeable chunk of business after several years of underperformance from its core factor-based funds. Which ultimately makes sense, since in order for the firm to compete with the likes of Vanguard and BlackRock for advisors' increasingly ETF-focused investment business, it's a lot easier to do so by offering an ETF that anyone can invest in rather than intentionally limiting access for exclusivity's sake!

The Downsides Of Diversification

(Nick Maggiulli | Of Dollars and Data)

Diversification has been called "the only free lunch in investing": By investing in a basket of less-than-perfectly correlated assets, an investor can reduce the overall volatility of their portfolio without a proportional drop in its expected return. This was the central insight of Harry Markowitz and the foundation of Modern Portfolio Theory, which itself has been a cornerstone investment principle of financial advisors for over 30 years.

However, the time period from 2010 to today has made painfully obvious one of the biggest downsides to diversification, which is that although a diversified portfolio can significantly dampen volatility, it also by definition won't be the highest-performing asset in any given time period. And while that has always been the case, the last decade has been particularly painful for diversified investors given that U.S. stocks have been the best performing major asset class during that time: Because the S&P 500's performance is so constantly visible (on TV and in the financial news and as a benchmark on many performance reports), and because it has so constantly beaten most diversified portfolios, investors are often left to wonder why they shouldn't simply invest solely an S&P 500 index fund given that it's beaten a diversified approach for more than a full decade.

Of course, it isn't fair to compare a diversified portfolio to any single asset class, since diversification by definition means combining some "winners" and some "losers" at any given point in time, meaning there will always be at least one asset class (and likely more than that) that outperforms the diversified portfolio. And focusing only on the asset classes that outperformed the portfolio also leads one to neglect that there will inevitably be asset classes that underperform the portfolio as well, and that diversification eliminates the risk that the investor will be stuck in one of those asset classes by only investing in one thing at a time.

Ultimately, what matters is not how well the portfolio performs compares to the best or worst asset classes in any given time, but how well it works toward achieving the investor's goals. If an investor needs a 5% average return to successfully save for retirement and their portfolio achieves that goal, there's no point in losing sleep over the one investment that returned 10%. And so the main challenge of investing in a diversified portfolio isn't the diversification itself, but rather simply dealing with the disappointment that there's a better performing asset class somewhere, and staying focused on the strategy that will prove "good enough" to reach the investor's goals over the long run, rather than stressing over which asset class will be the "winner" over the next 10 years.

10 Gifts Under $100 For Clients And Colleagues

(Michael Fischer | ThinkAdvisor)

At the end of the year, financial advisors often make it a point to send small gifts to clients as a token of appreciation. And while there are limits to what can be considered an appropriate gift – as FINRA caps the value of client gifts at $100 per person per year, while the SEC doesn't set a specific limit but expects RIAs to have clear policies on gift-giving – this still leaves a lot of leeway for advisors to show their thanks to clients for their business.

At the same time, advisory firm leaders can also consider small gifts for their employees – particularly on teams that work remotely, where there may be limited opportunities to show appreciation.

Ultimately, while some gifts like engraved wine boxes and potted plants can make a statement, even something relatively simple like a branded water bottle or Bluetooth speaker can show the recipient that they're being thought of. And of course, if all else fails, some nice chocolate will likely please almost anyone.

New And Creative Ideas For Holiday Gifts

(Beverly Flaxington | Advisor Perspectives)

Advisors tend to serve clients with a wide range of values and personality types, and as such it can be hard to find a client thank-you gift that works for everyone. Some clients might not appreciate the extra clutter of more "stuff" around, others may have already had their fill of cookies and sweets over the holiday season, and still others may view a logoed pen or stationery set as an act of self-promotion rather than a token of appreciation.

People who are less interested in "stuff" may appreciate it more when the gift comes in the form of an experience, such as a class from Masterclass or an "experience in a box" from Wonderbox. Alternatively, a donation to a charity in the client's name – particularly if the client has some say which charity the donation is directed to – can be a powerful way to make the client feel appreciated by supporting the things they value.

Ultimately, there are many ways to give gifts to clients without resorting to the usual standbys or giving them more stuff to clutter up their house. By thinking (literally) outside the box about what the client might find interesting to do, advisors can create a gift that will make a longer lasting impression on the client.

18 Luxury Gift Ideas For 2023

(Michael Fischer | ThinkAdvisor)

Advisors aren't the only ones thinking about gift-giving this time of year – clients may also be thinking about how they can make a splash with their spouses or family members. And although experiences – such as vacations, concert tickets, and sporting events – are among the most popular gifts, makers of luxury goods are also expecting a big year ahead.

Of course, in the age of social media, goods and services are often entwined: A pair of $30,000 diamond earrings can really liven up one's vacation photos, while someone could doubtless look just as good taking pictures with a $6,000 Leica Q3 camera as the camera's pictures themselves would look. However, there's also room for practicality: For instance, for someone who just has too many $28,000 Patek Philippe watches to keep them all running at once, a $2,500 6-watch winder can keep everything ticking in style.

Ultimately, this is the time of year when many people tend to let down a little of their inhibitions around spending. For advisors, then, it shouldn't be surprising to see their higher-net-worth clients splurging a little, whether that's buying a $1,600 track suit or a $6,500 briefcase. As the holidays approach, gifts to friends and family – whether it's "stuff" or experiences, luxury goods or Major Awards – can hopefully bring some joy and ultimately create a little more connection with one another, which is arguably the whole point of gift-giving in the first place.

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We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog.