The Compound and Friends - How the Financial Advice Industry is Changing (Tadas with Cullen Roche)

Starting point is 00:00:00 Hey, Cullen, it's Taddis. Hey, Taddis. How are you? Hey, I'm good. I'm on the line with Cullen Roach, who is the founder of Orcum Asset Management and is the author of the Pragmatic Capitalism blog. I asked Cullen on today to talk about a recent post of his entitled, How the Fee Structure of Financial Advisory Will Change in the Future.

Starting point is 00:00:18 There's a steady drumbeat of news and commentary about the state of the financial advisory business, and I thought it would be good to speak to Cullen about it. Specifically, how going forward advisors are going to charge for their services. Cullen's post did a good job of summing up the situation at hand. So I think that's a good place to start, Cullen. This piece puts in stark contrast the situation facing advisors today. Have you gotten any pushback from advisors? You know, surprisingly, not too much. I mean, I've kind of seen the various iterations of how the fee structure has changed, mainly because I think I've kind of been involved directly in the industry in a way throughout my career that I've seen that sort of transition from when I first

Starting point is 00:01:04 got into the business with Merrill Lynch, it was mostly a commission-based business. And the team that I worked with at that time, we were kind of just starting to transition into more of a fee-based, more of a fixed fee type of process. And it was interesting to see that change. One of the reasons I kind of was disillusioned with the big brokerage firms was because of the high fees that they charge and the way that it was being structured in a way that I thought was just excessively high. And so I transitioned to an RIA where I'm able to then use all of these low-cost funds and charge basically an advisory fee, somewhat similar to what we were doing at Merrill,

Starting point is 00:01:47 but different in that my fee basically was able to be more flexible, lower, because I didn't have all the overhead and the other costs of a big firm like a Merrill does. But so we sort of transitioned from a commission-based transactional business to more of a fixed fee type business, which I think is a function of people realizing that there isn't a lot of value in the transactional side of things. And the interesting thing, and the thing I really tried to focus on in my post, was that so much of the fee structure in our business is a function of the asset management side. And you see this really, the main driver of the change in the fee structure over time has been sort of these big passive indexing companies, firms like Vanguard and BlackRock, who have put so much downward pressure

Starting point is 00:02:38 on fees that it's forced everybody else to kind of follow their lead. Because in essence, from an economical perspective, they really have the huge economies of scale. They're the marginal price setter, basically, in the industry as a whole. And what's interesting about that is that an asset management firm is specifically a price setter in terms of the assets under management they have because that's the only way they can really scale their business. Vanguard can't charge a flat fee of, say, $4,000 a year like a financial planner theoretically could because Vanguard can't scale their business without having their assets tied to their fees. Because if, for instance, say you had a $4,000 fixed fee for a Vanguard account, well, you and I could, say, form an LLC and open up a Vanguard account

Starting point is 00:03:33 for $4,000. You could have literally huge firms that did it with billions of dollars charging Vanguard $4,000 in fees every year. It's just it's not a scalable business. And so by by nature, the asset managers are the price setters from the bottom, basically through the asset management business. And the thing I tried to really highlight was that I think the struggle that a lot of planners and advisors are going through now is really trying to figure out, well, where is the big value at? Is the big value at in our business, is it from the asset management side, which the fees are inherently connected to the AUM structure through the price setters like Vanguard and whatnot, or is the real value add through other services, tax planning, financial planning, which in my opinion can actually be

Starting point is 00:04:23 set in more of a fixed fee type of manner where you're doing something that's more almost like your typical accountant does, where the fee structure is more of like an hourly rate or some sort of fixed rate, almost like an accountant or an attorney retainer type of fee, something like that. And so it's kind of interesting to see all of this transition over time because the AUM structure is specifically an asset management fee. And in my view, the big value add for most advisors doesn't come from their asset management. It really probably comes from the tangential sides of the business, like financial planning and tax planning and things like that. And I think what we're seeing now with a lot of people kind of critiquing the 1% fee structure that you see

Starting point is 00:05:11 across the industry, I think a lot of people are basically attacking the way that that fixed fee is set because it is inherently an asset management fee And that's not really where the big value add is. Yeah, no, I think that's a good point. I mean, I think that all of the, you know, essentially the last decade has seen, you know, all of the headlines are about falling fees for ETFs, index funds and things like that. And it's really hard to ignore in that sense. Yeah. Well, it'll be really interesting to see how this plays out because some people, and I think this is the reason I didn't get too much pushback on this, is because I was pretty clear in my explanation that the 1%

Starting point is 00:05:56 fee structure that you see on average across the advisory space is interesting because there's an argument that firms that are, say, doing really complex types of planning, they might be undercharging with a 1% fee structure. They might find that if they moved to a fixed fee structure or even an hourly structure or something like that, they might actually find that they actually would increase their revenues. Whereas what I find that is somewhat bothersome with some advisors, what I see very commonly with particular people who transfer their accounts to me is that what a lot of advisors are doing is they're not doing a lot of planning. And what they've done is they've put together a 1%

Starting point is 00:06:37 fee structure and they've slapped together, say, a 60-40 Vanguard type of portfolio, and then they're charging 1% for it. And in my view, that's not really any different than a very active mutual fund manager who is pretending to be an expert stock picker running some fancy-sounding strategy under a C-share mutual fund structure that charges 1% per year. There's really not much of a difference. So a lot of people have kind of, I think, sneakily transitioned out of the brokerage firm, retained more of the profit, and are charging the same type of sort of unnecessarily high fees without the extra services that are added on. And so it'll be interesting to see over time whether or not

Starting point is 00:07:22 these sorts of advisors retain the business that they're able to peel off from the big brokerage firms and versus the firms that are really providing a lot of these other services where you're paying maybe 1% or maybe a fixed fee equivalent type of structure, but you're getting tax planning and financial planning and all these other services that arguably add a tremendous amount of value to people's lives. Yeah, no, I think disaggregating the asset management from the other function, I think, is an important point to make. this is happening is not only the reduced fees on the asset side, on the asset management side, but it's really the use of technology in terms of running a financial advisory practice. And I think that's really an important part about how these different models can be set up and be profitable for the advisor going forward as well.

Starting point is 00:08:26 Well, 100%. Yeah, the technology has made everything so much more scalable and streamlined that, I mean, you have a lot of advisors who are running RIAs that, in my view, are doing, they're running services that are a lot more complex, a lot more sophisticated than even the big firms are operating. And they're adding a lot more value. So the RIAs are, in a lot of cases, they're earning a much higher profit than the advisor otherwise would. And it's totally deserved. So it's interesting. I think that a lot of this is still, we're still kind of feeling it out. We're still kind of figuring it out. And I think the consumer is the one who is really figuring it out. It'll be fascinating to see over time how this transitions. And I suspect we're going to see more of the fixed fee type of planners who they really don't emphasize the asset management as much, and they're really focusing on building more of a financial planning, more of an advisory type of firm, as opposed to so much of the business traditionally has revolved around the asset management side and the sales pitch that, hey, you should pay me 1% to 2% because I can beat the market. And we're kind of slowly realizing

Starting point is 00:09:45 that whole narrative. It just isn't really where the value add comes from. I think that's a great place to start, Cullen. Thanks very much for joining me. You bet, Titus. Thanks for having me.

The Compound and Friends - How the Financial Advice Industry is Changing (Tadas with Cullen Roche)

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