Taking a more behavioural view of risk in structuring portfolios around clients’ personal values and goals can result in clients being more focused and more resilient in the face of portfolio volatility.

Introduction

One of the most enduring narratives within financial advice is the question of value – what is the real value of financial advice?

Various individuals and groups have attempted to answer this question, each in their own way. Some have focused on the quantitative benefits that result from saving tax or maximising Centrelink entitlements. Others talk about the emotional benefits that accrue when one has a sense of control over their lives. And there are those who are able to bridge the two concepts, and attach a quantified benefit to emotions and behaviours.

Both Vanguard and Russell fall into this latter camp, each conducting research that allowed them to calculate the performance gains that result when the adviser mentors/coaches the clients out of bad financial behaviours. (Russell’s 2023 Value of an Advisor Report estimated behavioural coaching by financial advisers could improve the performance of client’s portfolios by as much as 3.4% per annum^[1].)

But whilst this may be true, it begs the question whether more could be done earlier in the advice process, to build client plans and portfolios in a way that was inherently more resilient and less susceptible to poor client decisions and behaviours?

This article will explore the idea that the traditional, textbook ways of assessing clients’ risk profiles – building portfolios around those profiles – are flawed, as they ignore the realities of human behaviour. It will propose that viewing risk through a more behavioural lens, and structuring client plans and portfolios around goals and values, will result in clients being more focused, and more resilient in the face of portfolio volatility.

Traditional risk profiling leads to unsuitable portfolios

Despite the assessment of a client’s risk profile being an obvious – compliant – step to undertake, historically the processes used to complete this assessment have proved problematic.

Indeed, 2015 data from FOS (from which AFCA was born) found that 70 percent of cases escalated through them were due to inadequate or incorrect risk profiling of clients^[2].  And in most of the cases, the adviser is likely to be found to be at fault, with more recent AFCA data^[3] suggesting roughly two thirds of their determinations relating to ‘know your client’ failures found in favour of the complainant.

One particular finding reinforcing that the biggest red flag for advisers is not the failure to complete a risk profiling or risk tolerance questionnaire (RTQ), but rather it is the inherent flaws in those questionnaires themselves, in terms of whether clients understand them and the extent to which they accurately reflect a client’s true attitude to risk.

A typical advice process involving a RTQ would see a client answer the questions and then be classified as having a certain risk tolerance (conservative, balanced, aggressive) on the basis of their answers.

That tolerance or profile would then be matched to an asset allocation (50/50, 80/20 and so on).

Even assuming the client had accurately answered the questions, this approach is problematic. Not because it is formulaic and ‘cookie cutter’ (which it is), but because it ignores the realities of human behaviour.

Humans don’t behave in the real world like they say they will in a questionnaire

In a nutshell, a client may indicate – via a risk tolerance questionnaire – that they could stand a 20% drop in their portfolio. But, when the rubber hits the road and they see portfolio losses of that magnitude – even unrealised ones – the fact is that many people suffer a significant, visceral reaction, sometimes so severe that no amount of coaching and mentoring by their adviser can avoid them reverting to bad behaviours and poor, value-destroying decisions.

What drives our money emotions and behaviours?

Human beings are complex, emotional beings who are notoriously bad decision makers, especially when it comes to money and investing. Indeed, JP Morgan data for the 2001 – 2020 period found the average US investor achieved an average annual return of just 2.9%, compared to the 7.5% pa achieved by the S&P 500 over the same period^[4].

There are two key drivers of our financial decision making. One is that bundle of mental shortcuts and biases that help us make the thousands of decisions each day without falling into a heap in the corner. The other is our deeply ingrained money mindset, typically formed during our earliest experiences with money and finance and often shaped by our parents.

Mental short cuts

Scientists estimate the human body sends 11 million bits per second to the brain for processing, yet the conscious mind can only process around 50 bits per second^[5]. Research suggests we make 2,000 decisions every hour^[6].

The only way we can cope with this torrent of data and decisions is to rely on mental short cuts (heuristics) and cognitive biases (defined by Investopedia as a ‘rule of thumb’^[7]).

Biases that commonly come into play in our financial decision making include:

• Loss aversion: Research^[8] has shown, for any given amount, losses hurt twice as much as a gain of the same amount
• Present bias: The present bias refers to the tendency of people to give stronger weight to payoffs that are closer to the present time when considering trade-offs between two future moments
• Overconfidence: A tendency to overestimate our own ability to pick winners
• Confirmation bias: People tend seek out evidence and opinions that confirm their existing beliefs, ignoring other information that challenges or contradicts their views
• Availability bias: The availability bias sees investors base decisions on information and experiences that most readily come to mind.

Other biases commonly encountered by advisers include status quo bias, the endowment effect, the bandwagon effect, gambler’s fallacy, sunk cost bias, and anchoring.

The combination of biases, the presence and strength of which will vary between individuals, can drive a range of poor financial decisions, particularly our tendency to pay too much for stocks, panic in the face of a loss, chase winners and get our timing wrong.

Our money emotions

According to experts, our relationship with money is driven by a complex array of beliefs, attitudes, and behaviours, many of which were shaped early in our lives by the interplay between familial, ethnic, and cultural influences, and then further refined by our exposure to media messages. So powerful can these beliefs and attitudes be, they can effectively negate any financial knowledge we have acquired and contribute to us making sub-optimal financial decisions^[9].

Financial psychologists Bradley Klontz and Ted Klontz refer to the term “money script” to describe these core beliefs about money^[10]. These beliefs are typically unconscious and likely learned during childhood and adolescence, influenced by our parents’ own money attitudes and behaviours. For example, were they frugal? Were they judgemental about others based on how much money those people had?

The 4 money scripts

The 4 money scripts – akin to ‘money disorders’ – which were developed from the Klontz research, are money avoidance, money worship, money status and money vigilance.

Money avoidance

Money avoiders believe that money is bad or that they do not deserve it. They believe there is virtue in living with less money. Money avoidance is asso­ciated with ignoring bank statements, increased risk of overspending, financial enabling, financial depend­ence, hoarding, and having trouble sticking to a budget.

Money worship

At their core, money worshi­ppers are convinced that the key to happiness and the solution to all their prob­lems is to have more money. Money worshi­pers are more likely to have lower income, lower net worth, and credit card debt. They are more likely to spend compulsively, hoard possessions and put work ahead of family.

Money status

Money status seekers see net-worth and self-worth as synonymous.

They pretend to have more money than they do, and as a result are at risk of over­spending. People with money status beliefs are more likely to be compulsive spenders or gamblers, be dependent on oth­ers financially, and lie to their spouses about spending.

Money vigilance

The money vigilant are alert, watchful, and concerned about their financial wel­fare.

They believe it is important to save and for people to work for their money and not be given handouts. They are less likely to buy on credit. They also tend to be anxious and secretive about their financial status.  While vigilance encourag­es saving and frugality, ex­cessive wariness or anxiety could keep someone from enjoying the benefits and sense of security that money can provide.

Measuring achievement against goals, not performance against benchmarks

The setting and achieving of goals are at the heart of financial advice.

Research^[11] has found that participating in activities aimed at developing goal setting can increase subjective wellbeing and personal growth over time (in particular, life satisfaction), either by bringing about changes in self-perception and/or self-confidence, or by positive changes in one’s circumstances. Even a perception of progress towards goals can provide a positive psychological boost, ahead of those goals being reached^[12].

This suggests the regular client review process itself has a vital psychological benefit. It also suggests that what is more important to clients is not how their portfolio has performed relative to an index, but how it has performed in terms of getting them closer to their goals.

A performance discussion framed around progress towards goals is likely to be easier, even in times of market volatility, provided that goal is grounded in deeply held client beliefs and values.

Framing goals purely in functional terms (e.g., achieve an annual income of $xx in retirement, fund grandchildren through university) can often mean the emotional link between a client and a goal is overlooked or minimised. Goals framed around personal values are far more powerful.

This alignment between goals and values makes it more likely that client will feel a sense of ownership over the make-up of their portfolio, and a greater understanding of why they are taking the risks they are, and how the journey to their destination (goal) might look.

Without this emotional link reminding clients why they are following a particular course of action (such as paying for insurance cover or investing in a particular way), they will be more easily knocked off course when conditions become challenging, for example if their portfolio suffers volatility and/or losses.

Using personal values to create goals

Our personal values are a central part of who we are. They are our deeply held beliefs about what is important in the way we live, the way we work, and the way we interact with others. They determine our priorities and the measures we judge ourselves against.

Living according to our values can make us happy, just as behaving in a way that is inconsistent with our values can be a source of discord in our lives.

In an investment context, we are likely to be more disciplined and focused on pursuing goals that are grounded in our values, where the emotional link is stronger.

From an adviser’s perspective, determining a client’s values is therefore critical.

Personal values models

There are many frameworks for personal values. The example below from website Musing Mind, which identifies 16 values, is fairly typical:

It is easy to see how these values can be translated into goals.

• Freedom can be thought of as financial and emotional freedom, which saving for retirement, or financial independence generally, can be seen as.
• Enjoyment of life explains the desire to travel, buy a car, or live a particular lifestyle
• Achievement can also be a driver of the desire to travel, or take on particular pastimes or courses of study
• Stability is essentially security and safety, one of our most fundamental needs as humans, and a key driver of the need to grow and protect wealth

Determining client values can be challenging

Talking to clients about deeply held personal values and emotions can be challenging for some advisers, either because the client is reluctant to be open, or because the adviser themself struggles with more emotional conversations.

Advisers thus have a number of ways they can approach this process.

Firstly, they can utilise one of the many methodologies developed by psychologists to help clients express and prioritise their values, including the examples below:

• The life aspirations exercise, first found in the book Conscious Finance^[14], which involves clients writing down what they would do in a world without restrictions (financial, time, talent or other)
• The values card sort, where clients are presented with up to 100 cards (widely available online), each depicting a value, and asking them to rank them based on an immediate reaction
• George Kinder’s three ‘’life planning questions’ can help clients uncover priorities that may not be getting the attention they should be.

Closer to home, well-known advice software, such as Astute Wheel, incorporate questionnaires and other tools that can be used to capture, report on, then discuss client values.

Summary

This article delves into the perennial question in financial advice: the true value it provides.

It scrutinises the common practice of risk profiling clients and building portfolios around those profiles, arguing this is a flawed process, not just because of the formulaic nature of this approach but because it ignores the realities of human behaviour. The article emphasises the complexity of human decision-making, influenced by biases and deep-rooted money mindsets. It cites data revealing that inadequate risk profiling is a major source of complaints, highlighting the need for a more nuanced understanding of clients’ attitudes towards risk.

The piece advocates a shift towards a behavioural lens, proposing that aligning portfolios with clients’ goals and values can enhance focus and resilience against market volatility. It introduces the concept of “money scripts,” deep-seated beliefs about money, and explores four money scripts – money avoidance, money worship, money status, and money vigilance. The article contends that understanding these scripts is crucial for financial advisers to tailor advice more effectively.

Furthermore, the article underscores the significance of framing discussions around clients’ goals and values rather than benchmark performance, asserting that this approach fosters a stronger emotional connection to their financial plan. It suggests methodologies, such as life aspirations exercises and values card sorts, to help advisers uncover and prioritize clients’ values. Ultimately, it advocates an approach to advice that is more personalised and more emotionally resonant.

———

References:
[1] https://www.professionalplanner.com.au/2023/09/adviser-value-worth-5-9-pc-in-2023-report/
[2] https://www.griffith.edu.au/__data/assets/pdf_file/0027/205749/investment-risk-profiling-hunt.pdf
[3] https://www.moneymanagement.com.au/news/financial-planning/less-one-three-chance-defending-know-your-client-complaint
[4] https://www.fool.com/the-ascent/buying-stocks/articles/is-stock-picking-worth-it-heres-why-i-stopped-doing-it/
[5] https://www.britannica.com/science/information-theory/Physiology
[6] https://hbr.org/2019/08/6-reasons-we-make-bad-decisions-and-what-to-do-about-them
[7] https://www.investopedia.com/articles/investing/051613/behavioral-bias-cognitive-vs-emotional-bias-investing.asp
[8] https://en.wikipedia.org/wiki/Loss_aversion
[9] https://www.bristol.ac.uk/media-library/sites/geography/pfrc/pfrc1705-financial-well-being-conceptual-model.pdf
[10] https://caas.usu.edu/fcse/files/money-beliefs-and-financial-behaviors-development-the-klontz-money-script-inventory-jft-2011.pdf
[11] https://pubmed.ncbi.nlm.nih.gov/11908535/
[12] https://link.springer.com/article/10.1007/s10902-007-9057-2
[13] https://www.gabekwakyi.com/essays/core-values-definition
[14] https://www.amazon.com.au/Conscious-Finance-Uncover-Beliefs-Transform-ebook/dp/B0027P9PUC

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Although seen by some as futuristic, the transformative potential of AI is already in reach and already being used by Australian advisers.

