The recent decision by Fidelity Investment to not charge fees for certain index funds through its Fidelity Zero Total Market Index Fund for US stocks and the Fidelity Zero International Fund for stocks outside the U.S. raises some critical questions for advisors and investors.
The main question is: Now that more investment products (ETFs and mutual funds) have a very small or 0% cost, what is the dollar value of investment advice?
This question has been asked for decades, possibly since the debate over the value of active vs. passive fund management. However, with the growing popularity of robo-advisors and low-cost products, this discussion profoundly impacts the entire relationship between advisors, substantial investment firms, and their clients.
In an exciting roundup article on Fidelity’s announcement from a European source (Advisor 2.0, managed by Robin Powell in the UK), several advisors offered their opinions on this significant shift, and all of them said it was a game changer.
One advisor summarized the situation: “The financial advice profession, including robo-advisers, have embraced the low-cost fund/ETF model. The trend toward the commodification of asset allocation and portfolio management is already firmly in place,” according to Tadas Viskanta, Director of Investor Education, Ritholtz Wealth, “This development confirms that financial advisors will need to prove their value to clients in ways that go beyond portfolio construction.”
And since there are now more low- or zero-cost index funds (domestic and international) to choose from, investors can get more information from the fund companies themselves and the financial media. All this “creates an opportunity for sophisticated advisers to help them distinguish between smart innovations and gimmicks. And it’s not a moment too soon because the days of fund companies paying advisers to sell their wares are ending,” according to Nir Kaissar, (@nirkaissar) financial adviser and Bloomberg columnist.
So, how should financial advisors adapt to this significant change?
“From an adviser’s point of view, anchoring your value proposition to an active manager whose outcome you have very little control over is no longer viable,” Abraham Okusanya, @AbrahamOnMoney, Director of FinalytiQ, said. “The job of an adviser has now shifted to helping clients capture market return by managing clients’ behavior. That’s an enduring value proposition.”
Can Advisors Manage Client Behavior?
In the U.S., this means much more than the trite advice of telling investors to save more, work harder, take more market risk, and hope for a bull market.
Instead, it should be clear to financial professionals that most Americans seeking long-term financial security are not doing well.
And while it is a golden rule that most financial advisors only want to work with the wealthiest top 2% of Americans, it is safe to assume that 2% does not need your advice now. They have needs and contacts that don’t include anyone on LinkedIn or at the local Lion’s Club luncheon.
The political landscape Americans see today has enormous financial and wage inequality components that escape the financial advice scope of almost all advisors. This is understandable since investment firms religiously tell their advisors to avoid any discussions of politics. But the truth is that economics was originally the study of political economy, which initially encompassed moral philosophy.
Adam Smith was a moral philosopher who made ethical behavior central to his work, even in The Wealth of Nations (1776). By the mid-1800s, social engineering ascended “to heal the breach” between the natural world and the “puzzling, untidy, disturbing world of human
affairs.” (The Rise of Political Economy as a Science, Deborah Redman, MIT Press, 1997, p. 135). This was all part of making economics into a science so logical reasoning could be used to provide solutions to social problems.
Should Financial Advisory Firms Provide Advice to Solve Social Problems?
Not even close. This is understandable today since even the Federal Reserve makes policy decisions that exclude social “externalities.” Following this lead, global corporations favor institutional shareholders, while financial corporations disadvantage their clients by most notably opposing the fiduciary standard. This routinely happens when the big firms use their customers’ money to pay lobbyists to work against their customers’ best interests.
This puts advisors into an ethical dilemma, and now the expansion of low- or no-cost products means clients can more clearly see the value of the advice they are paying for, as well as what the parent investment company is doing to advance their financial interests outside of the face-o-face advice they receive.
Once more investors are informed about this situation, it should worsen. This will pressure front-line advisors to justify their services and costs.
One solution is to adopt the very popular fairtrade model used in many sustainable industries. This model states that fairtrade (in part) should create better prices for producers (in this case, lower costs for investors) and “fair terms of trade” (full transparency).
It also means that advisors and their firms cannot ignore the political environment, especially when addressing the permanent retirement crisis that can only be solved with federal and state programs and financial-fiscal reforms outside of providing individual, face-to-face advice. While this may seem like a sensitive issue, it’s worth noting that specialized financial advisory firms already exist that cater to gay investors, Evangelicals, and Muslims. A firm appealing to larger political interest groups, such as progressives, would also find a fertile audience.
However, ignoring the economic changes caused by an inequitable economic system won’t produce industry-wide sustainable growth in many financial advisors’ practices. For large investment firms, adopting a new business model based on political change will also mean that the days of paying for huge, expensive, wholesaler-sold, actively managed funds should be moving toward the elephant graveyard.
So watch the national and local political landscapes for indications of these changes. If the electorate makes changes promoting reform, the handwriting will be clear for the financial industry to see.
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