Illustrations By Mirko Ilic
If it's true that, as 17th Century English cleric Thomas Fuller noted, "Threatened folks live long," then we're going to be seeing a lot of tough, gray-haired financial advisors eschewing the shuffleboard courts and giving Methuselah a run for his money. In this case the threat - real or imagined - stems from growing competition in the financial services business, fueled by the onslaught of advisory services now available on the Internet.
From the time technology reared its silicon-chipped head in the early 1990's, we've seen an expanding universe of financial services delivered not by humans, but by machines. Cambridge, Massachusetts-based Forrester Research predicts that by 2005, 20 million U.S. households will be receiving financial advice in cyberspace, a tenfold increase over the 1.8 million who will get their advice electronically this year. By the end of 2000, some 80% of all financial firms are expected to offer online advice. That's a lot of advice. And while today the quality is often debatable - a criticism voiced by many advisors who find fault with the online offerings' rote solutions - there's no doubt that the overall quality will steadily improve as consumers become increasingly sophisticated and the competition intensifies.
Will the Internet replace financial planners? If current programs designed to help 401(k) plan participants are any indication, the short answer is: No. A more thoughtful response might be that it depends on the type of advisor and the type of client.
For sophisticated advisors, who probably already have a powerful array of financial tools at their disposal, the news is good indeed. For them, this electronic competition will likely make good advisors (and their Web sites) even better, and bring better business, in the form of more knowledgeable clients. Less sophisticated advisors, or ones with little time or resources to explore new tools, will likely feel the threat of online advisory services more. They are vulnerable to losing clients who are technically savvy and who have a desire to make more decisions themselves; such advisors could also lose clients who want professional advice but who have concluded that they need a more sophisticated advisor. Advisors targeting the burgeoning market of middle America have reason to worry; their counterparts serving the high end have - for now, at least - less to worry about.
But one thing is certain: for all advice givers, the bar of excellence will continually be raised. Thanks in large measure to the Internet, existing and potential clients will be demanding honest answers to tough questions regarding the merits of one advice delivery service over another. For the first time, the public will be able to compare what exactly advisors - and advisory services - are offering, and discriminate between those who are adding true value and those who are not. It's not a good time to fall asleep at the wheel.
One major factor that will determine the impact of online advisory services is a personality issue: whether the client can be characterized as a delegator or a validator. Delegators are clients who do not want to assume the responsibility of making their own financial decisions, and who are happy to turn that responsibility over to a professional. Validators are those who do a lot of their own researching and analyzing, but still like the "stamp of approval" from a professional. (A third category consists of "soloists," who generally prefer to handle things themselves instead of hiring professionals.) Advisors have a higher risk generally of losing validators than delegators, and the insurgence of online resources provides even more tools for building confidence among validators.
According to Forrester Research, the percentage of the affluent class that is considered validators is expected to increase over the next five years to 55%, from a current level of 40%. Delegators, on the other hand, are expected to decline from 50% to 30%. Soloists are also projected to increase from a current level of 10% of the affluent class to 15%.
The overall ranks of affluent investors are projected to enjoy strong growth in coming years, however, which will lessen the immediate impact of this shift on the financial advisor market. According to Jim Dillahunty, president of Fixed Income Securities, Inc., in San Diego, the number of people with a net worth of $1 million or more is growing at an annual clip of nearly 17%.
To serve these evolving investors, there's a virtual explosion of online advisory serv-ices, largely focused today on the participants in 401(k) plans. The Investment Company Institute in Washington, D.C., notes that 401(k) plan assets stood at some $1.4 trillion at year-end 1998 (the latest available year); these assets are growing at an average rate of 18% per year, claiming about 13% of the $10.9 trillion U.S. retirement market. At year-end '98 there were 273,485 401(k) plans with 36.7 million participants, up from 1990 figures of 97,614 and 19.5 million, respectively. These plans have come a long way since they were first introduced 17 years ago.
What's also growing is the number of available 401(k) investment options. According to a survey conducted by Hewitt Associates, a management consulting firm specializing in human resources, nearly twice as many employer-sponsored plans (42%) offer 10 or more investment options today than in 1997 (23%); the average number of options available over that period has grown from eight to 11.