Unless you have been living on another planet recently, it has been hard to avoid the topic of artificial intelligence. While ‘AI’ has actually been around for a long time, it was really the release of ChatGPT at the end of November 2022 that sent the whole world crazy for AI.

A little like the industrial revolution, there are two perspectives from which to view the AI ‘revolution’. There’s the pessimistic perspective of which jobs are most at risk of being replaced by AI (the good news for you as the reader is that financial advisers aren’t high on that list, the bad news for me as the author is that copywriters are!), and then there’s the excitement about the endless possibilities for AI to revolutionise our lives and indeed just about every field of human endeavour. This is the perspective that sees the share price of Nvidia runway ahead of its actual current earnings.

But regardless of which perspective you take, and how futuristic you may think AI is, the reality is that AI is already here, and is already being used by financial advisers in Australia, to deliver better customer experiences, to make better decisions, and to operate more efficiently.

Reinforcing this point, a recent study^[1] of Australian advisers found that most believed AI would be the technology that had the greatest impact on advice practices over the next five years.

In this article, we will examine AI through a practical lens, exploring the ways it can be used in conjunction with existing technologies to improve adviser and advice practice performance across portfolio construction, the advice process, the client experience, administration, compliance, and marketing.

First – a recap

Before we begin our exploration, it is worth briefly recapping some of the common language used in conversations about AI.

AI will replace jobs – but advisers shouldn’t be worried

Much has been made of the likelihood of AI cutting a swathe through the job market. Certainly, as with any technological advance, an impact on the workforce is to be expected. But AI promises quite the disruption. A report^[2] published by the World Economic Forum in 2020, for example, predicted 85 million jobs will be replaced by AI by the year 2025. Mckinsey’s more conservative 2021 estimate^[3], on the other hand, is 45 million by 2030.

One recent list of roles most likely to be impacted showed the power of AI to generate content, with the top 10 list including copywriters, graphic designers, and even software coders.

It may or may not come as a surprise that ‘financial adviser’ doesn’t feature in such lists. Despite the predicted surge of interest in pure robo-advice (which AI is well positioned to support), the real-life market experience, and countless research studies, show that people still want the human touch in their advice, partly because they don’t fully trust machines to get it right.

The latest survey to reinforce this point was conducted by CNBC, which found that the vast majority of adults – 63% – aren’t interested in using generative AI tools specifically for financial advice^[5].

A further survey^[6] by the CFP Board, found that, of the 4% who are already using AI tools for financial advice, more than half (51%) are verifying the information and recommendations they receive with a real – human – financial adviser.

Big picture applications for AI

The vast potential for AI to be a ‘game changer’ for financial advice becomes obvious when we consider how much of advice is reliant on data, and the use of that data to drive insights, then create rules and make decisions based on those insights. At a high level, aspects of advice that will be revolutionised by AI include:

Data analysis and decision-making

AI can rapidly process large volumes of data, including historic and current market information and client specific data, to identify trends and produce insights. The power of AI lies in its ability to process complex, unstructured data and create actionable intelligence, in effect providing answers to questions which we didn’t even know to ask. Decisions and recommendations based on these insights will be grounded in more evidence, and will be more robust, leading to better client outcomes.

Automated portfolio management

AI-powered algorithms are transforming portfolio management by automating key processes, including algorithmic trading based on predefined rules, scanning a wide range of sources (including news and social media coverage) to develop more robust research on specific stocks, automatic real-time portfolio rebalancing at a more personalised level, and more efficient (cost effective) trading.

Back office/administration

Integrating AI into existing systems can allow automation of tasks such as document production, client data gathering, onboarding, and reporting.

Personalised recommendations

By analysing individual client data such as, risk preferences, time horizon, financial goals, and even past investment decisions, AI can generate truly tailored investment recommendations far quicker, and to a far more granular level, than humans can do alone. AI makes it viable to genuinely start with a clean piece of paper, rather than relying on a cookie cutter approach,

Customer service and chatbots

AI-powered chatbots and virtual assistants are revolutionizing customer service in financial advice. Indeed, research by Netwealth^[7] suggests that, of those Australian advice firms who are ‘dipping their toes’ into the AI water, the majority (65%) are experimenting with the use of chatbots.

These chatbots can handle routine customer inquiries, provide basic financial information, and assist with account management. By automating repetitive tasks, financial advisors can focus on more complex and high-value activities.

AI-driven customer service solutions improve response times, provide 24/7 support, and enhance overall customer experience. Clients can access relevant information, obtain quick assistance, and feel more engaged with their financial advisors, strengthening the adviser-client relationship.

Risk assessment, fraud detection and cyber security

AI can play a crucial role in risk assessment and mitigation for financial advisors. Furthermore, AI algorithms can detect patterns and anomalies in financial transactions, aiding in fraud detection and prevention, and even monitoring cyber security breaches.

Compliance and regulatory adherence

AI powered RegTech can monitor transaction data and communications and alert advisers to potential compliance issues, faster, more comprehensively, and far cheaper than the equivalent human system.

Client communication and marketing

For many advisers, writing is not a core strength, and generative AI can be used to craft client facing communication, such as document templates, newsletters, articles, and even personal emails. Google already uses the power of AI to help advertisers become more effective in their selection of keywords and target audiences when implementing SEO strategies.

At the coalface, how are Australian advisers using AI?

As mentioned above, of those advisers already experimenting with AI, most are focused on trialling chatbots.

When we further expand the universe to also include areas where advisers are interested in exploring the potential for AI, we can see a strong focus on communication, content, and document production:

Practical examples of how to use ChatGPT now

Using ChatGPT to create written content may well be the easiest and quickest way for advisers to start on their AI journey.

Specific examples can include:

• writing emails on specific topics
• writing blog posts for LinkedIn or your website
• creation of educational materials, such as ‘how to guides’
• summarising meeting notes into a more professional format
• summarising and simplifying long-form content, for your own benefit, or for clients’
• conducting research (notwithstanding the free version of ChatGPT is still limited to data from September 2021 or earlier.

Of course, ChatGPT isn’t perfect, indeed it frequently makes fact-based errors, but in terms of crafting the written word, it is very, very good (which is why copywriters are under so much threat!). For this reason, most observers, including US advice guru Michael Kitces, encourage users to think of ChatGPT as providing drafts of materials, which advisers then need to edit, fact check, and, if needed, personalise. As Kitces says, it is far easier to edit than create something from scratch.

A couple of real-life examples below show the prompts typed in to ChatGPT by Kitces, and the actual response from ChatGPT.

Example 1

ChatGPT is asked to ‘write an email to calm my investment client who is worried that mass adoption of ChatGPT and other AI tools will cause mass unemployment and trigger a stock market crash in the next few years.’

Example 2

In this example, ChatGPT is asked to create three social media posts, based on a longer article the adviser had previously written (perhaps with the help of ChatGPT!).

Example 3

In this example, ChatGPT is asked to generate headline ideas for a previously written article.

Tools that can work with ChatGPT

As an open-source platform, many companies are taking ChatGPT as a base, and then tailoring around their own needs and systems. While in the long run ChatGPT is likely to be integrated directly into advisers’ core systems, in the meantime, there is a growing range of third party add-ons and plugins that can help advisers be specific in their use cases.

Advisers can sign up for ChatGPT free of charge, and immediately start prompting it for content. At this stage, content which requires data after September 2021 is only available through the premium ChatGPT Plus service.

At present, ChatGPT cannot accept document loads, it can only summarise pasted-in text, which is subject to word limits. However, Microsoft is already trialling a product called ‘Co-pilot’, which will integrate ChatGPT directly into Microsoft’s Word, Excel, PowerPoint, and Outlook applications^[12].

Merlin^[13] is a Chrome extension that, when added to a browser, can give ready access to ChatGPT, enabling users to summarise content they are viewing online, or generate emails through a browser-based email service (e.g., Gmail).

If anything is certain, it is that the rapid pace of adoption of ChatGPT and similar AI systems (such as Google Bard^[14]) is likely to be matched by the rapid roll out of innovative tools to help leverage their power.

Summary

The article has shed light on the multifaceted landscape of AI, offering both a glimpse of its potential and the practical ways it can be harnessed by financial advisers in Australia.

The practical applications of AI, exemplified by ChatGPT and similar systems, are vast, with the potential to revolutionise various aspects of financial advice. From data analysis and automated portfolio management to back-office administration, personalised recommendations, and enhanced customer service, AI stands as a valuable ally to advisers, streamlining tasks and enhancing client experiences.

Content, customer communication, and document production is arguably the easiest area for advisers to start their AI journey.

The rapid development and roll-out of new tools designed to leverage the capabilities of AI should make the power of AI more accessible, to even small practices, enabling a revolution in practice efficiency and client experience.

As evolutionary as AI may be however, it is clear that the ‘human touch’ will remain a cornerstone of financial advice, ensuring trust, understanding, and a personal connection in a world increasingly driven by technology.

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References
[1] https://www.netwealth.com.au/web/insights/netwealth-2023-advicetech/
[2] https://cepr.org/voxeu/columns/impact-artificial-intelligence-growth-and-employment#:~:text=The%20World%20Economic%20Forum%20concluded,information%20security%20and%20digital%20marketing.
[3] https://slate.com/technology/2021/03/job-loss-automation-robots-predictions.html
[4] https://tech.co/news/ai-job-replacement-experts-reveal-risk-roles
[5] https://www.cnbc.com/2023/09/12/3-in-10-adults-would-use-ai-for-financial-advice-cnbc-survey-finds.html
[6] https://www.cfp.net/-/media/files/cfp-board/knowledge/reports-and-research/trust-but-verify-deck.pdf?_zs=sIctj1&_zl=j9TA9
[7] https://www.netwealth.com.au/web/insights/netwealth-2023-advicetech/
[8] Ibid.
[9] https://www.kitces.com/blog/chatgpt-ai-financial-advisor-trust-writing-calculator-meeting-notes-client-emails/
[10] Ibid.
[11] Ibid.
[12] https://blogs.microsoft.com/blog/2023/09/21/announcing-microsoft-copilot-your-everyday-ai-companion/
[13] https://ravindrasingh01.medium.com/streamline-your-workflow-with-merlin-the-ultimate-ai-powered-chrome-extension-42506a684c51
[14] https://blog.google/products/bard/google-bard-new-features-update-sept-2023/

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The choice of fee model is one of the most important decisions an adviser can make.

Introduction

Advice fees – their quantum, and how they are charged – remain one of the most discussed, dissected, and debated topics within financial advice. They are at the heart of many issues fundamental to the future of financial advice – practice sustainability, affordability and take up of advice, and client trust.

In an earlier article, we explored questions around ‘what’ to charge for advice, examining critical considerations for advisers seeking to strike the right price for their service. In this follow-up article, we explore the ‘how’, examining the different fee methodologies and payment methods advisers can use. We will examine the topic from both sides, looking at the advantages and disadvantages of different fee models, usage trends for the different models, and client preferences. We also look at the often-vexed issue of how to communicate fees, and the value of advice, in a way that reinforces client trust in the individual adviser and the advice itself.

Different fee models

1. Flat or fixed fee

While different people interpret the concept of a fixed or flat fee differently, in essence it is the opposite of a fee linked to variable components, whether that be AUM, or hours spent with the client. A flat or fixed fee is generally taken to mean a set fee, agreed in advance, for the year ahead for all the work the adviser is likely to do for that client. It doesn’t mean you need to charge every client the same fee (a point explored in point 2 below)

2. Tiered fees

Really a variation on the flat or fixed fee, under the tiered fee option, clients are grouped into tiers based on the depth of the services provided to those tiers, and all the clients in that tier pay the same amount as each other. This approach might work well if clients can be fairly easily segmented based on complexity and workload. A fee pyramid (e.g., gold, silver, and bronze) and fee menus are commonly seen with this model.

