Venture capitalists are betting hundreds of millions of dollars on firms that deliver web-based investment services. They are betting these firms will change the way millions of investors buy financial services – the same way Amazon changed the way people buy books. However, the purchase of financial advice is a lot more complicated than buying a book. There are no best-seller lists that make the decisions easier. Selecting the right financial advisor or online service is an inexact science that is fraught with risk. Mistakes are not just costly. They destroy hopes and dreams of secure retirements.
The online services are attacking the financial advisor model because it is the most expensive. Millions of investors are paying premiums to obtain personal attention from an investment expert. The basic fee structure is usually two percent or more for the typical investor who has less than $1 million of invested assets. One percent goes to the advisor and one percent goes to the money manager (mutual fund, separate account manager). Additional fees may apply if there is a third party custodian.
Online Investment Fees
The online services use model portfolios that invest in Exchange Traded Funds (ETFs) – index funds that trade as securities. The online service provider charges .25% and the ETF charges .25% for a total expense that is 75% lower than the financial advisor model.
The role of the ETF is matching the performance of particular asset classes such large capitalization stocks or specific types of bonds.
The online service is a no-brainer if your only criterion is a fee. But, what do you give up to get the reduced fee?
- The development of a financial plan that is tailored to your needs, circumstances, and goals
- A personalized investment strategy that is based on your goals and tolerance for risk
- Personal meetings to review results and update strategies
- The security of knowing a professional is watching your assets so you don’t have to
The online firms are also up against an 800-pound gorilla (Wall Street) that has a major vested interest in maintaining the status quo. It employs or licenses 650,000 reps and advisors who have personal relationships with millions of investors. Wall Street firms will fight tooth and nail to protect their way of doing business.
The expense differential will not matter if investors believe their financial advisor is an expert who adds enough value to justify the expense. High quality advisors who deliver competitive results for reasonable risk and expense are not dinosaurs.
On the other hand, a bad financial advisor should be a dinosaur. They provide bad investment recommendations and they produce bad results for excessive risk and expense. These advisors should be easier to replace. However, investors may not know they have bad advisors. Personal relationships and advisor sales tactics cloud their objectivity.
The online services can save money, but they are not a substitute for high quality financial advice and services. Online providers should figure out a way to target low quality advisors who sell bad advice and bad products. If investors knew the quality of their advisors they may be more open to new ideas.
The online services would be better served focusing on younger investors who are more tech savvy. Plus, they do not have long-term relationships with financial advisors. They may like model portfolios, algorithms, low fees, and online access to calculators and reports.
A second market is the do-it-yourselfers. Many investors manage their own assets because they got tired of paying excessive fees for bad results. They could be open to a new paradigm that is based on matching market returns for low fees.