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The Great Transition

Jeremi Karnell
Jun 7, 2017

The advisor industry is facing seismic change over the coming years, yet few within it neither recognize the coming transformation nor are prepared for what's to come. According to the consulting firm Accenture, some $30 trillion dollars will change hands as retiring baby boomers transfer their wealth to their children and grandchildren.

Other estimates put that number significantly higher: A Boston College Center on Wealth and Philanthropy study suggests aging boomers will pass on $59 trillion to their heirs.

At the same time, the industry itself is graying. The average age for advisors today is 63, with nearly a quarter of active advisors are age 60 or older. On the other hand, fewer than 25% are under age 40--and just 5% age 30 or younger.

Recent research by Pershing Advisor Solutions suggests that the industry will need to add 237,000 advisors over the next decade just to maintain current levels, given the wave of retirements. Further complicating the picture, of the 42% of advisors who intend to retire within 10 years, only 19% have a succession plan in place according to Jamie Price, CEO of Advisor Group. The advisors in this 60-and-over age cohort manage over $2.3 trillion in wealth among them, according to Accenture.

This convergence of issues will fundamentally transform the advisor industry in the coming years, a transformation made even more profound by the prevalence of fintech and the newly expanded Department of Labor fiduciary regulations. 

In short, firms must prepare today to meet the coming challenges of the Great Transition.

Deep Generational Shifts

The intergenerational wealth transfer has begun in a climate of shifting attitudes. Those in Generation X and Generation Y, the Millennials, approach wealth and wealth management in a completely different way than their boomer parents.

Gen Xers are more skeptical of the stock market, having experienced the dot.com bubble, the crash of the housing market, and the Great Recession. Paradoxically, they are both more proactive about preparing for retirement (eight in 10 contribute to a 401(k) account ) and more heavily in debt (the average Gen Xer carries $88,000 in consumer debt excluding mortgage debt) than other generations. Nearly 40% have more debt than cash and retirement savings.

Millennials have an inherent distrust of financial institutions and Wall Street in particular. A study by the American Institute of CPAs discovered that 53% of Millennials aren't investing and 21% say they know nothing about stocks or other investments. Just one in three is currently investing. Nearly eight in 10 use apps or online tools to manage their money. Of those that are investing, the vast majority prefer to be actively involved in the research and decision-making process.

Millennials are currently the largest demographic cohort and Gen Xers, currently sandwiched between the Boomers and Millennials, are expected to overtake the Boomer generation's numbers by 2028.

A Backdrop of Disruption

These two generations of investors are moving in an industry marked by rapid digital disruption.

By far, the largest disrupter in the investment space is the robo-advisor. BI Intelligence, the research and analytics arm of Business Insider, projects that robo-advisors will control 10% of all global AUM by 2020, or $8 trillion.

Their research showed that currently, 49% of high net worth individuals use a robo-advisor to manage at least some of their wealth. By 2020, they forecast that 60% of HNWIs will have at least 20% or more of their assets managed by robo-advisors, equating to roughly $6.7 trillion.

While stand-alone firms such as Scalable Capital target these high net worth investors, others, such as Betterment and Wealthfront, are marketing to the emerging Millennial investors using low account minimums and low fees to attract everyday consumers. Wealthfront reports that 60% of its clients are under age 35 and 90% are under age 50.

Legacy firms such as Vanguard are also exploiting the technology, offering a popular hybrid product, Vanguard's Personal Advisor, which combines computerized recommendations with on-demand advice from a financial advisor. Schwab's newly launched Schwab Intelligent Portfolios is free for retail investors.

 An Increasingly Complex Fiduciary Landscape 

The new Department of Labor fiduciary rule will dramatically impact the industry. The expanded definition of "investment advice fiduciary" demands a higher level of accountability and compliance, especially for broker-dealers and RIAs.

Smaller independent firms are likely to be most affected. Consolidation is already shaking up the advisor industry, and the added complexity will only accelerate the trend. Advisors who dabble in the retirement space may be forced out due to the new compliance issues.  

In the U.K. for example, the number of advisors dropped 22.5% after a similar rule was passed there in 2011. The number of broker-dealers in the U.S. is already down 12% from 2008 levels in the wake of the financial crisis.

As compliance costs continue to rise, smaller firms will be priced out of the market and larger firms will benefit from economies of scale. Compliance requirements have driven costs up tenfold from the 1990s, choking margins for smaller enterprises.

These mergers and acquisitions are already occurring; at the end of November 2016, there were 3,869 registered broker-dealers open for business, according to FINRA, down from 4,456 at the end of 2012.

Large independent broker-dealers are moving quickly to benefit from the rule's impact on smaller firms. Advisor Group recently hired Steve Chipman, the former CEO of Foothills Securities, to take over planning for strategic broker-dealer acquisitions. 

Kestra Financial's CEO James Poer also indicated his firm is actively pursuing deals, specifically individual advisors and small BDs who are "feeling the pain" from the new DOL rules.