3. Asset-based fee

The asset-based fee is typically charged as a percentage of funds/assets managed (AUM/FUM) by the adviser for that individual client. By its nature, it is a variable fee, the quantum of which is at the mercy of investment returns, and which therefore can’t be known in advance.

4. Hybrid fee

Typically a combination of a fixed fee and a percentage-based AUM fee.

5. Hourly rate

An approach used by many professions who provide services on a more episodic basis, such as accountants, doctors and lawyers. Under this model, the client is charged based on the amount of time the adviser spends working with/for each client. The hourly rate is usually a fixed rate, known in advance. In its purest form, the adviser is valuing an hour of his time at the same rate, regardless of the client. A variation on this model is that different employees working on that client may charge at a lower rate. So, an hour of a paraplanner or client services manager may be charged at a lower rate than the actual adviser.

6. Project-based fees or modular fees

In contrast to an hourly fee – where a simple hours worked x hourly rate calculation applies – project-based fees are set (and quoted up front) based on either a cumulative estimate of the time to complete the project for the client (working backwards from the value of an hour of the adviser’s time), or based on the perceived value of the project for the client (and what the time is worth to the client).

Typically, a project will be self-contained and on- off in nature, with common examples being advice around life insurance or estate planning. A variation of the project fee is the advice module fee, where the advice process is broken down into distinct – often linear – modules, which are undertaken individually (such as cash flow and budgeting, superannuation, saving for and buying a home, and so on). Another variation is breaking down the advice process into steps, such as initial advice, implementation, and ongoing care, with a different fee levied for each of those steps.

7. Commission

Although not strictly a fee model, advisers can still choose to be paid for their advice in relation to life insurance via commission, capped under law at 60% of the value of the first year’s premium, with a 20% commission payable on the premium at each subsequent annual renewal.

Payment methods and frequency can also vary

In addition to deciding a fee model, advisers also have a degree of discretion in how they collect those fees.

For example, advice fees may be charged up-front, in advance of the work, in arrears, or on a regular ongoing basis. The meaning of upfront can vary. For newer clients, where the client work is heavily front loaded, up-front typically means a fee is levied upon presentation of the advice. For existing clients, up-front may generally mean ‘paid in advance’ for the year ahead. In arrears means after the work has already been completed.

In addition to requiring fees to be paid in full, either upfront or arrears, advisers may also choose to break down fees into regular instalments, such as monthly, quarterly, or half yearly.

A major consideration for advisers is whether to offer clients the ability to pay from their superannuation balance. The appeal for clients and advisers alike is there is no strain on cash flow, making the fees more affordable. But this method also comes with strict guidelines and limitations, explained in more detail below.

Subscription models

At this point it is worth mentioning subscription models. Whether viewed as a fee model in its own right, or more of a payment frequency choice, subscription advice fee models generally involve clients paying a regular fee – typically monthly – for some pre-agreed service. That pre-agreed service could range from access to educational resources, a fixed amount of ‘face time’ with a financial adviser each month, through to advice modules and even the full advice service (in which case ‘subscription’ really means paying fees by instalments).

Industry trends on fees

In line with overseas trends showing a gradual decline in the use of asset-based fees, Australian advisers have been shifting towards fixed fee models, a trend which accelerated after the Hayne Royal Commission in 2018.

Indeed, Adviser Ratings analysis^[1] showed that between 2018 and 2019, advisers using:

• fixed fees increased from 50% to 69% (a figure almost certainly higher now)
• asset-based fees decreased from 13% to 7%, and
• hybrid fees decreased from 37% to 24%.

Considerations when choosing a fee model

The choice of fee model is one of the most important decisions an adviser can make, a choice which can literally make or break a practice. There are many considerations an adviser must weigh up when making this decision, including internal business-related factors, regulatory factors, and of course client factors.

Fixed v percentage: What are you actually charging for?

One of the most fundamental questions for advisers to ponder is what they are charging their clients for. This is almost an existential question, which is really about asking yourself whether you are charging clients for advice, or to manage their investments.

If – like the majority of advisers – you are charging clients for the advice you provide (rather than for investing their money), then an asset-based approach may drive a disconnect between the work you are doing and the fees you charge them.

The simplest example of this can be seen in a market downturn, when the work you are doing for, and the time you are spending with, your client is likely increasing, while the percentage fee is being levied on a shrinking AUM base, meaning your remuneration is decreasing.

A related disadvantage of the asset-based fee from an adviser perspective (the regulator and client perspectives on this will be explored below) is that the adviser is essentially tying their value to investment performance, which, by extension, means when markets underperform, the adviser – in the eyes of the client – has also underperformed, putting their willingness to pay fees, and indeed the entire advice relationship, at risk. Charging a fixed fee breaks this nexus between the value of advice (which an adviser can control) and investment returns (which they cannot).

Client and advice homogeneity

The extent to which clients can be grouped into similar work, will determine how to apply a fixed fee model. Where the services provided don’t vary appreciably from one client to the next, perhaps because the adviser is serving a well-defined niche, or providing a highly rigid service offering, then a pure flat/fixed fee, where every client pays the same, may work.

On the other hand, if different clients need different needs, a tiered approach, with pre-defined fees and service levels, may be more appropriate.

The adviser’s business model is also an important input into this decision. Ad-hoc, episodic advice may be better suited to a project fee, or even an hourly rate.

Special considerations about life insurance advice

While Quality of Advice Review recommended the retention of the life insurance commission system – having considered a general appetite among consumers to pay for life insurance advice – the review also recommended the 60% cap on up-front commissions be retained. Increasingly, this is creating a situation where the cost to provide that advice far exceeds the commission amount payable (especially for younger people with low average premiums). For this reason, advisers remaining active in this space are increasingly looking at augmenting those commissions with fees. These can include a fixed advice preparation fee (paid regardless of whether the client proceeds with cover), a gap fee which covers the difference between the commission amount and some pre-agreed advice fee, and claims management fee.

Regulatory considerations

Setting aside the various disclosure requirements relating to fee consents, there are also some ‘big picture’ regulatory matters advisers must consider when choosing a fee route.

FASEA

One of these is FASEA Standard 7, which mandates:

“Any fees and charges that the client must pay to your or your principal, and any benefits that you or your principal receive, in connection with acting for the client, are fair and reasonable, and represent value for money for the client.”^[2]

Implicit in this is the idea that fees charged without providing a related benefit (fees for no service) is unethical, which does throw into question the idea of retainer fees, or indeed any sort of fee levied where the adviser has done little or no work to justify that fee (regardless of whether the client has agreed).

There is much less clarity around the concept of ‘value for money’. Some commentators advocate that – to the extent ‘value’ is a measure which is determined by, and varies between, each individual client – each client should be charged a bespoke fixed fee, based on the value they receive. While this is notionally true (a client with a larger portfolio can theoretically benefit more than a client with a smaller portfolio acting on the same advice), this can be seen as a variation on the idea that people who can afford more, get charged more, which many would find unethical.

Sole purpose test

Another major regulatory consideration relates to the collection of fees from a client’s superannuation fund(s).

Under the sole purpose test, superannuation funds to be maintained ‘solely’ for the core purposes of providing benefits to members on retirement and death, and certain ancillary purposes, such as disability benefits.

Any advice fee deductions from members’ superannuation accounts can only be used to cover the cost of financial advice about superannuation investments. Examples include

• consolidation of superannuation accounts
• selection of superannuation funds
• selection of superannuation investment options
• asset allocations within a fund
• taking pensions and/or lump sums
• contribution strategies.

Advice provided outside these topics would not meet the sole purpose test, and the client would need to pay the fees from another non-super source^[3].

Client considerations

Arguably the most important considerations of all are those relating to clients, with affordability, transparency, and value for money as much a priority with financial advice as they are with other product and service categories.

Extensive research, including the 2019 Global Wealth Management Research Report^[4] by EY, has found that financial advice clients are largely dissatisfied with asset-based fees specifically, and with the overall perceived complexity and opaqueness of advice fees generally.

While advocates for the asset-based approach argue that clients appreciate the ‘skin in the game’ that this approach theoretically embodies, the vast majority of clients dislike this approach, with dissatisfaction higher amongst higher wealth levels (which amplifies the size of the fee), and younger clients, who have become more accustomed to clear, simple, and predictable pricing for everything from taxi fares to financial products.

Indeed, EY found 60% of Millennials desired a different fee model to their current one. Fixed and hourly fees were the two most preferred fee options, with asset fees being favoured by less than one in five respondents overall, and the remainder favouring other options.

Another source of dissatisfaction among clients relates to their perceived complexity and opaqueness.

According to EY – which surveyed 2,000 advice clients around the world, including Australia:

• 45% of clients do not trust their adviser or wealth manager to charge them fairly, and
• only 56% of clients say they fully understand the fees they pay.

This is a longstanding theme, with Australian research⁵ also finding that advice fees were seen as complex and confusing, and that client trust in advisers was being eroded as a result. (That same research found that clients who understood fees were more likely to refer their adviser to a friend or family member.)

Fee affordability is obviously critical, with the nature of the target client, and their capacity to pay fees, also a critical consideration for advisers.

Fee equity is also an important consideration for clients, most of whom would be uncomfortable with the idea that different clients were paying different amounts for the same service (which can make clients feel they aren’t as important, or their bargaining skills aren’t as strong).

4 tips for confidently communicating fees to clients

Understanding the importance of fee transparency to clients, it is important to communicate fee schedules clearly and early.

Indeed, the first tip is to proactively communicate fees, at the first meeting, rather than doing a slow reveal later in the process because you think you will have greater ‘buy-in’ by then. In the words of an adviser interviewed for this article,

“Unless you deal with the topics of fees early in the very first meeting, the clients will be anxious and distracted, sitting there thinking ‘how much is all this going to cost me?’. They won’t be paying attention to what you are saying before then. Once you get that topic out of the way, they are more relaxed, more forthcoming, and pay more attention, which leads to better advice outcomes.”

The second tip to confidently talk about the value for your fees is to describe your fees with absolute clarity and make sure clients understand your value proposition.

This means doing a detailed breakdown of what the size of fees, the basis of their calculation, and the work that is covered by those fees. The mechanisms to pay those fees should also be discussed, positioned as offering them more flexibility and convenience in how they are paid. Phrases like ‘most clients prefer to pay to pay fees from their superannuation’ provide important social proof and help put them at ease about their ability to pay.

Tip three is to ensure simple, jargon free language is used in any fee documents and conversations. Clients can feel distrustful of advisers who use overly technical terminology, fearing they are hiding something.

Finally, advisers should talk about fees regularly with clients. This could be done during regular reviews and framed from the perspective of making sure the client understands them, and also that they are representing value for money. This not only demonstrates transparency, and a willingness to hear client feedback, but it can also help advisers build their own confidence that fee discussions are not something to be feared.

Conclusion

The choice of fee model is one of the most important decisions an adviser can make. As well as being a key driver of both advice affordability and practice sustainability, fee models, and the way they are communicated, can greatly influence a client’s trust in their adviser. The trend towards more fixed and flat fee arrangements reflects a growing client preference for more transparency, clarity, and equity in advice fees, while also enabling advisers to break the nexus between investment market performance, and the perceived value of their advice.

Read part 1 – Pricing advice for trust, sustainability and loyalty (Part 1 – pricing framework and context).

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References:
[1] https://www.afr.com/wealth/personal-finance/how-to-pick-the-right-financial-advice-fee-model-20200206-p53y9f
[2] https://faaa.au/wp-content/uploads/2019/07/FPA-Understanding-the-FASEA-Code-of-Ethics-Version-1.pdf
[3] https://www.moneyandlife.com.au/professionals/insight/five-things-to-know-about-the-approach-of-regulated-superannuation-trustees-to-advice-fees/
[4] https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/wealth-and-asset-management/wealth-asset-management-pdfs/ey-global-wealth-management-research-report-2019.pdf
[5] https://www.ifa.com.au/news/16810-adviser-investor-confusion-driving-trust-issues

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Numerous studies have shown the price of advice is one of the main barriers to consumers seeking financial advice.

The importance of advice pricing

It sounds obvious to say that pricing can make or break a business, but in the case of financial advice it’s a particularly pertinent issue that remains one of the most debated and discussed across the entire adviser community.

There are several reasons for this.

