No free pass for Van­guard

It’s the same old sleight of hand, fo­cus­ing at­ten­tion on costs of a loss leader rather than the real source of prof­its.

Financial Planning - - Contents - BY BOB VERES

It’s the same old sleight of hand, fo­cus­ing at­ten­tion on costs of a loss leader rather than the real source of prof­its.

Af­ter Van­guard CEO Tim Buck­ley gave his star­tling key­note ad­dress at the In­side ETF’S con­fer­ence in Jan­uary (sole di­a­mond spon­sor: Van­guard), I re­ceived at least 30 email mes­sages from ad­vi­sors. Buck­ley’s words were cer­tainly alarm­ing: He said that Van­guard plans to at­tack fi­nan­cial plan­ning and in­vest­ment ad­vice fees the way the com­pany once launched its very ef­fec­tive broad­sides against the fee struc­ture of the mu­tual fund in­dus­try. Van­guard would drive ad­vi­sor fees down to the bare bones low­est cost, and take no pris­on­ers do­ing so.

Ad­vi­sors were ask­ing what this war on their liveli­hood meant for their firms.

To me, the an­swer is not com­pli­cated, but it does re­quire you to fol­low a chain of logic. For years, I’ve preached the virtues of pro­fes­sion­al­ism in the ad­vi­sory space, which means a va­ri­ety of things: ex­per­tise, an eth­i­cal frame­work, putting the clients’ in­ter­est first, a body of knowl­edge, and cer­ti­fi­ca­tions that ac­tu­ally mean some­one has ac­tu­ally mas­tered com­pli­cated ma­te­rial rel­e­vant to ex­cel­lent plan­ning ad­vice.

One of the most en­cour­ag­ing trends in this march to­ward pro­fes­sion­al­ism is the grow­ing dis­con­nect be­tween in­de­pen­dent ad­vi­sors and prod­uct man­u­fac­tur­ers — that is, mu­tual fund and in­sur­ance com­pa­nies.

We are rapidly mov­ing away from the cap­tive in­sur­ance field force. Mu­tual funds, by and large, no longer pay com­mis­sions to the ad­vi­sors who rec­om­mend them. Bro­kers are leav­ing the cap­tive world for the greener pas­tures of in­de­pen­dence — no longer re­ly­ing on the squawk box to tell them what to sell.

I’ve been a long­time ad­vo­cate of fees over com­mis­sions gen­er­ally. I have al­ways be­lieved that if you are only paid by the client for your ad­vice, then you’ve given your­self the free­dom to se­lect the in­vest­ment and in­sur­ance so­lu­tions ob­jec­tively that a client’s fi­nan­cial sit­u­a­tion re­quires. That doesn’t mean you’re nec­es­sar­ily com­pe­tent, or that your ad­vice is first-rate. But it does mean that you have no in­cen­tive to push this in­fe­rior prod­uct over that other su­pe­rior one.

Through this lens, I look at Van­guard, whose Per­sonal Ad­vi­sor Ser­vices now has more than $100 bil­lion un­der man­age­ment, of­fer­ing in­vest­ment ad­vice for 30 ba­sis points via rep­re­sen­ta­tives on the phone. To me, this is a fa­mil­iar sight. Since the begin­ning of my ca­reer in the 1980s, in­sur­ance agents, an­nu­ity sales­peo­ple and pur­vey­ors of load funds have pre­tended that their agen­da­con­flicted ad­vice — of­ten in­clud­ing fi­nan­cial plan­ning anal­y­sis — was free of charge. All you had to do was buy their prod­ucts — and of course, then (they would tell you) the prod­uct com­pa­nies were re­ally pay­ing for these ad­vi­sory ser­vices, not you, the cus­tomer.

Van­guard is do­ing them one bet­ter. It’s charg­ing a very low fee, which makes the ad­vice its rep­re­sen­ta­tives pro­vide over the phone a bit more cred­i­ble. And then,

Van­guard reps charg­ing 30 ba­sis points for ad­vice are salaried sales­peo­ple try­ing to steer cus­tomer as­sets to the firm’s prod­ucts.

when it comes time to make in­vest­ment rec­om­men­da­tions, the Van­guard rep­re­sen­ta­tive steers the cus­tomers to — can you guess? — Van­guard funds.

No­body would be alarmed if Van­guard were giv­ing fi­nan­cial ad­vice away for free, the way the prod­uct ped­dlers have been do­ing. Ad­vi­sors — and their more savvy clients — would know in­stantly that the prof­its were ac­tu­ally com­ing from the (very pre­dictable) prod­uct rec­om­men­da­tions. But the fact that Van­guard is charg­ing a fee, and then com­par­ing that low fee with the “ex­or­bi­tant” 80 ba­sis points or so that more ob­jec­tive fi­nan­cial plan­ners charge for a much more com­pre­hen­sive, per­sonal ser­vice, causes alarm bells to ring like a ter­ri­ble gong of doom through­out the pro­fes­sion.