Brace for a Rapidly Changing Industry

Pershing Advisor Solutions' CEO Mark Tibergien recently noted in a speech that about 16,000 advisors and brokers will retire this year, a number he expects to increase every year over the next decade. Yet statistics show that just 3,000 CFPs are added each year--in many cases to experienced advisors adding a new credential to their resumes.

For every newly minted financial planning graduate who enters the workforce, two advisors reach Social Security age. The number of financial advisors has actually decreased 4.3% in the past decade.

These demographic shifts are occurring in the midst of the greatest generational wealth transfer in history. Ernst & Young forecasts that Gen X and Gen Y investors will amass $46 trillion in assets by the end of the decade, including some $18 trillion in inherited wealth.

These younger investors overwhelmingly prefer a younger financial advisor. Research by Ernst and Young suggests that these investors develop the strongest relationships with their financial advisors and generate 80% more referrals than their Boomer parents and grandparents.

Within the industry, fewer than 40% of advisors over age 60 have a succession plan in place--and one in three advisors saw retention rates below 50% during their succession process, far below the optimal rate of 90%.

It is clear that the industry must recruit younger talent to fill the estimated 64,000 financial advisor positions expected to open up by the year 2020. This will require firms to focus on the technology investments that attract Millennial advisors. Roughly 70% of advisors still use paper transactions, although leaders in the industry have begun to migrate to digital transactional platforms that can be accessed by mobile device.

In addition, the new generation of advisors places a premium on transparency and outcomes, a leading driver in the fee-based compensation trend. Within the industry, fee-based revenues grew from 59% in 2015 to 66% by the end of 2016, and is expected to grow even more in the coming years.

The Advisor's Changing Role

As a consequence of the habits and characteristics of the next generation of investors, the financial advisor's role must change. In the past, advisors targeted individuals who had already acquired substantial savings and net worth. Today, however, given the high debt of the Gen Xers and the inherently cautious approach of the Millennials, many advisors are taking a hybrid approach between advisor and life coach.

Life coaching is a natural fit for FAs in many cases; money is the foundation of much of life. In an era of rapid growth in robo-advisors, these additional coaching services are a way for FAs to differentiate their offering and generate fee-based revenues.

Advisors moving in this space traditionally don't require a minimum asset level and they tend to focus on a broader range of financial fundamentals, including cash and debt management, real estate, and entrepreneurship. Services are fee-based and there is more transparency in the cost structure.

The XY Planning Network is an example of this hybrid approach. This rapidly growing fee-only organization targets the Generation X and Y demographic and offers education, coaching, and financial planning services in a virtual environment that emphasizes the leading edge technology these younger investors favor.

The Cyborg Advisor

Morgan Stanley recently announced that it's rolling out a machine-learning algorithm to assist its 16,000 financial advisors. Known internally as "next best action," the algorithms will give advisors recommendations based on the client's life events and even changes in the market.

Built around the idea that advisors, who typically form relationships with hundreds of individuals and families throughout their career, face information overload when it comes to markets, their clients' investments, and their immediate and future needs.

Technology gives FAs the tools to process that information and score it based on how it benefits the client. The company is also rolling out an artificial intelligence platform, something like Siri for brokers, that can quickly sift through Morgan Stanley's mass of internal research and reports to find the most up-to-date and relevant information.

 Putting It All Together

To succeed in this new environment, advisors must take steps to proactively prepare for the changes facing the industry.

Embrace the Digital Disruption

This is the first and perhaps most important step to address the convergent forces of demographic change in the emerging investor class and the need to attract a younger FA workforce.

But moving from a traditional WM model to a digital one is more than just investing in the right suite of tools--it's a cultural change that requires a commitment to a data-driven mentality. In many cases, a cloud-based platform that offers flexibility, scalability, and ease of deployment makes the transition less painful, while also offering access to business intelligence and seamless integration with other tools such as the CRM and the portfolio analytics and rebalancing software.

 Others may prefer to join the robo-advisor wave, either by offering a white-label robo-advisor platform on their own website or by embracing robo-advisor platforms for their own FAs in the "cyborg" model.

Prioritize the Next Generation

The generational shift involves both next-gen investors and the FAs who will service them. This means evaluating products and services to ensure they align with the changing priorities of the emerging investor class and designing the type of transparent fee structures that they prefer.

It also means revamping the hiring and training process, defining a clear career path that matches the needs of Millennials entering the workforce. Ernst & Young found that Gen Y employees prefer a job that aligns with their values and "feels right" over a more high-paying job with less personal satisfaction. They also prefer a compensation structure in which their incentives better align with the needs of their clients.

Finally, prioritizing the client's best interest is crucial, both for attracting Gen X and Y investors and younger FAs. Millennial FAs place a high premium on transparency, outcomes, and client needs and interests. Revising revenue streams to encourage a higher level of fee-based services--and transparent compensation schemes for FAs--is another important step.

Ultimately, FAs need to take a lean startup CEO approach to managing their practices if they hope to efficiently respond to the Great Transition with the right leading edge technology and a culture that both welcomes and caters to the next generation of clients and advisors.

 You May Also Be Interested In Reading: The Next Generation of AUM

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