Firstly, numerous studies^[1] have shown the price of advice is one of the main barriers to consumers seeking financial advice in the first place, and is one of the main reasons people switch advisers, or exit the advice system altogether.

Secondly, advice – and indeed financial services generally – has a longstanding trust issue with the community at large, and perceptions about adviser remuneration is undoubtedly a key contributor here.

Thirdly, from the adviser perspective, the cost to provide advice continues to rise. With the streamlining of red tape recommended by QAR yet to yield tangible benefits to advisers, the costs of the various inputs into advice (wages, rents, PI insurance, licensee fees, ASIC fees etc) continue to rise, and advisers face a difficult choice – either pass these increases onto their clients, or reduce their own margins, potentially undermining their long-term sustainability.

Coming from the other angle, advisers must also deal with two forces that effectively limit their flexibility with regards to remuneration. One is an overall consumer reluctance to pay an amount for their advice that comes close to covering the cost of providing that advice. The other, specific to life insurance, is the LIF related upfront commission cap of 60% (which was essentially locked in by QAR).

With this in mind, this article – the first in a two-part series – will seek to go back to first principles and offer advisers a way to consider and construct a price for their services that can both ensure their business remains sustainable, while building trust and loyalty with clients and prospects. The second part in the series will explore the mechanics of ‘how’ to charge, looking at different pricing methodologies and models, as well as addressing the all-important question of how to communicate your fees.

The starting point – your philosophy on price

Your philosophy on pricing your services is arguably the most fundamental business decision you can make. That’s because unlike the perfectly competitive marketplace depicted in economics textbooks, the market for advice has a key structural imperfection – namely the gap between what most consumers are prepared to pay for advice, and the costs incurred by advisers in providing that advice.

Advice practice owners must decide whether to price their advice from the inside out, or the outside in.

Pricing from the inside out means your starting point is what it costs you to provide advice (your cost to serve). After calculating your total cost to serve you can then add your desired profit margin to arrive at the amounts you need to recover from your clients.

Pricing from the outside in means starting with your potential clients, and what they are prepared to pay. This is a truly client centric approach.

To the extent that the two perspectives will result in entirely different numbers, they will actually drive your entire business model.

The first approach is likely to take you down a traditional, labour-intensive path. Many people will be unable to afford your advice, but the limited supply of advice (courtesy of shrinking adviser numbers) means there will be enough of a market to make your business sustainable. Under this approach you are probably deciding to prioritise a high touch approach to client care, which many will love.

The second approach will require you to build a business model that strips the cost of advice to the bone. This could require a more mass produced, low touch, modular approach to advice, which relies heavily on technology, virtual meetings, home offices, and outsourcing.

Each approach is as legitimate as the other, giving advisers equal scope to act in their client’s best interests and provide value for money, while remaining sustainable. But each approach is very, very different.

Pricing route 1 – inside out

The inside out approach starts inside your practice and involves setting your pricing by calculating the cost of every single aspect of you providing advice. This means forensically examining every single step in every single process in your practice, to calculate your ‘cost to serve’. You can then add a desired margin to arrive at the minimum price you need to charge each client for your advice (the minimum recoverable amount, or MRA).

A convenient framework to conduct this analysis is the one used by KPMG in research they conducted in 2021 on behalf of the FSC². In their study of advice costs, they broke down the advice process into seven key steps:

1. Identification of an advice need.
2. Meeting between client and adviser.
3. Preparing the financial plan.
4. Second client and adviser meeting (to present the advice).
5. Client signs the SOA.
6. Implementation of recommendation.
7. Regular reviews and ongoing service (for ongoing advice clients).

Calculating the cost of each step in this framework requires you to understand (a) how long each step takes and (b) the cost of the practice staff involved in those steps.

Estimating time taken at each step can be as simple as completing timesheets in excel, or as sophisticated as using workflow or accounting software to track the time taken on tasks.

The second dimension of this calculation is the cost of spending that time. This is an amalgam of business overheads (including, but not limited to rent, software, licensing fees, PI insurance, utilities etc) and then variable people costs, including salaries, training, memberships, workers compensation and other on costs levied at the per-person level.

A corollary of this analysis is that different categories of staff within a practice will have different costs – equating to different hourly rates. Advisers for example will generally cost more than paraplanners, who in turn cost more than administrative staff.

What does this look like in real life?

Based on their survey of licensees representing over 2,000 advisers, KPMG arrived at a cost to provide advice of $5,334.64^[3]. This is hardly surprising given how time-consuming parts of the advice process can be.

A study^[4] by Iress and Business Health for example, found that in 2023, the typical hours taken to produce key advice documents was as follows:

The previously mentioned KPMG survey^[5] found the average costs of practice personnel to be as follows:

Note the rates above are the actual cost of these personnel, not their charge out rate.

Problem number 1

Having arrived at an average cost to produce advice of almost $5,500, this means advisers looking to break even, let alone make a margin, need to be charging clients at least this amount.

But according to several studies, including those by Adviser Ratings, KPMG, and software provider Padua, the average advice fee is well short of that amount, meaning their initial advice is essentially loss making (making them reliant on ongoing fees to be sustainable).

Adviser Ratings found that in 2022 the median advice fee charged to clients in 2022 was $3,710^[6], an increase of over 40% on the median fee charged in 2018 but still well short of KPMG’s 2021 cost calculation.

A study by Padua^[7] found the loss on the initial advice was even higher, estimating the average initial advice fee to be only $3,315.

Problem number 2

The second problem stemming from the $5,500 cost to produce advice (a figure which doesn’t allow for recent inflation!) is the disconnect between that figure and what the typical consumer is prepared to pay for advice.

According to Adviser Ratings^[8], while nearly two thirds of the 1,200 Australians surveyed said they saw value in financial advice, the majority of those people (61%) said they were only prepared to pay less than $500. Just over one in five (22 per cent) said they’d pay up to $1,000 annually, while less than 10 per cent said they would pay up to $2,500 a year.

Of course, this disconnect doesn’t in itself mean that it is not possible to run a sustainable advice practice in Australia. On the contrary, it simply means the potential market for consumers willing/able to pay reasonable advice fees is more limited. Against a backdrop of falling adviser numbers, demand is still likely to exceed supply. And of course, if your chosen client niche is the high-net-worth segment, then ability to pay fees is unlikely to be an issue.

The other implication of this disconnect is that advisers are more reliant on ongoing advice fees to remain sustainable, and as such are less able to meet consumer demand for more ad hoc, episodic advice.

It is this disconnect which sees some newer advice practices basing their entire business on the second – more client centric – pricing route, being the outside in.

Pricing route 2 – outside in

The outside in approach means pricing your advice based on what consumers are willing to pay. Tied up with this is, of course, your chosen target audience. As mentioned above, if your target audience is high-net-worth clients, then their capacity to pay fees should mean you can afford to deliver a highly bespoke, high touch, labour intensive service proposition. But if you are wanting to bring advice to a more mass market, such as mums and dads or Millennials, then you will likely need to do so via a different, lower cost business model.

Taking a client centric lens also means recognising the widespread demand for piece by piece, or modular advice (limited or scaled advice by another name).

Various surveys have highlighted the latent demand for piece-by-piece advice, including 2021 research by Investment Trends, which found that while 11% of consumers wanted comprehensive advice, 38% wanted limited advice^[9].

One practice who adopted this client centric lens from the very start was Finnacle.

Case study: Finnacle business model supports affordable pricing^[10]

Driven by a vision of making advice affordable and accessible to young Australians, Finnacle founder Prashant Nagarajan and his partner designed their advice practice from the ground up. Having conducted three months of extensive client research before they even opened their doors, they recognised the needs of their target client for affordable, modular advice.

Shaping a business that could meet these needs in a sustainable way resulted in a Finnacle opening as an online-only practice, where clients become ‘members’, paying an affordable monthly fee to access personal advice in a progressive, modular fashion. These modules can include sorting your super and saving and borrowing for your first home.

Limiting face to face engagement strictly to video calls significantly minimises overheads, and their ‘just in time’ approach to administrative resourcing, a concept borrowed from the car industry, sees them outsource administrative work to a team of virtual assistants, allowing support to be dialled up or down – and paid for – according to need.

Adding a margin to your costs

Having arrived at a cost to provide advice, via either Route 1 or Route 2, you then need to decide the margin to add in order to arrive at your final price (fee) for your advice.

There are many approaches you can adopt here, including a flat profit margin of X%, or approaches based on competitive pressures (which may limit margins), or on what the market will bear (which may allow upside). The concept of the value of advice is intrinsic to your decision (and will be explored in a follow-up article).

According to 2023 Financial Advice Efficiency Report by Iress and Business Health^[11], the average profit margin across all advice practices is 27%, whereas as high profit practices were averaging a profit margin of around 60%.

Averages can of course be misleading, and the most recent Advice Landscape Report^[12] by Adviser Ratings found that smaller practices in particular were more challenged to remain profitable, creating a sustainability challenge with potentially adverse consequences for the accessibility of advice.

More specifically, Adviser Ratings found that in single adviser practices, just over one quarter (26%) were making no profit, and around 40% were making between 20% margin or higher. For practices with 5 advisers or more, the respective proportions were quite different, with only 11% unprofitable and 64% making margins of 20% or more.

In summary

The decisions about how to price financial advice are complex, and can quite literally drive the shape of a new practice, and determine the sustainability of an existing one. In this article we have explored the fundamental philosophical principles about how to price advice. We have provided a framework for calculating cost inputs, and provided a market context in terms of margins, average fees, and consumer fee tolerances.

In the next article in the series, we will explore the mechanics of how to charge fees, examining the different methodologies, consumer preferences, the quantification of value, and the market trends that are playing out. We will also look at how to communicate pricing in a way that builds trust.

Read part 2 – Pricing advice for trust sustainability and loyalty (Part 2 – choosing and communicating fee model options)

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References:
[1] https://www.adviservoice.com.au/2022/11/advice-costs-continue-to-rise-as-affordability-remains-main-barrier-to-australians-seeking-financial-advice/
[2] https://fsc.org.au/resources/2299-kpmg-the-cost-profile-of-australia-s-financial-advice-industry-final-research/file
[3] Ibid.
[4] https://www.professionalplanner.com.au/2023/07/business-is-booming-near-50pc-gains-in-advice-revenue/#:~:text=The%202023%20’Financial%20Advice%20Efficiency,more%20than%2045%20per%20cent
[5] https://fsc.org.au/resources/2299-kpmg-the-cost-profile-of-australia-s-financial-advice-industry-final-research/file
[6] https://www.adviserratings.com.au/news/what-your-industry-colleagues-are-charging-and-more-2023-adviser-landscape-preview/
[7] https://www.firstlinks.com.au/latest-costs-strategies-financial-advice
[8] https://www.adviserratings.com.au/news/what-everyday-aussies-would-pay-for-financial-advice/
[9] https://www.moneyandlife.com.au/professionals/grow/improving-access-to-advice/
[10] https://www.hub24.com.au/insight/advice-entrepreneurs-in-action-modular-advice/
[11] https://www.professionalplanner.com.au/2023/07/business-is-booming-near-50pc-gains-in-advice-revenue/#:~:text=The%202023%20’Financial%20Advice%20Efficiency,more%20than%2045%20per%20cent
[12] https://www.adviservoice.com.au/2023/04/adviser-ratings-landscape-report-showcases-the-professions-revival/

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Financial advisers are increasingly realising the need for their own investment philosophy to manage and guide client expectations.

Experts should have opinions

As investment markets continue their rollercoaster ride, and with many developed countries on the cusp of recession, discussions around investment philosophies have ramped up in many circles. This is understandable because, while the current economic climate may not be entirely without precedent, making sense of the way forward has certainly become more complex, and the relative merits of many common philosophies – such as active, passive, value, growth, and contrarian – are now being hotly debated.

Importantly, these discussions and debates are no longer the exclusive domain of fund managers.

Increasingly, financial advisers are recognising that they too should have an investment philosophy, not just because their clients are paying them to have an opinion on such matters, but because a well thought out adviser investment philosophy can drive business efficiencies, deeper client relationships, more effective marketing and referral activities, and more rational investment decision making. Ultimately, a robust, well-articulated investment philosophy can drive better client outcomes.

This article will act as a practical guide for advisers seeking to develop their own investment philosophy, examining:

• the essential components of an investment philosophy
• the benefits
• steps to create a robust investment philosophy, and
• client communication considerations.

