Originally published in Advisor Perspectives, October, 17th 2016
Here’s how to price your services in a way that reinforces your value proposition.
In a recent article, Michael Kitces made a compelling case against trying to be the lowest cost financial advisor. Instead of competing on price, Kitces recommends trying “to improve your differentiation by focusing on a niche or specialization, such that clients will focus on your unique value instead of comparing you to others on price alone!”
On the surface, this is sound advice. But implementing it is a challenge for advisors. Here’s how to price your services in a way that reinforces your value proposition.
Underestimating the threat
It’s difficult to argue with the quality of advice from robo-advisors like Wealthfront, whose investment team lists Burton Malkiel as its chief investment officer and Charles Ellis and Meir Statman as advisors.
Another leading robo-advisor, Betterment, states that it invests “…your money in a globally diversified portfolio of low-cost index funds and give[s] you personalized financial advice – all at a fraction of the cost of traditional financial services.”
Betterment recently announced the availability of a “tax-coordinated portfolio,” which automatically applies an asset location strategy. It calculates a boost in after-tax returns of 0.48% a year, on average, for investors utilizing this feature. It also offers tax-loss harvesting, tax-minimized lot selling, tax-impact preview (which shows an estimate of the tax consequences of a change in asset allocation or a withdrawal) and “smart rebalancing.”
While the issue of whether robo-advisors are fiduciaries is controversial, an extensive white paper authored by the global law firm of Morgan Lewis concluded, “Digital advisers possess unique advantages that strengthen the fiduciary relationship and promote the delivery of sophisticated, consistent advice.” The authors of the study make this unflattering comparison to traditional advisors: “In contrast to advice delivered through individual human financial advisors, which may be offered ad-hoc, by phone, or conducted without reliable documentation, digital advice enables the consistent application of investment methodologies and strategies to client accounts, providing transparency, improved recordkeeping, and ease of audit.”
Those benefits are resonating with investors. Projections of assets under management of robo-advisors varies greatly, but a report from BI Intelligence estimated that robo-advisors will manage about $8 trillion (representing 10% of global assets under management) by 2020.
I believe this estimate understates the potential of robo-advisors.
Meeting the threat
For many advisors, specializing in niche markets is not a practical option. The majority of advisors I deal with have the same business model: They invest their client’s assets in an “evidence-based” portfolio and coordinate with other vendors of the client, including their accountant and estate-planning attorneys.
These advisors have a broad client base. They are not in a position to shift their business model to specializing in a particular segment of investors (like dentists, doctors or teachers). For those few firms that have developed a unique expertise in a niche area, specialization may well be an option.
For the majority of advisors, differentiation based on value is very challenging. The investing service they offer is often indistinguishable from the offerings of their competitors and what clients can obtain at a lower price from robo-advisors. The value of their other services is difficult to quantify and often impossible to compare to other firms offering the same “coordination.”
Here’s the uncomfortable reality missing from the discussion about differentiating based on value: There may be no way for advisors whose primary value is investing in index funds and coordinating with other service providers to justify their asset-based fees.
Contrast this scenario with an advisory firm that, through strategic alliances or in-house personnel, provides the client with tax and estate planning services for no additional fee or a reduced fee, in addition to an asset-based fee. The client will be saving or eliminating the substantial cost of paying for an accountant and estate-planning attorneys and will have the benefit of real coordination of all aspects of financial planning in one firm.
An advisory firm with a family office that provides a litany of services (both financial and otherwise) to its high-net-worth clients or one that has acquired a specialized expertise serving a particular sub-set of investors can meet this challenge.
It’s far more difficult for others to do so.