Recently, a new client joined my practice and her investing costs dropped by almost 70%. She was paying far too much for a big, old brand name with their fancy suits and high-rise office space. Her accountant finally convinced her that the “value” she was receiving was not worth the cost.
She’s not the only investor coming to this realization. As you may already know, the financial services industry is undergoing a massive reinvention as technology and government involvement are forcing narrowed margins. Transparency is causing “fee compression,” where costs to the consumer are coming down, but expenses for financial professionals are increasing, reducing gross profit. With shrinking income and increased regulatory costs, broker-dealers and advisers must decide what to do with their businesses. Some are adjusting willingly, but others are digging their heels in. Some insurance and investment companies are reducing costs by reducing the number of investments they offer. Financial advisers are deciding to cut segments of their less-profitable clients.
The reality is that the industry has long operated with a set of rules and expectations that I do not think hold true any longer. The seismic shift created by technology has plunged transaction costs, and the average investor can access mind-boggling piles of information. The speed at which innovative and useful investment products can be crafted and brought to market has increased dramatically. (Don’t forget, only 50 years ago you had stocks, bonds, whole life insurance and a few mutual funds. Look at the options now!) And the expectations of consumers continue to shift, often to the unreasonable, in all parts of life.
Are investors reaping the benefits of these changes yet? Possibly, but there are some challenges as some costs aren’t as easy to pull out as others. Here is a quick overview of the costs of investing:
- The cost of the transaction. Economies of scale are definitely in consumers’ favor here, and these cost-busting opportunities are obvious with online discount brokers — it does not cost 100 times as much to buy 100 times the number of shares. But these online systems are designed with the expectation that you will trade all the time, which is not prudent for most investors. Depending on the platform they choose, investors have considerable control over transaction costs.
- The cost of the product. Many products used to have high commissions or expenses. But the pressure to reduce these has product providers re-examining their own cost structures for creation and distribution, yielding dramatic shifts in what investors are paying. For example, exchange-traded funds have expense ratios that may be 90% lower than traditional mutual funds. Of course, the product may be quite different, but my point is the investor has a choice. So, as the industry moves, this is also a cost that is easier for the investor to minimize.
- The cost of labor. This might be better called the cost of relationship. One of the downsides of the fee compression is that it has become increasingly difficult for smaller investors to find personal help. Right, wrong or otherwise, if an adviser makes only minimal income from a small account, then that adviser will likely not work with that client. For example, if an adviser has 500 clients (which would be a big practice) who each pays $500 per year, and she has the costs of an office and a staff, there may not be much left over. Across the industry, smaller accounts are being pushed away to other alternatives. Small investors must go somewhere “cheap,” like the Internet, to find help, and any advice they receive may be quite generic. While it is sad for those folks, it is a math problem. If relationship and advice is valuable to you, this is the most difficult cost to remove.
Please note that these costs are each independent of one another. You can pay high transactional costs and get no relationship (not ideal). You can also pay modest relational costs and receive innovative products. Or you may choose to forgo the relational costs in the name of the lowest transactional costs. You get to decide what makes sense for your situation and your expectations.
However, please let me be abundantly clear — there is a cost to relationship. You want highly qualified, high-character people handling your money. And those folks will not work for free, at your job or in the financial industry. But do not resign yourself to believe the only way that you can get relationship is to pay exorbitant fees.
Here are a couple of ideas you might use to find an adviser who is right for you:
- Look for independence. The added overhead costs of large organizations must be paid from somewhere. Historically, it has come through higher costs to the investor.
- Look carefully at product costs. Through the transparency shift, these are now the costs that are easiest to find. Make sure you understand the costs of the products you buy. This may include commissions, expenses ratios, surrender charges, mortality and expense charges, among others.
- Look for someone you like and trust. If you are going to pay someone to give you advice, please make sure you listen and follow that advice. Otherwise, you are throwing both time and money away. And if you don’t like the advice, find another adviser!
I know you can pay modest fees for good products and great relationships. I know this exists because that is how I have built my practice and have many friends who have done the same thing. Go out and find them.
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