The impact of investing costs on investors' returns and on the ability of those saving for retirement has been well-chronicled in the financial press. The popularity of index mutual funds and exchange-traded funds (ETFs) has skyrocketed in recent years. There has also been a realization that active fund managers often have a difficult time consistently delivering index-beating performance.
In the financial advisor world, fee compression has also been happening for several years as well. Add in the rise of the robo-advisor in recent years and it is tougher and tougher for many financial advisors to justify high fees. This certainly includes commissioned-based and fee-based advisors who earn some or all of their compensation from the sale of financial products or trailing commissions from mutual funds with generally higher expenses. It also includes fee-only financial advisors whose fee structure is generally far more transparent and straightforward. (For more, see: Trends Challenging Financial Advisors.)
Mutual Fund Expenses
According to a 2015 study by Morningstar Inc., mutual fund expenses are decreasing for investors on an asset-weighted average largely as a matter of their preferences. In 2014 the weighted average expense ratio for the mutual fund investors studied was 0.63%, down slightly from 0.64% in 2013. Five years earlier this expense ratio was 0.76%. Additional observations from the study:
- Over the prior decade 95% of fund flows into mutual funds have gone into funds in the lowest quintile of the mutual fund universe. Passively-managed index funds have been among the largest beneficiaries of this trend.
- Firms with low-cost mutual fund menus, like Vanguard, have been gaining market share in recent years.
- Over the prior five years, 63% of the mutual fund and ETF share classes observed in the study reduced their expenses. Overall, 24% of these funds and ETF share classes experienced a reduction of 10% or more.
As a further example of the trend towards both lower-priced funds and the resulting boon this has caused for passively-managed index funds, Vanguard’s market share increased by 4.1% from 2009 to 2014, the largest percentage gain of the top 10 firms ranked by their 2014 market share. (For more, see: Shrinking Management Fees: How Advisors Can Protect Them.)
Financial Advisor Fees
Even before the rise of the robo-advisor, there was a trend towards fee compression for financial advisors. With investment advice from robo-advisors mostly in the 15 to 35 basis points range, the cost of pure investment advice from human advisors will surely be questioned by many investors.
However, the decline in the average percentage of assets leveled off in 2014 (the latest year available), according to a survey by Pricemetrix. After a decline from 1.14% in 2011, to 1.06% in 2012, to 0.99% in 2013, the average asset-based fee was 1.02% in 2014. Unlike mutual funds and ETFs, there is no definitive data base of financial advisor fees. While there are some excellent industry surveys and studies, there is no central hub of this type of information. As clients become more knowledgeable and sophisticated, many are and will continue to seek out arrangements with lower fees for asset management. (For more, see: How Financial Advisors Can Adjust to Robo-Advisors.)
Potential Impact of Robo-Advisors
As assets managed by robo-advisors continue to grow, the impact will surely be felt by traditional financial advisors at least to some extent. More so than the pure robo-advisors, Vanguard’s hybrid robo-advisor seems like the most disruptive in my opinion. They have been successful in attracting Baby Boomer clients, some of whom might otherwise have worked with a traditional financial advisor. For a fee of 30 basis points clients have access to a live financial advisor who will prepare a financial plan and suggest an asset allocation strategy. Clients have access to this financial advisor on a periodic basis in combination with the robo-technology used by the service as well.
Pending Fiduciary Rules
The Department of Labor has proposed a new set of fiduciary rules pertaining to financial advisors who provide advice on retirement accounts. One of the aspects of these proposed rules is the disclosure of all fees charged and the total amount of these fees to clients. This would occur under an exception allowing the continued use of commissioned products or other potential conflicts of interest called the Best Interests Contract Exemption or BICE. This is a proposed agreement that would be signed by each impacted client and would fully disclose how much the financial advisor would earn from the products proposed. (For more, see: What the DoL’s Fiduciary Policy Means for Advisors.)
The rise of robo-advisors and the increase of both clients and financial advisors with an online presence is likely to increase the transparency of financial advisor fees. This is especially so among younger Millennial and Gen X clients who are more used to shopping for products and services online. The internet has increased the transparency surrounding both the cost and types of financial advice available.
Will the transparency of the proposed fiduciary rules help bring down the cost of financial advice? Hard to say. You would think so, but honestly I’m not sure that all clients understand how their financial advisors are compensated even if explained to them. The financial services industry, and especially advisors compensated via commissions, does little to add transparency to the conversation regarding the cost of advice. Additionally, I suspect these disclosures will be written in terms that are not intuitive to many of the clients reading them. (For more, see: Financial Advisors Need to Seek Out this Group NOW.)
A Changing of the Guard
Many of the current traditional financial advisors are in their 50s and 60s and likely will be retiring or otherwise exiting the business over time. From what I have observed, many of the younger financial advisors entering the business and serving younger clients seem to work in a more transparent fashion. I suspect this transparency, coupled with the rise of online advice, will serve to bring down the cost of financial advice over time. Or at least clients will have a better understanding of what they are paying for and how much this costs. Clients who need more sophisticated wealth management services may pay higher rates than clients with very simple, straightforward needs that can be served by a robo-advisor.
The Bottom Line
The move towards passive index ETFs and mutual funds has served to drive down expense ratios for many investors. A similar trend toward lower costs for financial advice has been occurring to some extent, but unlike with mutual funds there is no central public database like Morningstar to track this data. Over time the continued rise of online advice and the trends in more transparent fees by younger financial advisors may help move the needle towards lower costs for advice. (For more, see: How Financial Advisors Can Capture the $240B Worth of Fees Coming by 2030.)