What is an investment philosophy?

According to Investopedia, an investment philosophy is:

“A set of beliefs and principles that guide an investor’s decision-making process. It is not a narrow set of rules or laws, but more a set of guidelines and strategies that take into account one’s goals, risk tolerance, time horizon, and expectations”.^[1]

An investment philosophy can be based on many different approaches, including:

• the type of stocks you may invest in (e.g., value v growth)
• actively or passively managed investments
• the outcomes sought (growth, income, tax efficiency)
• the approach to analysis (technical v fundamental)
• the importance of factors
• the importance of sustainable/responsible investing
• portfolio construction approaches, and
• your approach to advice (is it, for example, goals based?).

A fund manager’s investment philosophy is the set of guardrails within which investment decisions are made, now, and into the future.

Ultimately, the investment philosophy is how every fund manager ‘nails their colours to the mast’, signalling to the potential investors what they believe in and what to expect.

As an adviser, you wouldn’t dream of investing with a manager who didn’t have a clear investment philosophy, it would be too much of a risk, a leap into the unknown. A manager’s philosophy gives you clues about how likely they are to deliver on their goals, and how they may react during turbulent market times. It’s the difference between chaos and calm.

So why would a client be any different? Why would they choose an adviser without an investment philosophy?

In the words of Australian financial adviser, Justin Brand:

“An adviser without an investment philosophy is like a boat without a rudder. If your adviser doesn’t have a convincing, evidence-based set of beliefs about the markets and how to invest in them, then you risk drifting from one idea to another.”^[2]

An investment philosophy can deliver many benefits to advisers and clients

There are many important ways an investment philosophy can enhance your offering:

1. Provide confidence and clarity to your clients
   Regardless of the type of clients you deal with, recommendations around the investment of assets is likely to be a central part of your advice. A documented investment philosophy, that you can keep referring to, is a distillation of your experience and specialist knowledge, and helps reinforce client trust in your expertise.
2. Helps ensure consistent, emotion free decision making in volatile times
   Investing is complex and risky by virtue of the uncertainty. Volatile markets can be stressful for clients – whose real tolerance of risk is often lower than they have stated – and this stress can in turn be directed towards the adviser. Referring back to your investment philosophy can remind you and your client why you have pursued a particular strategy, and how that strategy is likely be impacted by different economic conditions, helping you ease the pressure and encouraging them to stay the course rather than make knee jerk, emotional decisions.
3. Referral partners
   Having a clear investment philosophy can give your referral partners more confidence in your expertise, and can improve the success rate of referrals by providing more clarity about the type of clients they should – and shouldn’t – refer to you.
4. Marketing
   As with referral partners, your investment philosophy can be an effective marketing tool, both in helping position and differentiate you with potential clients and referrers, and in more efficiently aligning you and your practice with the right type of clients. It goes without saying that your investment philosophy should be easily found on your website.
5. Selecting investment partners
   Regardless of the extent to which your investment management is insourced or outsourced, and regardless of how much you play a part in selecting your APL, you are still likely to have considerable discretion in which investment solutions and managers you recommend to your clients. Having absolute clarity about your investment philosophy helps narrow your focus when researching and selecting managers
6. Focused client communication
   As an adviser you will typically have access to mountains of data and research, which can be valuable in informing your different channels of client engagement, including face to face meetings and regular newsletters. Your investment philosophy helps narrow down which of this research you should pay attention to, and pass onto your client, meaning more efficient use of your scarce time and less ‘noise’ for your clients.
7. More appropriate pricing
   Your investment philosophy will drive your investment style, which in turn will determine your resource requirements and pricing. A philosophy built on low-cost passive investing will be cheaper to implement, which can be reflected in your fees. On the other hand, more active management will likely be more differentiating, but also resource intensive, requiring higher fees and different processes to be sustainable.
8. A more consistent client experience across a practice
   A documented investment philosophy is akin to having a ‘house view’, making it easier to ensure everyone in a practice is aligned and able to deliver a consistent client experience.

Steps to developing your own investment philosophy

The starting point to developing your own investment philosophy is to reflect on your own beliefs about the way investment markets behave.

• Do you believe that markets are efficient or inefficient?
• Do you believe in the long run all outperformance is fleeting and not worth the cost and stress?
• Do you believe that performance is driven more by investment factors than the stock picking skills of an individual manager?

From there you need to consider a range of other factors, including your own skills and resourcing, your philosophy on advice, your beliefs about your own role as an adviser, and your ideal clients.

The following questions can be useful thought starters when developing your own investment philosophy: 

1. What is your view about how markets behave?
   What research have you read and agree with? What investment manager philosophies resonate with you and shape your approach? Do you believe markets are efficient or inefficient?
2. What are your own convictions and how have your experiences shaped them?
   Drawing on your own observations and experiences, personally, and on behalf of your clients, do you have a view on the ability of fund managers to add value? This entails forming a view on the different schools of thought – active versus passive, for example.
3. What restrictions do you have in place?
   You may have licensee imposed (APLs) or technology (chosen platform) or license driven restrictions (for example, MDA licensing) which will shape your philosophy.
4. Can your philosophy be flexible enough to cater to your different client segments?
   Or do you need a different philosophy for different client groups?
5. Do you insource or outsource investment implementation?
6. Do you have the skills, knowledge and resourcing to maintain your approach?
   If your philosophy entails portfolios that require constant monitoring and adjusting, do you have the capability and interest?
7. What are the cost and scalability ramifications?
   A more active and/or bespoke approach can add value, but will likely come at a higher cost, which needs to be reflected in your fees.

Different foundations on which to build an investment philosophy
As previously mentioned, there are a number of different approaches you can adopt when infusing your beliefs into an investment philosophy. The best approach will depend on you and your answers to the questions above.

The nexus between your investment philosophy and your advice philosophy

Your investment philosophy and your advice philosophy need to work hand in hand, and can lead you down quite different paths.

A conventional, risk profiling approach to client investing is consistent with a philosophy based on strategic asset allocation. Followers of such an approach might believe:

• Psychometric risk profiling, to determine the clients appetite for gain and loss, is the best way to determine an investment strategy.
• Risk means volatility of capital.
• Markets are efficient and repeatable, so optimal portfolios can be built using historical data.
• Over the long term, clients are always adequately rewarded for risk.
• Eventually all markets and managers are mean reverting, so the true value add in a more dynamic approach is likely to be minimal and not justify the extra risk and cost.

On the other hand, if you provide goals based advice, an aligned investment approach will likely be a dynamic one, likely reflecting your beliefs that:

• Investors’ actual needs and goals are the most important building block of an investment strategy.
• Risk is the likelihood of not meeting an investor’s goals.
• Investors will have numerous different goals – so a one strategy fits all is not possible.
• Markets are not always efficient – risk-reward opportunities arise from time-to-time.
• Forward-looking estimates and projections are more relevant than historical data – as markets will not always perform as they have historically.
• The world is continuously changing – a more flexible, and dynamic approach can do more to drive growth or minimise losses.

Your advice and investment philosophies are your ‘north stars’ – reference points you can refer back to help guide your decisions. They are intensely personal, reflecting your own inner ‘why’. But while there are countless different approaches you could adopt; they need to work hand in hand. Bespoke, premium, strategic advice and a philosophy based entirely on low-cost passive ETFs are unlikely to support each other.

The importance of simplicity in your investment philosophy

The most powerful investment philosophies, and the most easily understood by clients, are generally the simplest. This means articulating your philosophy in a way that is short, and jargon free.

Warren Buffet, regarded as the world’s greatest investor, has a simple approach to investing, summed up in many ‘quotable quotes’. Three of his best-known utterances are:

“It is far better to buy a wonderful company at a fair price, than a fair company at a wonderful price”^[3]

“If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”^[4]

“Our favourite holding period is forever”^[5]

Distilling these beliefs down might result in an investment philosophy which looked like this:

“Buy wonderful businesses at fair prices, with the intention of holding them forever”.

Now that’s powerful!

Stress testing your investment philosophy

Once you have developed your investment philosophy, it’s important to see how it stands up in the real world. There are two ways you can ‘stress test’ your investment philosophy.

The first is to run it by others, including your peers, researchers, fund managers, asset consultants, and even clients. Does it make sense, and is it understood?

The second, more scientific approach is to actually simulate the performance of your philosophy across a range of market scenarios.

Many fund managers and researchers offer tools that allow you to ‘back test’ constructed portfolios based on historic market events (and we have a few to choose from!). Along the same lines, there are portfolio x-ray tools which can simulate the impact of potential stress scenarios, and quantify the ‘value at risk’ (VaR)^[6]. These findings can help you see how your philosophy might perform in certain circumstances, allowing you to decide whether it is consistent with the expectations you have set with clients.

Conclusion

A documented investment philosophy is an essential tool for financial advisers, regardless of their advice philosophy and regardless of the extent to which they insource or outsource investment implementation.

By providing guidance on how you invest, a well-articulated and understood investment philosophy will help build trust and confidence among clients, by demonstrating your expertise, setting expectations, and ensuring philosophical alignment.

An investment philosophy can also provide advisers with powerful efficiency and marketing benefits, and help ensure a more consistent client experience across a practice and across client segments.

After developing an investment philosophy which is aligned to their own beliefs and their own advice philosophy, advisers should stress test their philosophy, by seeking the views of their peers, and using the various quantitative tools widely available from asset consultants and research houses.

———

References:
[1] https://www.investopedia.com/terms/i/investment-philosophy.asp
[2] https://justinbrand.com.au/blog/the-importance-of-an-investment-philosophy/
[3] https://longviewassets.com/buy-at-a-wonderful-price-or-buy-a-wonderful-company/#:~:text=As%20Warren%20Buffett%20once%20said,company%20at%20a%20wonderful%20price.%E2%80%9D
[4] https://www.fool.com/investing/how-to-invest/famous-investors/warren-buffett-investments/
[5] https://www.mfs.com/content/dam/mfs-enterprise/mfscom/sales-tools/sales-ideas/mfse_timing_fly.pdf
[6] https://ensombl.com/articles/how-to-stress-test-your-investment-philosophy/

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The ultimate outcome of greater client trust will be a deeper, more open relationship between adviser and client.

Trust is the bedrock of successful financial planning relationships. The establishment of trust between an adviser and client has been proven to facilitate more open and comprehensive communication, allowing the advice to be more tailored, more effective, and more valued. Trust has also been shown to drive greater client satisfaction, loyalty, and practice sustainability.

And yet many advisers lack a systematic approach to building trust, believing it to be more of an outcome of behaviours that are intrinsic and therefore ‘come naturally’.

While it is true that trust is to be earned rather than asked for, contact between client and adviser is generally infrequent and sporadic, meaning that advisers need to take every opportunity they can to build and reinforce trust. The most effective and efficient way to do this is to systemise trust into every aspect of your business, meaning trust is reinforced not just through adviser behaviours, but also through the processes used throughout the practice.

Why trust is so important in financial advice

There is an extensive body of research into the nature and outcomes of trust in financial advice.

Similarly, there is also research which demonstrates the extent to which the lack of trust is a barrier to the uptake of advice.

ASIC’s REP 627, published in 2019, found that distrust of financial advisers was one of the top reasons for not seeking financial advice:

By contrast, research suggests that once a client engages an adviser, they become much more positive about the value of advice, and trust is a key driver of this.

A study of US advice clients^[2] found that 81% gave their adviser a high trust rating, and that trust in an adviser was positively correlated with the client’s age, wealth, and tenure with the adviser.

That same study also quantified the extent to which trust was a driver of client satisfaction, loyalty, share of wallet and likelihood to recommend:

The findings reinforced those of an earlier Australian study^[3] – The Trusted Adviser – which concluded that trusted advisers:

• have higher client advocacy
• have better prospect conversion
• are more involved in their client’s personal and financial affairs
• deliver improved financial and outcomes and real value to their clients
• have higher client satisfaction
• have clients who are more accepting of, and willing to pay, advice fees
• run more profitable practices.

The drivers of trust

In order to build trust, it is important to understand what drives trust in a financial advice context. A University of Western Sydney research paper^[4] published in the Financial Planning Research journal synthesised research from around the world, resulting in a framework comprising seven characteristics of trust:

Vulnerability/risk

In order for trust to exist, there must be an element of risk or vulnerability. This is clearly true in a financial advice context, where the client is placing their financial futures in the hands of someone they may never have met before. The client can be vulnerable on a number of levels:

• they may be entrusting the investment of their life savings to the adviser
• they likely lack the knowledge and experience by which to assess the competence of the adviser and the efficacy of the advice
• the need for advice may be triggered by circumstances which leave them emotionally and financially vulnerable, such as retirement, divorce, or the death of a loved one.

