Executive Summary
Most advisory firms that do “wealth management” – some combination of financial planning and investment management – will have three core technology platforms they use: portfolio accounting software to track the investment portfolios, financial planning software to build the financial plans, and CRM software so you can just keep track of all the clients. And this software will come with a cost, but one thing that's interesting about financial advisor #FinTech, is how much (or how little) we are willing to pay for different types of software.
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we examine how financial advisors pay for different types of technology, why these dynamics influence how much we are willing to pay for software, and what this means for the future of financial advisor #FinTech!
As a starting point, just consider how much this software costs for a typical advisor to use. CRM software in our industry is typically about $500 to $1,000 a year. Financial planning software is a little more expensive, with packages like MoneyGuidePro or RightCapital at about $1,000 to $1,500 a year (and some, like eMoney Advisor, are a bit more expensive at over $3,500 per year). Portfolio accounting solutions, though, are typically the most expensive at all, with costs like $40 to $70 dollars per year per account, which means 80 clients who each have an average of 3 accounts leaves the advisor paying about $10,000 to $15,000 per year. Which raises the question: why the huge discrepancy, and why are advisors willing to pay so much more for some software solutions that others? Or stated more simply, why isn't there a $15,000/year financial planning software solution, as there is for portfolio accounting software?
We can gain some insight by looking at the typical financials of an advisory firm. The classic advisor's Profit and Loss statement reduces gross revenue by both Direct Expenses (the costs it takes to actually get the revenue in the door and service it, such as client-facing advisors), and Overhead Expenses (e.g., administrative staff, rent, E&O insurance, and technology) to arrive at the bottom line: Net Profits. In essence, there are two primary “categories” of expenses here, direct expenses that produce the revenue, and overhead expenses that support the operation of the business, like admin staff and office space and technology.
The reason this distinction matters is that typically, we will pay a lot more for direct expenses than we will for overhead expenses, precisely because the cost tends to produce more revenue and it "pays for itself" over time. Yet while advisor technology is typically classified as an overhead expense of the business, but it's not actually always the way we think about the costs when we decide what to buy. After all, for advisors running the typical assets under management model, the reality is that portfolio accounting software isn’t really just an overhead expense, but more of a direct expense, because advisors need portfolio accounting software to validate their AUM fees. By contrast, even for firms that do rigorous financial planning as part of their AUM fee, the planning software isn't a core requirement for generating that AUM fee. It's still good to do good planning work, but you can do good planning work more profitably by reducing the cost of this overhead expense! Thus, we’ll pay 10 times the cost for portfolio accounting software than financial planning software because, when we run an AUM model, we think of portfolio accounting software as something that drives revenue, while financial planning software is just a cost to be managed. And pay accordingly.
In fact, if you extend this line of thought further, it actually becomes clearer why and how it is that even within existing advisor technology categories, some software providers charge a lot more than others. For instance, while financial planning software is typically an “overhead cost to be managed”, MoneyGuidePro costs about $100 a month while eMoney Advisor costs over $300 a month. Both are good financial planning software packages, but what eMoney Advisor does have, that MoneyGuidePro does not, is its client portal. And it matters, because when clients link all their accounts to the portal and engage with the portal, they tend to be “stickier” clients, who are less likely to leave, and therefore the firm has a higher retention rate and keeps more revenue. Thus why eMoney Advisor charges triple the fee of MoneyGuidePro... and similarly why Riskalyze charges nearly double the price of FinaMetrica... because that is what happens when software is positioned as a revenue driver (that can be used for business development and revenue growth and retention), instead of an overhead cost!
And the other reason why all of this matters is the implications for the future of advisor technology. As more and more advisors converge on the AUM model, it’s getting very competitive to gather new assets, and it’s driving advisory firms to focus more and more on financial planning to differentiate themselves (or even become their primary revenue model). And as investment management shifts to the background as a “supporting service” that financial planners offer, there’s going to be immense pressure on portfolio accounting software solutions to bring their costs down, as they get shifted from a revenue-driving software to an overhead expense to be managed. At the same time, if we are primarily in the business of doing financial planning and financial planning fees are driving our revenue, then we will also pay a lot more for financial planning software as a revenue driver. And if advisors were will to pay $15,000 per year for financial planning software, how awesome could that financial planning software be!?