Employers offering 401(k) plans have a responsibility to help educate participants so that they can make appropriate decisions regarding their investment options. And employers are increasingly using Web-based advisory services to perform the participant education component of the plan. Hewitt says that 86% of the 491 employers who responded to a national survey provide investment education for their employees, up from 59% in 1997. More telling is that 62% of employers use the Internet as a medium for employee investment education, up from 20% in 1997. Of those using the Net, 92% report the experience to be "very effective or somewhat effective in communicating investment concepts."
When these employees and plan providers boot up, where can they head for help? Just a click away are Bill Sharpe's Financial Engines, Quicken's 401(k), Morningstar's Clear Future (introduced in January), along with 401Kafe, Standard & Poor's 401(k) Advisor, Advisors 401(k), and a spate of others.
Released in 1998, Financial Engines Investment Advisor has been roundly praised for its Monte Carlo calculating power and condemned for being cumbersome and non-specific. The interactive model lets users tinker with four variables: retirement age, amount of desired income in today's dollars, 401(k) contribution rate, and level of investment risk.
Advisor Ileen Malitz, of I.B. Malitz & Associates in Milford, Pennsylvania, and Naples, Florida, has experimented with Financial Engines and says that while she appreciates the "simulation," in general she is less than impressed. Purporting to be useful for all retirement plans - in mid-March, Engines upgraded its service to handle tax-deferred accounts - she discovered that the program would not accept a contribution greater than $10,500 per year into a 403(b) account. Malitz laments the lack of online advice concerning investments and the fact that there is "no real attempt to find out specific information about the person."
The program's inability to handle tax-issue vagaries is something that troubles Sameer Shah, managing director of Tampa-based Shah and Associates. Shah has had clients use Financial Engines and come back to him with more questions than answers. He says that as an advisor, one of the important strategies he employs on clients' behalf is the use of taxable and non-taxable accounts in different ways to structure a portfolio combining the two. Engines does not examine taxable accounts and, according to a company spokesperson, has no immediate plans to try and do so.
"Essentially, you want things in the taxable accounts that you buy and hold forever, like a Vanguard Total Market Index Fund, or individual stocks, that try to defer capital gains as long as you can," Shah says. "You use 401(k) or tax-deferred accounts for rebalancing, for trying out different funds, and for using funds that are tax-inefficient. Engines doesn't take into account these important nuances."
He feels Financial Engines simply crunches historical data and extrapolates into the future. As an advisor, he believes that his job is to make reasoned assumptions about expected future returns, rather than simply to key in past returns. "At the end of the day, it's an optimizer," he says of Engines. "Sort of garbage in, garbage out." Al Coles of Financial Designs Associates in Stinson Beach, California, puts it this way: "Systems such as Financial Engines don't show the real world, and tend to employ weak methodologies with regression analysis. When you go into the program, what they're giving you is an econometric weather report, and that's not enough." The information lacks the depth required by the types of people coming to financial advisors such as himself, says Robert Horowitz, president of New England Investment Management in Stamford, Connecticut. Machines can't "customize" advice, or add depth and flesh to issues that need careful explaining, he says.
Nor can programs like Financial Engines delve into psychological issues. As an exercise, Shah likes to take clients on an imaginary trip through 1973-1974, and says, "Okay, you really want an all-equity portfolio? And if the market drops 40%, are you going to stick with it?" A machine can't achieve this type of understanding of clients in terms of getting a handle on their risk tolerance, he says. A machine can generate an allocation, but whether it's the right allocation for that person based on his or her psychological risk profile is something better determined through human interaction.
Despite these shortcomings - and no doubt helped by the program's $14.95 per quarter price - Merrill Lynch saw enough in the Financial Engines electronic service to offer it to its 1.4 million 401(k) customers. Particularly interesting is the comment made by Merrill's director of digital benefits solutions, who said that for people with simple financial situations not requiring estate or tax planning, Financial Engines sans advisor might suffice - and for people with more complicated situations, the tool "is better delivered with a financial counselor."
