Will The Cost Of Financial Advising Drop Like Other Fees In The Financial Services Industry?

Nearly every service in the investment industry has declined in cost over time. Commissions, mutual fund fees, and bank fees have all declined over the years.

But perhaps the single most costly service in the investment world, financial advising, remains extraordinarily expensive. The typical fee for financial advising remains around 1% of assets under management, which hasn’t significantly declined over time in the way that mutual fund fees have in recent years. Why is this the case and should we expect downward pressure in financial advising costs in the future?

Other Financial Services Are Now Free

Think about all of the other financial services that have declined in cost over the years:

Banking Fees and Interest Rates

The introduction of online banks, who don’t need to pay for expensive, ubiquitous physical branches, has significantly reduced the cost of banking. Popular online banks, such as Ally Bank, offer zero monthly maintenance, ACH transfer, and incoming wire fees for their savings accounts. Many of these banks will also reimburse a significant portion of ATM withdrawal fees for their checking accounts.

In addition, online banks typically offer better interest rates in savings accounts and CDs. For example, Ally currently (as of October 2018) offers 1.85% interest on their savings accounts. These rates are higher than those at the major banks.

Commissions

Decades ago, in order to make stock trades, you had to call up your broker, who could fill your trade for astronomically high commissions like $89 per trade.

Electronic trading and the Internet has not only made stock trading more efficient, it has also made it significantly less expensive. Online trades at major brokerages have been less than $10 per trade since the 1990s.

In the past decade, online stock brokers have been continuing to lower the cost of stock trading. Now, brokers such as Vanguard offer over 1,800 ETFs commission-free, Fidelity offers over 240 ETFs commission-free.

And new financial startups such as Robinhood offer commission-free trading for all trades to investors.

Mutual fund expense ratios

In the past, mutual fund expense ratios (especially for actively-managed mutual funds) would be 1% or more. Index funds, which have less overhead costs for research and staff, are much less expensive to manage than actively-managed mutual funds. And with the rapid adoption of index funds by investors, fund companies have aggressively have been cutting costs of index mutual fund and ETFs. Fidelity even recently introduced four index funds with zero expense ratios.

Why Financial Advisors Are So Expensive

So if every other financial service is free or significantly less expensive than it was 10-20 years ago, why is financial advising still so expensive?

Financial Advising Is Personal

As much as blogs and books try to give blanket advice on personal finance and investing topics, the reality is that each individual’s circumstances are unique. That is why this site, and every other blog or podcast, has disclaimers stating that our content should not be construed as financial advice, and that you should discuss your specific financial situation with an investment professional.

And many financial questions have no one correct answer. Take for example, the very common question of whether to pay down low-interest student loans or invest. In a general sense, the pros and cons of each option are straightforward. But the best answer for a specific individual is based on personal preferences, and a financial advisor can often help investors make the best decision for them.

Financial Advising Is Not A Commodity

To extend the previous point, financial advising is not a commodity like commissions or running an index fund. Making a trade, at least at the surface to the regular investor, appears to be exactly the same from broker to broker. Trade commissions simply become a commodity where investors are more likely to trade with the broker with the lowest commissions. Because of this, commissions have dropped essentially to zero.

Similarly, running an index fund is simple in that you don’t have to have professional fund managers picking stocks. Vanguard, iShares, Fidelity, Schwab, and others all do a great job with their index funds in tracking their underlying index. As a result, they have to compete on price, and the current lowest price for index fund management is zero.

On the other hand, financial advice is not a commodity, because not every financial advisor provides the same quality of financial advice. There are good financial advisors, and there are bad financial advisors. A financial advisor could provide their services for free, but if they give you bad financial advice, it’s useless. On the other hand, a good financial advisor has the potential to provide far more value than what they are charging, even in a 1% assets-under-management (AUM) model.

It is expensive to give financial advice

Michael Kitces wrote an excellent blog post about the direct and indirect costs of starting and running a financial advisory business.

It turns out that while the startup and recurring costs of becoming a financial advisor are low (after all, giving financial advice is a labor-intensive, not a capital-intensive, job), it takes significant time to build up a Rolodex of paying clients. Young financial advisors toil for years trying to woo and sign the 100-150 long-term clients they need to run a sustainable long-term AUM financial advisory business.

While they are acquiring those clients, their income will be very low. Therefore, they need to charge their clients not just for the services they are directly providing, but also for the “sweat equity” necessary to get their business in the first place.

Recent Changes In The Financial Advising Industry

This is not to say that there haven’t been significant changes in the way financial advice is given. There have been significant changes, almost all of which has been to the benefit of investors like us.

The decline of commission-based financial advising

In the not-too-distant past, financial advisors were routinely paid to sell mutual funds to investors. They would get paid an upfront fee (called the load) to have an investor buy a mutual fund.

Now, more and more financial advisors are fee-only, which means they are paid only by the client, not by insurance companies or mutual funds. In addition, financial advisors are often explicitly stating that they will act as a fiduciary to their clients, which means that they will always offer advice and act in the best interests of their clients. You would think this should be a given for financial advisors, but it often is not.

Roboadvisors bring automation to some aspects of financial advising

Several startup companies, including Betterment and Wealthfront, have introduced the concept of roboadvising, where a computer automates much of the mundane, time-consuming tasks of financial advising. Because they remove much of the human element (and costs) of financial advising, they are able to provide financial advisory services at a lower cost than traditional financial advisors.

While I do not believe roboadvisors will replace traditional financial advisors, I think the technology that the roboadvisors created and popularized will be integrated into financial advisor systems. This will help financial advisors save time on tasks such as manually rebalancing portfolios.

Index funds have removed the fund-picking component of financial advising

It is far simpler, and less time-consuming, for financial advisors to offer low-cost index funds than to try to pick the best fund managers or time the market. This should “even the playing field” among financial advisors, which will force them to compete on price. If financial advisors cannot claim that their choice of mutual funds or ability to time the market will provide superior returns compared to their competitors, then they must earn customers’ business by offering their excellent financial advice at a lower price.

Conclusion

There are several reasons why financial advisor fees have not declined in the way that mutual fund expense ratios and commissions have. However, because it’s easier than ever to DIY your investing without a financial advisor, and there are opportunities for virtual, online-only financial advisory practices to thrive, my expectation is that the cost of financial advice, like every other service in the industry, will decline over time.

What do you think? What is keeping the cost of financial advice from going down? What financial advisory models (either current or in development) do you think could help lower the cost of financial advice?