The bottom line, though, is just to recognize that it is the ability of software to drive revenue that makes us willing to pay so much more for some software than others. And with the coming divide between advisor technology for planning-centric firms and investment-centric firms, we're going to see a shift as increasingly financial-planning-centric firms that typically treated planning software as an overhead expense to be managed begin to treat it as a direct expense to generate revenue, while simultaneously beginning to cut back on portfolio management expenses (including portfolio accounting software). Which may mean some big changes for the future of advisor technology, as it is exciting to think about what some software types could look like if advisors were willing to pay 10X more than the tools they currently use!
(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)
#OfficeHours with @MichaelKitces Video Transcript
Welcome, everyone! Welcome to Office Hours with Michael Kitces.
For today's Office Hours, I want to talk a little bit about the technology that we pay for as advisors, how we pay for it, and reflect a little why it is that I think we will pay so much for some types of advisor technology and so little for others.
Pricing Differences In Advisor Technology: Portfolio Accounting vs Financial Planning vs CRM Software [Time - 0:32]
Most advisory firms that do what we'll call "wealth management" (i.e., some combination of financial planning and investment management), have three core technology pieces that they use: portfolio accounting software to track all their portfolios, financial planning software to build all the plans, and CRM software that you use just to keep track of all the clients and keep it all together.
I want you to think for a moment, though, about how much this software costs for the typical advisor to use. CRM software in our industry, usually about $500 to $1,000 a year, maybe something like $40 to $80 per month for each advisor that uses the software. Financial planning software is a little bit more expensive. Packages like MoneyGuidePro, RightCapital are about $1,000 to $1,500 a year, with a few like eMoney Advisor that are actually even much more expensive at about $3,000 per year.
Then we get to the portfolio reporting solutions, though, which are typically the most expensive of all. You'll often see costs like $40 to $70 per year per account. So if you have 80 clients and they each have an average of 3 accounts, you've got about 240 client accounts for, you know, his IRA, her IRA, joint account, times all the different client combinations, and you'd probably end up paying about $10,000 to $15,000 a year with a client base like that. In fact, companies like Orion Advisor Services have a $15,000 dollar a year minimum fee just to get you up to that number.
I want to reflect on that for a moment, though. As advisors, we'll pay $600 for CRM that we must have to run our businesses as they grow, $1,200 a year for financial planning software, but upwards of $12,000 a year for portfolio accounting software. Those are really big differences for things that are all kind of part of a stack.
Now, you might attribute some of that just to the specialization of the software, which I think is fair. There are lots of CRM platforms out there in the competitive landscape. You know, we have industry solutions like Redtail and Wealthbox and Junxure that are built for advisors and are a little more customized and relevant to our industry than the more generic alternatives like Less Annoying CRM or Solve360 or SugarCRM, while financial planning software and portfolio accounting are more complex to design and build because of all the depth of the calculations that have to be done correctly, and there really aren't any industry-neutral alternatives.
But still, with all due respect to some of my friends at the portfolio accounting reporting software companies, I'm not really convinced that the difficulty of designing and programming portfolio accounting software is really 10 times more complex than financial planning software to justify that it's typically 10 times as much money for the software license. And the reality is that even if it really is actually that challenging and complex to build, if it becomes so expensive that it's just not worth it to the business, we won't pay for it. We just won't justify that price. So the fact that Orion could charge $15,000 a year while MoneyGuidePro can't even charge $1,500 a year isn't just about the challenge to execute and implement the software, it says something about what we as advisors are willing to pay for in the first place. And I want to talk for a few minutes about why I think that is, and why it matters.
How Advisors Pay For FinTech: Cost Of Revenue Vs Overhead [Time - 3:55]
But first, let's actually step back for a moment and just think about how financials work in an advisory firm, to begin with. The classic advisor's profit and loss statement for their business looks something like this: At the top, there's gross revenue. Out of that, we subtract out what are called the direct expenses, which is the cost it takes to actually get the revenue in the door and service it. Classically this is where you subtract the cost of the firm's client-facing advisors and business development people because they're the ones that directly solicit and manage the revenue. Often a chief investment officer goes here as well because he or she is the one directly responsible for managing the portfolios that produce the revenue, at least in the typical AUM model.