Feeling

Trust in personal financial planning was found to have a large affective component – described as ‘a feeling’. In other words, trustworthiness is something that we are able to detect on a deep emotional and physical level. We all give off verbal and non-verbal cues that are indicative of our trustworthiness, and given the high financial stakes involved in an advice relationship, clients will generally increase their focus on detecting and interpreting these cues.

Honesty

Honesty is clearly a major pillar of trust in a financial context. Respondents in the Cull & Sloan study explained the meaning of honesty to be:

“The integrity of a person, their honesty, their fairness, their reliance, but most importantly, above all that, they carry out that fiduciary duty”.

Transparency, around fees for example, is an important aspect of honesty, with clients preferring advisers gave them a full and honest breakdown of their remuneration as early in the engagement as possible.

Faith

For trust to exist, clients must have confidence, or faith, that their adviser can be relied upon. Relied upon to give appropriate advice, and relied upon to honour their commitments, doing what they said they would do.

An important pointer here is that investment performance that is below expectation, or even negative, can undermine faith, and therefore trust. Successful advisers have learned not to tie their value to investment performance, which is largely out of their control.

Best interests

Beyond the regulatory and FASEA requirements around best interests, findings suggest that trust cannot exist in the client-adviser relationship unless the adviser is seen to put the client’s best interests first. The client must believe the motives of the adviser are benevolent, and not driven by self-interest. The approach to remuneration was a commonly cited marker of such benevolence.

Accountability

Clients acknowledged that they trusted their advisers because they understood that

their advisers could be held to account by their employer, regulatory body and/or professional association in the event of untrustworthy conduct.

Competence

As consumers, we seek counsel from professional service providers because we lack the knowledge and skills to deal with situations ourselves. This is as true for advisers as it is for doctors, lawyers and accountants. Clients seek financial advice because they recognise that they are at risk because of their own lack of knowledge about complex financial concepts and products, which is why competence – indicated by qualifications, experience, technical skills, and behavioural attributes – is a key driver of trust.

A practical framework for trust building

Having understood what drives trust in a financial advice context, it is necessary to then view those drivers through a more practical lens, so we can then design processes which emphasise those drivers.

Helpful here is research by Morningstar^[5] which refers to categories of behaviours seen by clients as markers of trustworthiness:

Systemising trust

Understanding these practical ‘markers of trust’ enables us to review every aspect of the advice value chain, and the underlying processes, to ensure that every opportunity to create and/or reinforce trust is being taken.

A useful way to conduct such a review is to follow the typical journey from prospect to new client to established client.

Building trust with prospects

Advisers have two important ways to ‘bake trust’ into engagements prospects have with a firm, even before any meetings take place. These are through a formal process of referrals and through their website.

As consumers, referrals from trusted sources – be it colleagues, friends, or other professionals we are working with ­– are important because they enable an efficiency of decision making. Researching what lawyer/accountant/architect to use can be an exhausting process, and the stakes can be high if you make the wrong choice. Being referred to a service provider by someone whose opinion we trust allows us to shortcut a lot of that work and also lowers the risk of making a mistake.

By ‘formal’ referral processes, we don’t mean that they have to be paid or underpinned by contracts. But rather there is a degree of systemisation around those referrals:

• a request for referral from clients is built into the agenda or script or run sheet for clients – not necessarily when advice is first given but after the first or second annual review when the client has had enough time to build genuine trust
• any external referral partners (e.g., accountants or other advisers) are equipped with materials, scripts, or other information which allows them to identify ideal clients to refer and can articulate with consistency and accuracy the details of you and your practice – in other words, it’s not an ad hoc process where the referrer has only sketchy details.

Your website is the window into your practice. Our first port of call when researching any product or service these days is almost always online, and so your website represents an easy way to build trust.

For example, if we refer to the Morningstar trustworthiness markers above, you can see how many can be reinforced through your website:

• communication (make it easy to contact you through your website and have a system to ensure messages are acknowledged and responded to promptly)
• expertise (while they shouldn’t be front and centre, your qualifications and experience in helping similar clients can be showcased, as can any industry awards)
• personalisation (testimonials from clients who are similar in their life stage and challenges)
• shared values (your website should tell a story about you, your firm, and your philosophies around advice)

Online reviews, such as Google, Trust Pilot, or even Adviser Ratings^[6] are also an increasingly important tool for consumers to build trust from the outset by seeing the views of satisfied clients. Encouraging clients to post these reviews – by sending them an email link – is another process that is easy to systemise.

Other tips to reinforce trust through your website include:

• reinforcing your longevity as a business (make it clear you are no fly by night)
• taking the time to keep the content and appearance fresh and contemporary (rather than stale, with the latest blog post being two years ago)
• providing educational content, whether that be through tools or blogs.

Initial meeting

Your initial meeting with a new client provides many opportunities to build trust, and many of these can be built into processes to ensure they are repeatable. Creating scripts or run sheets for these meetings is one way this can be achieved.

Such a script might include acknowledging and demonstrating gratitude if the client has come to you via a referral source.

Such a script might also include a discussion about fees as early in the meeting as possible. This is because the cost of advice can be substantial, and the uncertainty over the quantum of that cost can be a source of anxiety for many people. Until that anxiety is removed, the client is unlikely to be giving you their full attention, which can undermine the effectiveness of that meeting. Experienced advisers recognise that, rather than talking about remuneration too early being rude, it actually helps put the client at ease.

On the topic of fees, another way to systemise trust is by ensuring your fees are transparent and consistent.

As mentioned above, being seen to treat all clients equally underpins integrity, a key marker of trustworthiness. Whatever your fee approach (flat, percentage, commission), it should be clear and applied equally to all clients. If clients get a sense that fees are negotiated on an individual basis, this can immediately make them suspicious that an adviser is out to extract the highest fee they can negotiate, severely undermining trust.

The first meeting should be scripted in a way that it is clear that the adviser wants to truly understand the client as an individual. Structuring the meeting to ensure the client is doing more of the talking, and the adviser more of the listening, is key.

Another functional way to demonstrate care and build trust is to have – and be seen to have – robust privacy and data protection procedures. The nature of their role means advisers will be working with sensitive financial data from clients. Designing strong data protection processes, and explaining those processes to clients, can help build trust. 

The importance of education

Building an advice process which emphasises client education (through the structure of meetings and/or the provision of educational resources) can go a long way to building trust, as can ensuring all communication (verbal and written materials) is based on simple, jargon-free language.

Most advice clients have a financial knowledge gap which creates a vulnerability and makes trust paramount. In a sense, they are at the mercy of the adviser, and maintaining an air of mystique around advice as a way of creating a client dependency is not the way to engender trust. Those advisers who are open in sharing their knowledge and who have a process designed to educate their clients will not only be more successful in building trust, but they will also find their clients better understand and better appreciate the value of their advice.

Reviews

Clients do not see an 80-page SOA as the embodiment of advice. Rather, they are paying for help and for tangible outcomes, and in that context, regular review meetings are actually where the value of advice becomes truly tangible.

Extensive research^[7] has shown that discussing progress towards goals has both a positive psychological effect, and – as referenced above – helps reinforce trust in the value of the advice.

Reviews should be systemised to ensure:

• the importance of them is explained to clients
• they are always held (don’t leave it up to the client to decide)
• they are structured in a way that prioritises discussion of progress towards goals.

As previously mentioned, the review meeting can also be the ideal time to introduce a question about potential referrals.

Ongoing client care

Ongoing client care can be systemised to reinforce trust, underpinned by timely, effective communication.

So, what does systemising trust into communication look like?

Frequency of communication is clearly an important opportunity to demonstrate both the value of your advice, and your level of client care.

Aside from newsletters and statements and normal ‘regular’ communication, many successful advisers schedule time in their diaries to make personal check in calls to their clients, for no reason other than to see how they are. This can be a highly effective use of time which may otherwise be unproductive, such as when on the road, or between meetings.

Making a deliberate effort to use simple, jargon-free language, clear infographics, case studies and even the structuring of communication in a way that breaks information down into more easily understood ‘bites’ will go a long way to reinforcing trust.

Accessibility and service level agreements

It goes without saying that being accessible to your clients helps build trust. But this needn’t mean you have to be available 24/7. Systemising this through pre-defined response times and service level agreements can help reinforce trust by setting clear expectations and creating a series of opportunities to make, then honour, commitments.

Remind clients what you have done for them

Acting reliably and with integrity is obviously critical to building trust. But interactions with their financial advice are rarely top of mind for clients, making it important to remind your clients of all the individual tasks you have completed on their behalf. This helps build trust in two ways:

• it demonstrates you have kept your promises, and
• it reinforces all the work you do, and all the value they get for the fees they pay.

Systemising these reminders might include some sort of itemisation of work completed (beyond that necessary for fee agreements), which can be sent to clients at periodic intervals, or it may be as simple as scheduling calls or emails to let the client know work has been completed.

For more complex, time-consuming tasks, regular communication about progress, even if there has been none, reinforces your care and competence, in turn reinforcing trust.

Conclusion

Trust is clearly fundamental to successful adviser/client relationships and outcomes, and for most advisers, acting in with honesty, integrity, and caring for their client, is something they do intrinsically and naturally.

But the relatively low frequency with which clients and advisers engage means every opportunity to demonstrate the trustworthiness must be taken. Systemising trustworthy behaviours into advice processes throughout the entire client journey helps ensure these opportunities are always taken. It also ensures trustworthy behaviours are more repeatable, and can be delivered with more consistency by all staff within an advice practice.

The ultimate outcome of greater client trust will be a deeper, more open relationship between adviser and client, allowing advice to be more tailored, more effective, and more valued.

———

References:
[1] https://download.asic.gov.au/media/5243978/rep627-published-26-august-2019.pdf
[2] https://static.vgcontent.info/crp/intl/auw/docs/resources/adviser/Vanguard_research_Trust_and_financial_advice.pdf?20190930%7C173924
[3] https://www.afa.asn.au/wp-content/uploads/The-Trusted-Adviser.pdf
[4] https://www.griffith.edu.au/__data/assets/pdf_file/0018/205713/FPRJ-V2-ISS1-pp12-35-characteristics-of-trust-in-personal-financial-planning.pdf
[5] https://www.morningstar.com/financial-advice/how-keep-building-trust-with-clients-why-you-should
[6] https://www.adviserratings.com.au/
[7] https://eprints.qut.edu.au/215310/

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Digital and human advice may form new a ‘hybrid advice’ offerings.

While, at the time of writing, the Federal Government was yet to respond to Michelle Levy’s QAR recommendations, there is little doubt about the growing role for digital advice in bridging the advice gap.

“And so I am satisfied that the recommendations in this Report will assist existing providers – financial institutions and financial advisers – to provide more digital advice tools to their customers and clients. In many cases they will do so at no additional cost. I am also satisfied that they will help existing and new providers of digital advice tools to offer new digital advice services to consumers. To quote the Terms of Reference, they promise to ‘enable mass market adoption of low-cost advice”.
Michelle Levy^[1]

Driven by three underlying macro trends – the increasing cost of advice, the increasing digitisation of our lives, and the consumer preference for ad hoc, piece by piece advice – digital advice is likely to prove critical in allowing advisers and licensees to provide advice more efficiently, at lower cost, and in a more engaging way. Whilst the foreshadowed legislative streamlining of advice that could result from QAR would undoubtedly accelerate the adoption of digital advice technologies, the train has, in reality, already left the station, and the question is more when, not if, digital advice will be normalised.

But just as the advice landscape has been rapidly evolving, so too has our understanding and concept of what digital advice actually means.

Not many years ago, most of us interpreted the term ‘digital advice’ to mean ‘robo-advice’, which, in the absence of any precedent, was viewed by advisers as an existential threat, a faceless competitor that could eventually put them out of business by providing a cheap, algorithm-based, 24/7 service.

But times have changed. With the benefit of actual market experience, and countless research studies, it has become clear that consumers – even younger ones – still demand a degree of expert human interaction as part of their financial experience. Advisers too have changed their perceptions, realising the potential for technology to drive both efficiency and a superior client experience.

