Journal of Financial Planning: January 2013
Over the past five years, the financial crisis has wreaked its havoc on the economy and consumers, and U.S. households still have not recovered their total net worth to where it was before the crisis began. As a result, the financial planning industry too has been suffering in this “new normal” environment, as firms struggle to grow revenues in the midst of sluggish organic growth, rising costs, and the lack of any tailwind from markets that haven’t entirely recovered to their pre-2008 highs.
The Impact of Net Worth Stagnation
At a recent Tiburon CEO Summit, Tiburon Strategic Advisors’ Managing Partner Chip Roame noted how the pool of available household wealth to which advisers provide services has been remarkably stagnant for the past five years, barely recovering back to the pre-2008 highs.
The problem is similar (see chart drawn from Roame’s presentation) when viewed in terms of the portion of net worth available for investment advice, including “Household Investable Assets” (i.e., bank/investment accounts) and “Household Retirement Assets” (i.e., retirement plan accounts), which rose by 70 percent from 2002 to 2007, but are up only 3 percent cumulatively since then. And notably, the chart is in nominal dollars, which means the stagnation is even worse on a real, inflation-adjusted basis. (For context, the other components of “Household Net Worth” not shown on the chart include tangible assets—which includes home equity as a major component—and small businesses, the value of which has actually followed a very similar path.)
And unfortunately, the challenges illustrated in the chart are not likely to end soon, as we are in the midst of what PIMCO founder Bill Gross has dubbed a “new normal” environment, where the average returns and growth of the marketplace going forward will simply not be the same as they were in the past. Instead, we are in a sustained environment of flat or very modest growth.
As a result of this fundamental trend—stagnation of investment assets and overall net worth for consumers in the aggregate for five years—the financial planning industry has been suffering a severe headwind of its own, which in turn is resulting in several implications for financial planning firms:
Reaching for Returns
Firms are struggling with the lack of a return tailwind that they enjoyed in the five years leading up to the financial crisis. As a result, there seems to be a reach for return, as both firms and their clients grow increasingly frustrated with the lack of growth. This in turn is driving a heavy shift toward investing in alternatives, which often may be declared as a reach for better diversification and risk management, but in practice appears to be more of a reach for raw return. The drive for return also is pushing many firms toward more active investment strategies, as tactical asset allocation is on the rise as well. In other cases, firms are pushing in the opposite direction and trying to drive down cost, leading also to a boost in passive investing from Vanguard to DFA funds.
New Revenue Models Aimed at Growth
Given the stagnation of the asset base upon which much of the industry calculates its fees, there has been a growing trend toward alternative business and revenue models that can better facilitate growth, such as retainer fees and stand-alone financial planning fees.
However, such approaches may not actually improve a firm’s revenues in the long run. As I have written about in the past (see the practice management category at www.Kitces.com/blog for more), retainer fees may have difficulty keeping up with staff and overhead costs, and cause margin pressure when growth gets under way again, and in the meantime, these fees accentuate the cost at a time when clients are feeling more fee-sensitive than ever.
Overarching this entire environment is the simple fact that if wealth in the aggregate isn’t growing, consumers just can’t afford more financial planning services, regardless of the revenue model being used. In other words, it doesn’t matter if the business model is less investment-centric; if total net worth isn’t growing, it’s difficult for financial planning firms to generate more revenue by any means.
New Marketing Approaches
The drivers for financial planning services include major life events, many of which are driven directly or indirectly by changes in income and wealth—from a new job, to the sale of a business, to the transition into retirement. As net worth has stagnated, so too has the influx of new potential clients to the financial planning industry, as the frequency of these major life events has declined, leading to a world where more and more new business must be driven by attracting clients from other advisory firms.
At the same time, the industry itself has been going through a massive shift to increase the extent of financial advice provided, regardless of business model and firm type. Accordingly, not only are there fewer new clients in play than ever, but the competition for clients is fiercer than it has ever been. The net result: a dramatic slowing in organic growth, and a drive to come up with new ways to market to and attract new clients. For instance, while many firms have been attempting to go “downstream” and bring their services to a wider market for the benefit of consumers, it’s probably not a coincidence that such expansionary plans have only gotten under way as growth has stagnated in the previously “core” marketing segments.
The Urge to Merge
As financial planning firms struggle with stagnant household wealth, there is growing pressure on profit margins as an increasingly sophisticated and advice-oriented staff requires greater compensation, not to mention the rising costs of office rent, technology, and software to run the practice—and especially the rising cost of compliance. This combination of rising costs and weak revenue growth is pushing many firms to seek out greater efficiencies, and this, in turn, is fueling an urge for financial planning firms to merge in attempt to get larger with the hopes of obtaining economies of scale for the costs of running a financial planning business.
Growth by Acquisition
As growth rates for financial planning firms slow with the loss of any market tailwind (or the outright introduction of a headwind) and weaker organic growth, firms are increasingly turning to the only alternative left for growth—inorganic growth by acquisition. As a result, there seems to be an increasing interest from many firms to acquire smaller firms and assimilate them for growth. This trend seems to be occurring up and down the spectrum, as $3B firms want to acquire $1B firms, $1B firms want to acquire $250M firms, $250M firms want to acquire $100M firms, and $100M firms want to acquire $20M firms. In some cases, this is compounded by a desire to not only grow revenues for the sake of growth (and profits as well, assuming margins can remain steady), but also to grow the business to a larger size to seek out economies of scale and greater practice efficiencies to maintain those profit margins.
Outsourcing Bonanza
For firms that cannot merge, the alternative has been to aggressively outsource, seeking to gain scale and efficiency by delegating key functions of the firm to external businesses that have gained economies of scale by aggregating advisers. The outsourcing trend has manifested in everything from technology, server and software hosting, and cloud-based solutions, to outsourcing portfolio management functions (operational functions, or even investment decisions themselves), to basic office support, including bookkeeping and administrative assistance. With the ever-increasing availability of bandwidth, the outsourcing trend is well poised for continued growth in the emerging digital age.
The difficult “new normal” economic environment has been a struggle for most industries; financial planning is not singled out in this case, but merely an example of the broader trend. At the same time, though, every industry experiences difficulties in its own way, and the “new normal” is still playing out in its own unique way in the financial planning world. Nonetheless, as long as the economy continues to be difficult, and household wealth grows slowly or not at all, expect these trends to continue as growth becomes less about maintaining a slice of a growing pie and more about capturing a larger slice of the pie itself.
Michael E. Kitces, CFP®, CLU, ChFC, RHU, REBC, is a partner and research director at Pinnacle Advisory Group in Columbia, Maryland. He publishes The Kitces Report newsletter and Nerd’s Eye View blog through his website www.Kitces.com. He also serves as practitioner editor of the Journal of Financial Planning. An adaptation of this article originally appeared in the Nerd’s Eye View.