So we take our gross revenue, we subtract our direct expenses, that gives us our gross profit margin before we pay the rest of the cost of doing the business itself. Out of that, we subtract the broad category of overhead expenses of running the business, which is everything from administrative staff to rent, E&O insurance and also our technology costs, to arrive at the bottom line profits, net profits.
In essence, there are really two different kinds of expenses that get subtracted out here, direct expenses up at the top that are for things that produce revenue (client-facing advisors, lead investment managers, etc.) and then there are the overhead expenses that support the operation of the business (admin staff, office space, technology, etc.).
And the reason why this distinction matters is that most businesses will pay a lot more in direct expenses than we will in overhead expenses, precisely because direct expenses tend to produce more revenue that pays for itself, right? Firms hire more advisors because it lets them get and service more clients, who pay more revenue, which means the money you invest there tends to pay for itself as a business. That's why so many businesses are always looking for more advisors who can bring in clients.
While overhead expenses are simply costs... they're necessary costs of doing business and they're costs that tend to be managed, to bring them down as small as possible. This is one of the reasons why client-facing advisors get paid substantially more than administrative staff in most advisory firms. It's also why in most industries the top salespeople, who are direct expenses that produce revenue, get paid far more than anyone else in the company. Sometimes top salespeople get paid more than the executives because the executives are still overhead, some more than others perhaps.
But here's why this all matters, because while classically all technology is in that overhead expense category for the business, I don't think that's actually the way we think about it when we decide what to buy and what to pay for. We maybe don't think of it in the profit and loss version of direct expenses and overhead expenses, but if you're running the typical AUM model and you're charging clients an AUM fee, the reality is that portfolio accounting software isn't really just an overhead expense for you, it's more of a direct expense.
I mean, can you imagine trying to charge affluent clients an AUM fee and not even being able to track and report on how you're doing with the money you're managing, right? It's kind of a requirement in order to get the AUM in the first place. You have to be able to report on the assets and how they're doing. So when your firm charges an AUM fee and needs portfolio accounting software to validate the AUM fee, you'll pay a lot for the portfolio accounting software because you need it for the revenue.
By contrast, even for firms that do very rigorous financial planning as part of their AUM fee, you've kind of got to have the AUM fee no matter what if you've got the money and you're managing it, so doing good financial planning is good, it's a good value for clients, but doing good financial planning at a lower cost is even better because you're getting the same revenue and you're doing the same work. If you can do it for lower cost, you make more money in profit as a firm. So in an AUM model that doesn't charge for financial planning, the planning work itself is basically an overhead cost of doing business. So it may be a cost that has to be there, but as with any overhead cost, it tends to be something we're more price-sensitive about and something we manage more aggressively.
In other words, I think one of the driving differences as to why we'll pay 10 times the cost for portfolio accounting software than financial planning software is because when we run an AUM model, we think of portfolio accounting software as something that drives revenue, while financial planning software is just a cost to be managed, and so we pay accordingly.
Pricing Power For Advisor FinTech Solutions [Time - 8:23]
In fact, if you extend this line of thought further, it actually becomes a little clearer why and how some software providers charge way more than others in what should be a comparable solution for a comparable price. For instance, financial planning software is typically an overhead cost to be managed for the business when you're doing an AUM model.
As we just discussed, MoneyGuidePro cost about $100 a month while eMoney Advisor is over $300 a month. Now, they're both financial planning software packages, and they're both very capable. I don't think anyone is going to make the case that eMoney Advisor has three times the analytical power to charge three times the price.
But what eMoney Advisor does have that MoneyGuidePro does not is its client portal, and a personal financial management portal is something that advisory firms can give to their clients to really engage them. And it matters because when clients link all their accounts to that portal and engage with the portal, they tend to become stickier clients who are less likely to leave and therefore the firm has higher retention rate and keeps more revenue.
In fact, I know a number of advisory firms that specifically highlight the eMoney portal as part of their value proposition for which the client is paying their fee, and there's more than one firm out there I know that actually charges an ongoing monthly fee for financial planning, a big piece of which is, "Mr. and Mrs. Client, you get access to our special financial management dashboard." They're basically reselling eMoney Advisor as like an upgraded Mint.com for their clients.