Increasingly, it is being recognised that the future of digital advice is a hybrid one, where consumers can – depending on their needs and where in the advice journey they are – access a combination of digital self-serve, algorithm driven information, education, and even advice, along with the human touch of a licensed financial adviser. The approach therefore becomes one of ‘do it together’ (with an adviser), rather than ‘do it yourself’ (with a bot).

In this article, we will explore this new context for digital advice. We will revisit the underlying macro trends powering its growth, and examine the technology solutions advisers are using. A practical framework for advisers looking to build their own digital hybrid advice offering will also be provided.

The ubiquity of technology, especially for younger clients

Technology is now a ubiquitous part of our daily lives. Consumers research and purchase everything from fashion to travel to cars online. They are also increasingly comfortable conducting financial transactions online, from simple payments and everyday banking to trading shares and making insurance claims. Decisions to engage, and stay with, a financial adviser, are also increasingly being based on the quality of the adviser’s digital experience.

Crucially, the usage and confidence with technology is higher among younger ages. But by ‘younger’ we aren’t talking about the teenage Tik Tok generation, we are talking about Generations X and Y, very much the advice consumers of the present. This is demonstrated in Table 1, below.

US research by Refinitiv³ suggests that around one third of Gen X (who are now aged 43 – 58) and a similar proportion of Gen Y (now aged 29 – 42) consider a wealth manager’s digital capabilities before choosing an adviser.

Similarly, research by Netwealth into the aspects of advice most valued by consumers found digital capabilities and innovation were both important⁴.

The rising cost of advice

Studies have shown cost has long been one of the biggest barriers to consumer uptake of financial advice. And that barrier has only become bigger. Thanks to an onerous regulatory burden and dwindling adviser numbers, advice fees have continued to climb, well in excess of inflation.

Data compiled into the ‘Padua Advice Fee Data Report’ for FY22 shows initial advice fees charged by advisers on a per-advice-document basis increased 16 per cent, from $2,859 in FY21 to $3,315 in the past financial year⁵. Ongoing advice fees saw an even larger increase of 33 per cent from $3,656 in FY21 to $4,865 in FY22.

Adviser Ratings research⁶ suggests that while many consumers are willing to pay for advice, there is a large differential between the amount they are prepared to pay, and the cost of providing that advice. In contrast with the $3 – $4k costs mentioned above, a massive 61% of consumers said they would expect to pay less than $500 for advice. An additional 22% said they would pay between $500 and $1,000, and only 5% would be prepared to pay between $2,500 and $5,000.

In this context, the heightened focus on a technology driven path to lowering the cost of advice is understandable.

Consumers prefer ad hoc, ‘piece-by-piece’ advice

Another theme identified by Michelle Levy in the QAR Final Report was the importance of limited advice.

The consumer preference for limited advice has been well documented for many years.
In 2010, ASIC Report 224 ‘Access to Financial Advice in Australia’⁷ found that, in aggregate, more consumers prefer limited (piece-by-piece) advice over comprehensive ongoing advice, a preference which was highest among millennials.

Fast forward to 2021, research by Investment Trends found that 38% of consumers wanted limited advice, compared to only 11% who wanted comprehensive advice⁸.

Despite the obvious consumer demand for limited advice, there is a longstanding supply-side reluctance to meet this demand, amplified in recent years by the rising cost to produce advice and perceived regulatory uncertainty around the legality of limited advice.

According to a study by KPMG⁹, the prevailing view among most licensees is that, in order to be compliant, the same amount of work needs to go into producing limited advice as comprehensive. To the extent that limited advice would likely involve less opportunities to recoup the loss made on the initial advice, the economic challenges of limited advice become clear.

The opportunity for technology is clear, but people still want human interaction

The role for technology, to drive efficiencies through automation, and provide the digital experience sought by modern consumers, is clear. But in contrast to those initial fears that consumers would prefer to deal exclusively with ‘robo-advisers’, the preference for a degree of human interaction remains strong¹⁰, even among millennials.

In a US study of advice clients released in 2022, more than 90% of investors who worked with a human adviser said they wouldn’t consider switching to a robo-adviser, while at the same time, 88% of robo-adviser users said they would consider switching to a human adviser in the future¹¹.

In Australia, research¹² by Investment Trends found that two in three Australians were open to using a digital advice tool to plug advice gaps, but ‘most would prefer to use in conjunction with some form of human interaction’, while a study by Griffith University researchers, ‘Man and Machine’, found that consumers had little faith in investment advice involving amounts over $1,000¹³.

The new world of hybrid digital advice

Having understood the key trends creating the conditions for digital advice to thrive, but also recognising the continuing consumer preference for some degree of human interaction, many existing and newer players in the space have declared hybrid digital advice to be the way of the future.

In late 2022, global banking giant, JPMorgan, for example, noted that pure digital financial advice was starting to lose traction in the United States as consumers warm to a hybrid advice model coupling human advisers with digital capabilities¹⁴.

A few months later, Nick Eatock, CEO of UK digital advice platform, Intelliflo, told the Australian Financial Review that global momentum was shifting behind a hybrid format.

“That hybrid-type approach is the winner, we think, of the investments that have been made in robo-advice. That’s the next step forward, and we’re seeing that certainly in the UK and US already.”¹

Digital solutions to support a hybrid approach

Advisers may be surprised that there are already many established solutions in the local market that can support them in to develop their own hybrid offering. Indeed, a recent industry wide benchmarking report¹⁶ identified 16 solutions, with more likely to enter the market as it becomes more established. (Some providers are awaiting the government’s response to the QAR report).

The capabilities of these solutions vary, with some capable of offering client engagement support only, some limited to general advice, and others can offer comprehensive personal advice.

Solutions that are comprehensive advice capable include, but are not limited to, Intelliflo, Dash, Capital Preferences, Ignition and Money GPS.

What does hybrid advice look like?

In a schematic sense, clients working with an advice firm would be able to access services along a spectrum, from purely self-serve ‘guidance’, through digital advice, through hybrid advice (digital with human interaction) to full service, traditional advice. Figure 2 below depicts this visually:

Fundamental to digital advice, and hybrid advice approaches, is that a lot of heavy lifting is done by the client themselves and the algorithm. This means initial information gathering and calculations and scenario modelling – the low value add administrative work and number crunching – is essentially done before the adviser needs to get involved. This means the adviser can focus on those parts of the process where they add the most value.

(And yes, digital self-serve models are capable of creating a fully digital Statement of Advice.)

Midwinter’s Steve Davison explains this in practical terms:

‘It can be relatively simple, such as insurance calculators that allow prospective clients to assess their needs before talking to an adviser, or scaled digital advice that delivers a more affordable service for specific areas of advice. In the future, they might see an investment property they would like to buy; they could crunch the numbers through an app on their phone, then talk to their adviser, who sees the same data. The adviser reviews against the client’s other financial priorities, gives their tick of approval and sends the Statement of Advice (or other advice asset) online.’¹⁸

As well as the hybrid approach offering a more engaging, flexible and convenient client experience, there are significant efficiency gains, which can translate into hybrid advice becoming more affordable.

UK digital advice provider, EV, estimates the hybrid approach could be up to 50 per cent less costly to provide versus most of the current traditional advice services¹⁹.

Steps to developing a hybrid advice offering

The first step in creating a hybrid offering is to understand that digital advice and human advice are not binary. Rather than hybrid advice being about managing two different advice channels, a hybrid offering is a seamlessly integrated spectrum of advice

Simplistically, success in this space will require advisers to:

• work with digital advice providers on designing the advice journey and creating the integration,
• ensure referrals are handled well, and
• continue focusing on digitising as much of their high touch comprehensive advice offering as possible.

Noting that an approach of evolution, rather than revolution, is likely to be more realistically achievable, a framework for implementing a hybrid model might include the following areas of focus:

• The importance of good data, data management and protection:
  • digitisation of files
  • cloud technology
  • cyber protection.
• Automating workflow:
  • process design.
• Digital client engagement:
  • video conferencing
  • client portals
  • digital signatures.
• Compliance:
  • Regtech.

Bringing this all together involves creating your digital roadmap, the first step of which will be to do your research.

As with many aspects of running your practice, the most helpful source of wisdom is likely to be your professional peers and other practice owners. Get a feel for the software and apps used by practices that have already commenced their digital advice journey.

With any tech implementation, it is important to have clear short-, medium- and long-term objectives and priorities.

It’s important to evaluate the technology you are already using in your practice – such as platforms – and the flexibility for it to be integrated with any new software.

Also think about the future. ChatGPT has burst onto the scene, and there is no doubt AI will become a big part of the advice tech landscape. So, explore how this innovation is likely to change the way you work in the future to prepare your practice for it.

Digital advice vendors can be a helpful source of guidance and advice around systems design and implementation.

The opportunity to rethink your target clients and redesign your advice offering

While the focus of this article has been on ways to digitise your offering to your current target audience, successfully implementing a hybrid approach can make your advice more accessible and affordable to a wider audience, creating the opportunity to reconsider your target audience and redesign your advice offering.

Conclusion

Digital advice can be a powerful enabler of more affordable, accessible financial advice. But whilst once considered a threat or alternative to human delivered advice, there is an increasing recognition that a hybrid approach is more effective. By incorporating digital advice tools into their offering, licensed advisers can offer a more contemporary, convenient client experience and drive down their cost to serve, while still being able to meet their client’s need for human interaction at key stages in their advice journey. With more than a dozen digital advice vendors already established in the market, and more primed to enter in the future, advisers wishing to commence their digital advice journey can draw on a deep pool of expertise, guidance, and technology solutions.

———

References
[1] https://treasury.gov.au/sites/default/files/2023-01/p2023-358632.pdf
[2] https://www.netwealth.com.au/web/insights/the-advisable-australian/the-advisable-australian-2021_six-dimensions-guide/
[3] https://www.refinitiv.com/perspectives/future-of-investing-trading/are-wealth-advisors-still-relevant-in-the-digital-age/
[4] https://www.adviceintelligence.com/blog/quality-of-advice-review-modern-adviser
[5] https://www.professionalplanner.com.au/2022/10/unsurprisingly-advice-fees-are-still-rising/
[6] https://www.adviserratings.com.au/news/what-everyday-aussies-would-pay-for-financial-advice/
[7] https://download.asic.gov.au/media/1343546/rep224.pdf
[8] https://www.moneyandlife.com.au/professionals/grow/improving-access-to-advice/
[9] https://fsc.org.au/resources/2299-kpmg-the-cost-profile-of-australia-s-financial-advice-industry-final-research/file
[10] https://lendedu.com/blog/robo-advisors-vs-financial-advisors/
[11] https://smartasset.com/financial-adviser/human-advisors-vs-robo-advisors
[12] https://www.professionalplanner.com.au/2022/11/research-finds-advice-gap-for-over-12-million-australians/
[13] https://news.griffith.edu.au/2022/10/11/artificial-intelligence-not-trusted-for-financial-advice/
[14] https://www.afr.com/companies/financial-services/robo-advice-declines-as-investors-warm-to-hybrid-model-20221108-p5bwi3
[15] https://www.afr.com/companies/financial-services/1trn-fintech-to-unleash-hybrid-financial-advice-on-australia-20230305-p5cphs
[16] https://corporate.amp.com.au/content/dam/corporate/newsroom/files/CCM-1182_KPMG%20Digital%20Advice%20Report_RND2.pdf
[17] https://info.ev.uk/digital-financial-advice-whitepaper
[18] https://www.midwinter.com.au/whitepaper-digital-transformation-guide/
[19] https://www.ftadviser.com/opinion/2023/03/01/firms-must-adopt-hybrid-advice-if-they-want-to-attract-the-next-generation/

The post Implementing a hybrid digital advice strategy – an adviser guide appeared first on AdviserVoice.

Many of the pillars underpinning the investment strategies of HNW clients have come under intense pressure in the last 12-18 months.

HNW clients are more exposed to disruption

2022 ushered in a new period of financial uncertainty around the world.

A prolonged market downturn was accompanied by runaway inflation and a ratcheting up of interest rates, leaving consumers feeling bruised and unsure where to turn. House prices have plunged, leaving some owners facing a negative equity scenario.

Investors, too, experienced their share of pain, with bonds and equities both delivering negative returns, leaving a hole in many superannuation balances, and leading many to question traditional investment wisdom.

