I have been thinking about writing this post for quite some time and in fact scheduled to publish it this week. Events from the past several weeks and months have made it even more relevant. The trend of “free” and the related topic of price compression due to competition in financial services, and specifically for declining financial advisory fees may very well have a disastrous, unintended consequence of harming investors.
First, a quick examination of competing based on price and giving away items for free. There is nothing wrong with either in a vacuum, and in fact the notion of giveaways and heavy discounts indeed pulls in customers and in general works very well as a customer acquisition strategy and has been for well over one hundred years. However, in the relatively recent age of Silicon-Valley fueled internet companies, where a free service, or nearly free service has disrupted offerings, there are unintended consequences that in some cases have had jarring effects on consumers and society at large. I fear that if both the consumer and the advisory industry is not careful with how it approaches pricing, consumers may very well be much worse off.
For me, the prime example of where free went horribly wrong with long-lasting effect is journalism. Since the internet, Facebook, Twitter, and other tools have become so widely used, anyone with a device can be a “journalist”. People consume “news” on their device, believe pretty much anything that appears on their tiny screen, have attention spans that diminish and of course no longer buy newspapers. Publishers laid off thousands of journalists and what happened? The quality of the news is now horrific. Consumers love to get free content, opt-in to only what they want to read, and as a result get bad information. Those firms funding the various companies that support free don’t really care as they are simply waiting for their 5-7 year holding period to flip the company to a Facebook or Google. As a result of this free movement, consumers are less educated, more polarized, and only a small number of companies and people are enriched as a result. The easy litmus test for this is ask yourself a question: is news and journalism better and of higher quality since the internet? No, of course not. There is much more news, of course, and most of the new stuff is useless.
Now compare the free journalism trend of the last decade to the early warning signs in the financial services sector. Seven years ago when the first direct to consumer robo advisors came out they touted their price over traditional advisors, and in some cases literally stated traditional advisors were needless. Over the last several years, funds and ETFs are competing on price more than ever. Just two weeks ago I heard a radio ad while driving and the ad went something like this: “Before, index funds were too expensive and out of reach to small investors, but now with our low cost index funds……” I could not believe my ears-since when was an index fund expensive? Since when did an investor really understand the cost of an index fund anyway?
Related: The Coming of an Advice Renaissance?
Companies that pander to the allure of low-cost and free just to get new clients are on dangerous ground, and in some cases are disingenuous by not making it clear the true cost of free. Barry Ritholtz wrote a great piece on this by looking at some of the major players that are going free or deeply discounted in the financial services sector. The first shots across the bow of the financial advisor pricing issue have recently appeared with industry insiders opining that advisors fees are too high and need to come down. If the trend continues and advisors dramatically reduce their fees or larger firms charge no fee in order to capture some other hidden revenue stream, or flip their firm in 5-7 years, guess what brand of advice free advice will be? Its called bad advice. The old maxim you get what you pay for is and always will be true.
The huge difference with free advice is that unlike a newspaper, an app, or something else, free (bad) advice will harm people in a real way. Some free advisor in a call center cannot simply have the empathy, training or incentive to help a client like advisors do today. The race to the bottom will be a race to the bottom of service and support, it is simply economics. There is no true free lunch as they say. Would you fly an airline that touted free flights? While they theoretically could keep the enterprise running with kickbacks from vendors, ad agencies and the like, the risk of something kind of important, say airplane maintenance, not being paid attention to becomes a lot more likely. With financial advice, consumers and investors will be less educated, miss critical areas of their financial well being and miss opportunities.
What makes this issue more difficult than most is that most investors and consumers do not understand personal financial advice in the first place. When they start seeing slick marketing with “free advice here” they will come running without knowing what they are leaving or getting in return. What can be done? The short, simplistic answer is the financial advice industry needs to show leadership and get ahead of the free movement in part by educating consumers about advice, and that its worth paying for.
These days most of us only consume free news and its mostly of poor quality. Turning the poor state of journalism around is going to be very difficult and will take a very long time. I would hate to see the financial advice industry suffer the same fate.
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