By contrast, MoneyGuidePro is just a financial planning software solution. It does some good calculations. We generally get what we need from it. We do need something to do the math and the projections to produce a plan. But when our primary revenue source isn't the financial planning fee in the first place, we just don't pay as much. eMoney helps bring in revenue with its client-facing portal, MoneyGuidePro ends out being just another financial planning calculator tool.
Now, I don't mean to demean MoneyGuidePro here and the quality of the financial planning software solution they provide, but the numbers kind of speak for themselves. eMoney Advisor charges triple what MoneyGuidePro does, and has basically gained market share every year for the past decade. I'll say it again. They charge three times as much, they are growing faster, and they just got bought by Fidelity three years ago for a quarter of a billion dollars. Because that's what happens when software is positioned as a revenue driver instead of an overhead cost.
Another case in point example in this category is risk tolerance software and the breakout growth of Riskalyze over the past five years. Historically, risk tolerance was something you had to do for every client once they came on board to affirm to the regulators that you met the "Know Your Client" or KYC requirements before you invest the portfolio. So determining risk tolerance was a necessity but it was an overhead cost. You already had the client and the revenue, you just had to be able to check the box.
Some firms wrote their own questionnaires, a few used more rigorous third-party solutions like FinaMetrica, but FinaMetrica always had rather limited market share. And I think it was because risk tolerance assessments were an overhead expense and most firms want to manage down their overhead and cost, and in practice, that meant a lot of people saying, "Well, why would we pay for a third-party solution? We can just make a decent questionnaire ourselves."
But Riskalyze is different because Riskalyze is something you don't just use with clients you're onboarding, Riskalyze is something you use with prospects to bring revenue in. I think that's what was so brilliant about Riskalyze from its value proposition perspective. Instead of just giving risk tolerance questionnaires to clients to understand their portfolios that you're designing, Riskalyze made it easy for prospects to take the risk tolerance assessment themselves. You can embed it in your website, you can embed it in your email signature, you can just send it as a quick link to prospects, and then they can not only take their own risk tolerance assessment but also easily input their own portfolios to see how their risk tolerance lines up with their own portfolio.
And what inevitably happens? Prospects complete the risk tolerance assessment, enter their portfolio, see that their portfolio is overconcentrated and risky, because virtually every do-it-yourselfer is not well-diversified, and then Riskalyze basically helps them scare the crap out of themselves about how out of whack their portfolio is, realize what they have at risk and that the advisor's portfolio is better designed, and call the advisor for help. That makes Riskalyze into a revenue driver with prospects while FinaMetrica is simply used to meet KYC requirements for the client.
And, as a result, Riskalyze Pro costs nearly double what FinaMetrica does. Their new Premier platform is almost triple the price of FinaMetrica. And in barely 5 years they've grown more market share than FinaMetrica did in 20 years at double the price. This is why the positioning of advisor technology and where it's used in our process matters so much. We just flat out pay more for software that drives revenue for us, compared to solutions that are just in the overhead category. And because we want to grow, the firms that are giving us revenue growth opportunities like Riskalyze and eMoney Advisor are now some of the fastest-growing technology firms in our industry.
How Changing Advisor Business Models Will Upend Advisor Technology Providers [Time - 13:33]
But the other reason why all of this matters and I wanted to talk about it today is what it means for the future of advisor technology. Because advisor business models themselves are in the midst of a lot of change right now. As more and more advisors converge on the AUM model, it's getting very competitive to gather new assets and it's driving advisory firms to focus more and more on financial planning beyond just investment management to differentiate themselves, in some cases unhinging, at least partially from the AUM model, and charging additional financial planning fees, or even unhinging entirely from the AUM model and just charging financial planning retainer fees, especially now that we have a payment processing platform to handle recurring retainer financial planning fees.
But think about it for a moment how that plays out with advisor technology. In a world where financial planning is your primary value proposition and that's what you get paid for, and you either don't manage assets at all or you just implement simple index portfolios and focus your time and energy and value elsewhere because you're not really in the investment business, you're in the planning business, clients just need a portfolio, does anyone really think we're going to keep paying 10 times the cost for portfolio accounting software versus financial planning software in that world? Nope.