And while Engines has no plans to increase access to human advice, other online programs do - and that combination is what at least one advisor sees as the biggest single threat to his profession: objective human wisdom to complement those black-box smarts.
The new service, Quicken 401(k) Advisor On-Call, provided by TeamVest, LLC, under arrangement with Quicken Investment Service, Inc., combines Intuit's Quicken online tools with the opportunity to talk to an "expert investment advisor" in order to ask basic questions, be privy to "validating insight," or take advantage of ongoing advice and oversight, depending upon which plan the user chooses. The "insights" are derived from the institutionally-based analysis provided by Team Vest's research team, headed by a CFA and a Ph.D. Those on the end of the phone providing the advice? According to TeamVest, each is an RIA averaging approximately five years of successful financial services experience. The cost to consumers? From $89.95 to $149.95 per quarter.
New England Investment Management's Horowitz sees services like Advisor On-Call as an answer to the urgent problem of people faced with a profusion of information and a paucity of people to explain it. In effect, Quicken is providing free tools and charging a fee for telling people how to better use them. Horowitz sees it as the future of advice, at least for a huge segment of the market, namely those in the "sweet spot," which he defines as the middle of the high end, and all of middle America. However, "It doesn't mean that they have a chance in hell of getting to the high-end advisor's practice," he adds. "It's a completely different market segment."
The secret to what Horowitz believes will be Quicken's success is that its service is scalable, flexible, and available when and how the customer wants it. Other companies will follow suit; several already have. "You're going to be hard-pressed to find many advisors who will work that way, but that's what many people want," he says.
Despite a variety of shortcomings, these various online programs provide a service that many consumers couldn't have gotten elsewhere, and with "results" far better than most could obtain by themselves. "To an extent, these services compete with what we have been doing already," says Tom Batterman, a certified trust and financial adviser with Vigil Management Group, Inc. in Wausau, Wisconsin. "However, there is a tremendous need for this help among retirement plan participants, and as a result, I applaud any initiatives designed to help address this problem." Advisor Shah believes that many of the online programs are a good way of getting basic data into a format his clients can comprehend, especially those who are financial neophytes. "They can go through the process, and take their questions to an advisor who can answer them in a sophisticated way."
Online services also raise the specter of price: Will the new generation of investors weaned on and made wealthy enough by Web programs be willing to pay the advisor's hefty fee if and/or when they choose to search out an in-the-flesh advisor? After all, says John Cammack of T. Rowe Price, if the consumer has been paying less than $100 a year for a fruitful experience with, say, Financial Engines, he is going to ask the advisor, "What will you do beyond this for me, to justify the additional $14,900 you're about to charge?" In order to compete against the low-priced alternatives, financial advisors may need to learn how to scale their services to the needs of the client, rather than offering only one "take-it-or-leave-it" service that may cost more than the client is willing to pay. He maintains that much of what advisors do after the first year with a client is maintenance, and questions whether the new breed of consumer will pay the ongoing price for a traditional maintenance relationship. Advisors will need to become more realistic about the pricing of certain services, he adds, such as offering a much lower rate for managing the 401(k) component of a client's portfolio. Cammack suggests advisors experiment with ways to leverage themselves online; to extend their practices into different client market segments; and to be prepared to adapt from the no-questions-asked delegator model to serving the ever-growing ranks of the vociferous validator model.
The February 2000 edition of the Forrester Report notes that half the survey respondents believe that online advice "will never be a compelling alternative to working with one of their advisors, even as the technology changes." The report cites the comments of one insurance company executive: "You can't expect the general population to know how to use a brush and paint to produce a painting. Financial planning is a lot like creating art - you need the training and the talent to do it well, not just the tools."
What the good advisor brings to the table is his ability to build and supervise an integrated portfolio - which no machine is capable of doing, yet - of which an automated 401(k) plan would be a single, isolated part. The advisor who keeps pace with technology can point out to clients product faults and weaknesses, and say, "I can offer more." In this regard, online tools can become collaboration tools, not replacement tools.
Given the arguments, it seems "tech" without "touch" may be as inadequate an advice delivery system as "touch" without "tech." It remains to be seen what advisors - and their automated competitors - can accomplish utilizing both.