It’s the same old sleight of hand, fo­cus­ing your at­ten­tion on the cost of the loss leader rather than the real source of prof­its.

I hope I’m not mis­un­der­stood here: Van­guard is a fine com­pany, and we all owe it a debt of grat­i­tude for its role in push­ing fund fees lower. I re­mem­ber a time when Don Phillips at Morn­ingstar was point­ing out that fund com­pa­nies with $100 mil­lion were charg­ing a rel­a­tively high ex­pense ra­tio, and then, when their funds went up over eight fig­ures in cus­tomer as­sets, some­how those economies of scale were not find­ing their way into lower costs to the end con­sumer.

One could ar­gue that Van­guard’s pric­ing revo­lu­tion has also driven some re­ally good ac­tive man­agers out of the busi­ness. And one might imag­ine that the rise of ETFS — re­sisted by Van­guard ini­tially — would have caused those ex­pense ra­tios to de­cline any­way. But by and large, I be­lieve Van­guard has ex­erted a pos­i­tive in­flu­ence on the in­vest­ment land­scape.

This, too, makes the low-cost in­vest­ment ad­vice com­pe­ti­tion from Van­guard seem scary; the com­pany that is em­brac­ing man­i­fest con­flicts of in­ter­est in its ad­vice rec­om­men­da­tions has gen­er­ally been viewed as a con­sumer-friendly or­ga­ni­za­tion by your clients and the me­dia gen­er­ally.

But at the end of the day, I think we should not be afraid to call a spade a spade. The Van­guard reps charg­ing 30 ba­sis points for in­vest­ment ad­vice are salaried prod­uct sales­peo­ple of­fer­ing ad­vice as a loss leader to steer cus­tomer as­sets to the com­pany’s prod­ucts.

How do you com­pete with a com­pany de­ter­mined to drive the pro­fes­sion’s fee struc­ture be­low prof­itable lev­els?

More­over, I sus­pect that one could see a big dif­fer­ence be­tween a Van­guard fi­nan­cial plan — and the ex­pe­ri­ence level of the planner be­hind it — and the plan and planner of­fer­ing ad­vice at an in­de­pen­dent ad­vi­sory firm. The sales agents who gave away plan­ning were al­ways a bit per­func­tory in their anal­y­sis and ad­vice — they had to get quickly to the point, af­ter all — and how­ever earnest the planner on the Van­guard phone lines might be, chances are the cus­tomer is talk­ing to a young per­son just start­ing out and get­ting a fairly straight­for­ward re­tire­ment anal­y­sis along­side Van­guard­cen­tric port­fo­lio rec­om­men­da­tions.

If I were look­ing for ad­vice on mak­ing a large, planned-giv­ing do­na­tion that would pay my heirs an in­come for life or look­ing for how to re­struc­ture my small busi­ness to take full ad­van­tage of the Sec­tion 199A de­duc­tion, I prob­a­bly wouldn’t call up Van­guard Per­sonal Ad­vi­sor Ser­vices to do it. That “ex­or­bi­tant” 80 ba­sis points pays for a lot more than a scaled down re­tire­ment anal­y­sis de­liv­ered over the phone and the pre­dictable rec­om­men­da­tion of in-house funds.

But the ques­tion re­mains: How do you com­pete with a com­pany that is de­ter­mined to drive the pro­fes­sion’s fee struc­ture be­low prof­itable lev­els? I think the an­swer is the same as the pro­fes­sion’s (so far suc­cess­ful) re­sponse to the robo com­pe­ti­tion. You point out the value of ob­jec­tive ad­vice, and of per­sonal ser­vice, and you fight mar­gin com­pres­sion by em­brac­ing tech­nol­ogy and au­tomat­ing ev­ery­thing you pos­si­bly can. You move to­ward work­ing with a well-de­fined niche where you know your clients on a deeper level even than the per­sonal fi­nan­cial planner up the street.

And you tell clients and prospects the hon­est truth: There’s a place for sales in the fi­nan­cial ser­vices world, and that you can of­ten get pretty de­cent ad­vice from a sales agent. Just make sure that you un­der­stand the con­flicts in­volved in a sales re­la­tion­ship. And don’t be sur­prised when you see the rec­om­men­da­tions you re­ceive af­ter the “plan­ning” work.

That Van­guard rep­re­sen­ta­tive may fer­vently be­lieve that her com­pany’s prod­ucts are the best out there, but I guar­an­tee you that their de­gree of fer­vor is no greater than the life in­sur­ance sales­peo­ple I’ve in­ter­acted with over the years, or the in­dexed an­nu­ity sales­peo­ple who some­times joust with me on Twit­ter over my “holier than thou” pre­dic­tion that fees are the fu­ture. Con­flicts are con­flicts, no mat­ter who em­braces them, and I’m sorry, Van­guard, much as I re­spect you, you don’t get a free pass on this.

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