As investment management shifts to the background and it becomes the supporting service that financial planners offer, I think there's going to be immense pressure on portfolio accounting or reporting software solutions to bring their costs way down as they get shifted out of the revenue-driving category and into the overhead expense to be managed category.
At the same time, new doors are going to open for financial planning software, because if and when we're really primarily in the business of doing financial planning and earning financial planning fees as the primary revenue driver, well, frankly our financial planning software needs to get a lot better to actually be able to support that. I think we're overdue for the next generation of financial planning software. But we'll also realistically pay a lot more. I mean, if most advisors got paid solely in financial planning fees and it made us willing to pay $15,000 a year for planning software the way that Orion charges $15,000 minimum fee for portfolio accounting software, how awesome could that be as financial planning software?
So much of our planning software today is really just limited by the constraints of managing the company. I mean, if you only manage so much for your software, you can only hire so many engineers, you can only do so much to build it. But if financial planning software companies could charge 5 to 15 times as much and justify it because we as advisors can effectively grow our financial planning fees faster and charge more and add more revenue that we would happily pay those higher fees, what does that software look like?
And what happens to companies today like Tamarac and Black Diamond and Orion as that future unfolds and advisors are suddenly only willing to pay portfolio accounting software in the future at one-fifth or one-fifteenth the cost per client that they do today the way we do for planning software today? Perhaps RIA custodians will just start throwing in for free. Fidelity seems to be doing something along those lines with their increasingly robust Wealthscape platform. Because we'll still need something, but it's easier maybe to just let the custodian do it at their size and scale and save us the overhead expenses ourselves. That does introduce some other conflicts of interest for us and our ability to change RIA custodians in the future. But that's a discussion for another day.
Now, to be fair in all this, there are firms that solely are primarily managed portfolios and they're going to continue to doing that as their value proposition for the foreseeable future. They have a legitimate investment process, they're good at, and it adds value. And what that means is there will still be a need for independently provided more complex and sophisticated portfolio accounting reporting tools as well, at that higher price point.
But still it means there's a door opening up for, we'll call it simpler, low-cost portfolio accounting solution for all those firms that still need something but don't need the complexity and don't want to pay the price of a full-scale portfolio reporting solution. Maybe that'll be a growth opportunity for one of today's smaller portfolio reporting startups like Capitect and Kwanti and Blueleaf and Panoramix. Or maybe there'll be a newcomer that comes to the table.
But I do think there's going to be a major divide that emerges in advisor technology over the next few years. And the divide is going to be between the planning-centric firms on one side, that increasingly want much better planning software and will pay a lot more because it drives the revenue but who will de-emphasize and cut down on their willingness to pay for the portfolio reporting solutions, versus the firms that stay on the investment management side and will continue to control costs on their planning software but pay 10X the price for portfolio reporting solutions instead because they need it to drive their revenue.
Basically, there's a big FinTech divide, a split that's coming between the firms that become more planning-centric and the firms that stay more investment-centric. Because planning-centric firms will treat planning software as a direct expense and portfolio reporting as overhead, just as most of today's investment-centric firms today treat portfolio reporting tools as a direct expense and planning software as an overhead cost to be managed. When it comes to the CRM software, unfortunately, I think those folks are just stuck in the overhead category for the foreseeable future for no matter what.
But I hope this helps a little just as some food for thought about the evolution of advisor technology. Why it is that some software types cost so much more than others, and why it is that we pay so much for some software versus others. And perhaps a little fun thought experiment to imagine, if you were going to pay $15,000 a year for financial planning software, what would that software do? What could it do? How awesome would it be and what features would you want and need to create new value for clients and justify what could be a lot more in financial planning fees and a lot more value that you can create for clients with that new tool?
This is Office Hours with Michael Kitces. We're normally 1 p.m. East Coast time on Tuesdays but unfortunately, my calendar was tied up yesterday, so here we are this morning. Thanks for joining us, everyone, and have a great day.
So what do you think? Is portfolio reporting software a direct expense or an overhead expense for you? Will financial planning software increasingly become a direct expense for planning-centric firms? What features would you like to see in the next generation of financial planning software? Please share your thoughts in the comments below!
