Adapt to change, or perish

My argument is simple. Any time you identify something as “irrational,” you need to consider what impact a shift in that reality would have on your business.

Those inevitable changes are “ticking time bombs” – they’re going to go off; you just don’t know when. Even if these changes don’t come immediately, history shows that once change starts, it picks up momentum and assumes a life of its own.

I’m not talking about investment bubbles like the ones we saw in technology and U.S. real estate and may be seeing in today’s social media valuations. Rather, my focus is on unsustainable realities that run deeper and wider than overheated investments.

Here are some of the inevitable changes that will occur regarding the way advisors run their businesses and interact with clients:

– A dramatic rise in professional standards

Every advisor wants to be viewed as a professional, garnering the same respect as doctors, accountants and university professors. And given the critical role that financial advisors play and the extent to which they hold positions of trust, 10 years from now, advisors as a whole will be seen more as professionals and less as salespeople.

That’s the good news. The bad news for advisors who do the minimum to get by is that to be seen as professionals, they will be held to a much higher standard of training, disclosure and continuing education – not all that different from what is required today of accountants and lawyers. Some of this will be driven by regulators, but much will come from more knowledgeable and demanding clients.

Some of the inevitable changes I anticipate will be in place 10 years from today:

– Advisors entering the business will have to go through a longer period of “internship” and undergo more rigorous testing before being licensed to provide advice, in a manner similar to the education, training and testing that is required of chartered professional accountants.

– In order for you to be considered to be a professional on par with lawyers and accountants, it is not enough that your clients are comfortable with your competence. They must be absolutely confident that you are not putting your interests ahead of theirs and that any conflicts are resolved in their favour. That’s a high bar, but if the advisory industry wants to be viewed as a profession, it’s one that has to be met.

As a result, all advisors will have to meet a fiduciary standard in which client interests unambiguously come first.

In addition, any products that pay embedded commissions will have to be clearly disclosed, especially if the compensation is higher than the norm or that of established alternatives.

If an in-house solution is recommended, that fact will have to be explicitly communicated, along with any impact on overall compensation from sales of in-house products. And if your recommendations consist primarily of in-house solutions, that also will have to be clearly communicated. (The U.K. currently requires advisors to disclose whether they are tied, restricted or independent, based on the range of products they recommend.)

– Every profession worth the name has strict requirements for ongoing continuing education (CE), with clear standards regarding the quality of content and rigorous testing to ensure comprehension. While the financial services sector is moving in the right direction, the requirements in terms of quantity, minimum quality and measurement afterward still lag well behind those of doctors, lawyers and accountants.

– A redefinition of what constitutes value

A hilarious 1980s commercial for Wendy’s popularized the phrase “Where’s the beef?” It pointed out the gap between what Wendy’s competitors delivered and what Wendy’s delivered. That’s exactly the way many investors feel when their advisors describe their value to clients. Most advisors struggle to articulate their value in concrete terms, falling back on empty phrases such as “service,” “communication,” “planning” and “peace of mind.”

A new generation of more knowledgeable and assertive clients will put many advisors to the test. These clients will be willing to pay a premium only for value that is clear and tangible.

To address the commoditization of investment advice, many advisors already have shifted to a “total wealth” approach, incorporating advice on taxes, estate planning, interfamily wealth transfer and charitable giving. The big change that most advisors still have to make, however, is to narrow their focus to become specialists rather than generalists.

To stand out, you need to provide exceptional value to a few clients rather than offer solid value to everyone. In a mercilessly value-driven world, clients will pay for exceptional value, but anyone offering average value will struggle.

It’s not just me saying this; Michael Porter of Harvard Business School, today’s top thinker on strategy, says the biggest mistake that businesses make is trying to be “better” when they should aim to be “different.”

Defining your value in terms of investment performance can work as well, provided that you can back it up.

I recently talked to an advisor whose $5-million client had questioned the $50,000 in fees he’d paid the previous year. This advisor showed the client a spreadsheet demonstrating how his portfolio had performed in the previous five years compared with a portfolio invested in an index fund with a 60/40 stock/bond mix. The $200,000 in fees that the client had paid was dwarfed by the additional returns that the advisor had added – and the client walked away happy about the value that he’d received for the fees paid.

Without that spreadsheet, however, it would have been quite a different conversation.

– Grow big or go home

Advisors who operate today as solo practitioners are like small retailers before the arrival of Wal-Mart or corner diners before McDonald’s – in other words, endangered species. Even if those corner stores and diners have survived and stayed in business, pressure on revenue and margins meant that their owners face a constant struggle to survive.

Even in a world in which you can outsource technology, the future will demand scale. The maxim for future advisors will be: “Grow big or go home.”

In the future, the solo advisor with one assistant will be as obsolete as solo dentists who do their own cleanings and prep work and have only a receptionist to support them. Solo advisors will need to expand, partner up or join a larger team.

The landscape for advisors looking to acquire practices will change as well.

I recently spoke to an advisor who said that given what he can sell his practice for, he’s better off working part-time and winding down gradually. Even if he loses 10% of clients annually because he has scaled back to three days a week and takes eight weeks of vacation, he’s still better off financially than if he sold his practice.

Setting aside what that says about his client orientation, that kind of lackluster commitment won’t cut it, especially given the heightened regulatory burden. You’ll either be in the game or out, and advisors like this one won’t have the option of milking their books and will have to sell their practices instead.

The pressure to raise standards of professionalism, sharpen your value proposition and scale up your practice depend on your time frame.

Inertia is a remarkably powerful force. So, if your time horizon is three to five years and you’re doing a good job of staying in front of clients, chances are that you can continue doing what you’re doing. But if you plan to be in this business for 10 years or longer, now is the time to start thinking about how you make changes to position yourself for the future.

This is the second instalment in a three-part series on the future of the financial advisory business. Next month: Why average advisor compensation will drop by as much 50% – and the implications for advisors.

Dan Richards is CEO of Clientinsights (www.clientinsights.ca) in Toronto. For more of Dan’s columns and informative videos, visit www.investmentexecutive.com.

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