One group of investors that has arguably experienced the most disruption in the past 12 to 18 months are the high net worth (HNW) individuals. Not just because they tend to be the most exposed to market risk, and generally have more at stake financially, but because many of the pillars underpinning their financial strategies have come under intense pressure.

Building, protecting and transferring wealth has always been complex, but now especially so. The preference of many HNW individuals to adopt a DIY approach is looking increasingly questionable.

In this article, we examine the evolving landscape for HNW individuals, looking at the challenges they currently face and how – with the help of financial advisers – they are responding and positioning themselves for 2023 and beyond.

Who are the HNW and what do they look like?

A quick search reveals a number of definitions of HNW in use in Australia, including:

• the Investopedia definition^[1] – $1 million in liquid assets (family home excluded)
• the Coredata definition^[2] – $1m in the share market, or earning an annual income of $450k and over (family home excluded), and even
• the ASIC sophisticated investor definition^[3] (annual income over $250k or net assets of $2.5m).

To be consistent with the Australian-focused research – and because rocketing real estate prices are rendering the ASIC definition less meaningful every day – this article will use the $1m in net investable assets criterion common to both Coredata and Investopedia.

Across the globe, according to Capgemini’s 2022 World Wealth Report^[4], there are around 22 and a half million HNW investors (of these, around 200k are classified as ultra-high net worth individuals, with net investable assets in excess of $30m USD).

In Australia in 2022, the HNW segment was estimated by Investment Trends^[5] to comprise around 625,000 individuals, investing more than $ 2.8 trillion AUD.

The millionaire next door

As tempting as it is to think of HNW as one homogeneous group – that is perhaps largely male, middle-aged and professional – in reality, today’s HNW client is just as likely to be a female entrepreneur or a young tech firm founder. And the stereotypical signs of wealth – expensive car, luxury brands – are not always present. Today’s HNW individual could well be your neighbour.

While various studies^[6] suggest the average age of a HNW investor is around 60, that average is dropping as more wealth finds its way into the hands of millennials.

Segmenting the HNW by wealth tiers reveals differences in profile and behaviours.

The rising economic power of female investors is also a standout trend around the world, and is redefining the way firms are approaching this segment.

Global analysis^[7] reveals that females hold around 40% of all US wealth, and a third of Australian wealth. But they are growing their wealth around 40% faster than males, and are expected to inherit 70% of global wealth over the next two generations. By 2030, females are projected to manage two-thirds of all household wealth.

Motivations for investing

To some extent, the money motivations of HNW and ultra HNW clients mirror those of many other investors – saving for retirement, the desire to make a social impact, preserving wealth and passing it on to family members, and leaving a legacy. However, the quantum of the amounts involved increases the number – and complexity – of solutions available.

Older HNW clients, boomers and beyond, have ridden a wave of enormous asset growth over their lives, in both equity and housing markets. It is these clients who are at the very centre of the enormous intergenerational wealth transfer we will see over the next two decades.

They will be more focused on preserving wealth as opposed to chasing it, with key considerations being:

• an orderly transfer of wealth to younger family members (44% of HNW clients are worried about this) ^[8],
• asset protection, and
• optimising tax treatment.

As times become more challenging, their demand for advice is increasing

Wealth does not guarantee financial literacy, and while the majority of the population are not advised, this is true also true of HNW individuals. Rather than being a group of sophisticated and self-directed investors, the HNW have just as much need for expert advice as other clients.

More than half recognise they need financial advice, and recent Australian research found a strong and growing demand amongst those seeking to use advisers to get a second opinion, and for access to a wider range of investment opportunities than would otherwise be available to them.

According to Investment Trends^[9], between late 2019 and late 2020, the percentage of HNW individuals seeking to ‘validate’ their ideas with a financial adviser rose from 40% to 56%. Over the same period, there was a corresponding fall in self-directed HNW individuals, from 49% to 34%.

In the same way the demand for advice went up in line with the Covid-induced market volatility of 2020, it is fair to assume the events of 2022 have similarly decreased the appeal of DIY, driving up the demand for advice even further.

Conservative and calm investors

In contrast to the stereotypical notion that all HNW investors are frequent traders chasing higher returns through complex and risky investments, research suggests the opposite.

In Australia, the 2021 Crestone State of Wealth Report^[10] found the top 3 investments held by HNW and Ultra HNW individuals to be:

• Australian equities (73.4%)
• Cash (72.4%)
• Direct residential property (43.4%).

As a group, they tend to stick with a strategy and asset allocation even during the most challenging times.

Indeed, according to Investment Trends, under two in five HNW investors (37 per cent) reported making substantial asset allocation changes to their portfolio in the year through ended 30 June 2022, down from 41 per cent in 2021 and 50 per cent in 2020 (a record high)^[11].

Of course, taking the aggregate view can mask critical behavioural differences, for example by age group. Crestone found that Gen Y was most likely to have a broad range of asset classes, including Australian bonds and alternative and/or emerging investments (both held by 26.2% of wealthy Gen Y investors)^[12].

One possible reason for this could be their willingness to adopt new technology and mobile trading platforms. These typically offer ready access not just to shares but to exchange-traded funds (ETFs) covering a wide range of asset classes and geographic locations.

Older investors on the other hand may have already established their investment preferences and behaviour:

“Overseas shares, I don’t know, okay you hear about the bigger companies but all these other ones … at my late stage in life, I thought no, I’m not going to bother.” 63 y.o. male HNW.^[13]

What are they thinking about in 2023?

Decades-high levels of inflation and associated interest rate movements are without doubt the dominant economic themes around much of the world right now. And evidence suggests the silent wealth-eroding effects of inflation are weighing more heavily on the minds of HNW investors than market volatility.

Australian research found that military conflict (55%) and inflation (48%) to be the two biggest investment concerns for HNW investors^[14]. This was consistent with US research^[15] by The Wall St Journal and Barrons, which found that inflation, political uncertainty and taxation (rather than market volatility) were the top 3 concerns amongst HNW and  ultra HNW investors.

A UK survey^[16] of 200 HNW investors, conducted by the Charles Stanley Group, also found inflationary fears to be paramount. 59% of those surveyed said they were concerned about the threat of recession and high inflation, a figure which rose to 69% for the over 55s.

They aren’t panicking in the face of uncertainty

Despite the reality of an inflation rate that equates to the largest wealth erosion rate seen in decades, many HNW investors are slow to move. A survey^[17] released by Standard Chartered in late 2022 found caution remains the foremost sentiment:

• 30% said they were spending less
• 31% said they were prioritising the protection of their wealth rather than chasing growth
• only 25% said they were looking to make new decisions around their portfolio.

Additionally, 86% of respondents to the Charles Stanley survey said they planned to invest and save in the same way as they always have

They are contemplating some asset allocation changes

The spectre of inflation has shone the spotlight on asset classes proven to respond well to inflationary times, including:

• commodities
• gold
• alternatives, and
• infrastructure.

In terms of how HNW investors are responding to inflation, the Standard Chartered study mentioned above found that 61% were looking to reduce their cash holdings (despite rising interest rates), 37% said they had invested in gold, and 22% were investing in a recovering bond market. More than half were also looking to increase their holdings of sustainable investments.

On the equity front, a degree of pessimism remains, with the majority of those with an equity exposure indicating they would reduce it (‘buying the dip’ seems to have lost its lustre).

67% of US advisers^[18] surveyed in 2022 expect HNW demand for alternatives to increase over the coming years as investors look for uncorrelated returns.

Their appetite for ESG remains strong despite recent underperformance

HNW individuals typically have a higher propensity to seek socially responsible investment options than average.

The Capgemini 2022 World Wealth Report^[19] found that 55% of HNW and ultra HNW investors said investing in causes with positive ESG impact is a critical wealth management objective.

Interestingly, that same report found in APAC, 55% rose to 69%.

In Australia, an Investment Trends study^[20] reported that 69% of HNW and ultra HNW investors said advice around ethical investing was an ongoing requirement.

And despite many ESG slanted funds underperforming in 2022 – as energy stocks soared – the appetite remains strong and is likely to grow further in 2023:

• a 2022 survey by PWC^[21] found that 42% of US HNW investors planned to increase their exposure to ESG
• in the UK, the Saltus Wealth Index^[22] research found HNW intentions to invest in green and social impact funds were higher in December 2022 than they were 6 months earlier (73% versus 64%).

SMSFs are becoming less popular

SMSFs have been a popular vehicle with HNW and UHNW investors for decades, especially those looking to drive down costs, or seeking more control over how their superannuation was invested.

ATO figures show there were around 603,000 SMSFs – worth $868 billion – in Australia as of 30 June 2022. The median assets per member at this time were $472, 824, many multiples greater than the median assets held by superannuation members generally^[23].

But recently released figures show the popularity of SMSFs may be waning, with new SMSF establishments for the September 2022 quarter at the lowest level seen in more than a decade^[24].

Experts believe there are several reasons for this.

Firstly, the perfect storm of 2022 led many would-be trustees to realise just how complex and challenging investment markets really are. The self-belief possessed by many individuals that they could do better than professional managers has undoubtedly been dented by seas of red ink in portfolios everywhere.

And secondly, many industry and retail funds have developed offerings specifically to appeal to those investors seeking more control and a greater array of options. Meaning much of what could once only be achieved via an SMSF is now possible within a professionally managed – industry or retail fund – framework.

As one adviser told the Financial Review:

“When you can do all the things you want to do with your super in a public offer fund in terms of investments, running pensions, estate planning etc, then why take on the responsibilities and duties, and hassle of having your own fund?”^[25]

While there is no doubt that for the ultra-wealthy, and those with complex estate planning needs, SMSFs can be appropriate, their appeal at the lower tiers of HNW is much lower (as per table 1 above), and seems likely to get weaker over time.

They are starting to bring forward intergenerational wealth transfer

While increasing life expectancies will generally see inheritances occur at older and older ages, HNW individuals are in a much stronger position to transfer wealth at much younger ages, and several aspects of the current economic climate are encouraging them to do so.

With increasing interest rates putting home buying increasingly out of reach for many young Australians, and making existing mortgages unaffordable for others, many older HNW individuals are deciding it may be better to transfer wealth sooner rather than later (tax and estate planning considerations notwithstanding).

As one expert^[26] told the AFR, “Wealth transfers on death are now too late to meet intergenerational needs when they occur”.

Hence the appeal of gifting. Typically, smaller than the inheritance (ATO data^[27] from 2018 suggested the average gift was $8,000, while the average inheritance was $125,000), gifting is about transferring wealth to younger generations when it is most needed.

And, anecdotally at least, it seems HNW clients are increasingly choosing to purchase homes, make mortgage repayments, put money into mortgage offset accounts, pay private school fees and clear HECs debts for their children and grandchildren. At higher wealth tiers, this early wealth transfer is likely to involve more complex strategies and structures such as trusts.

In summary

While the perfect storm that continues to consume investment markets has seen many investors frantically changing their plans and running for cover, true HNW and ultra HNW individuals have – with the help of their financial advisers – remained calm and focused.

Enabled by their wealth to take a longer-term perspective, current market volatility barely registers as a risk, with concerns around inflation and geopolitical instability being more top of mind.

Whilst not panicking, several trends suggest they are certainly responding to the current environment and repositioning themselves for the future. These trends are evident in the way they are making portfolio adjustments, reducing their use of SMSFs, and bringing forward family wealth transfers.

——–

References
[1] https://www.investopedia.com/terms/h/hnwi.asp#:~:text=Key%20Takeaways,for%20increased%20and%20better%20benefits
[2] https://www.newmodeladviser.com.au/3335/six-things-that-are-on-the-minds-of-australias-high-net-worth-investors/
[3] https://moneysmart.gov.au/glossary/sophisticated-investor
[4] https://worldwealthreport.com/download-report.html
[5] https://www.ifa.com.au/news/32127-aussie-high-net-worth-investor-numbers-steady
[6] https://www.praemium.com/hnw-investor/
[7] https://www.bcg.com/publications/2020/managing-next-decade-women-wealth
[8] https://www.crestone.com.au/2019-state-of-wealth-report/
[9] https://www.ifa.com.au/news/29422-the-rise-of-high-net-wealth-advice-validators
[10] https://coredatainsights.com/wp-content/uploads/2021/12/Crestone-2021-State-of-Wealth-Report-new-addresses-ELECTRONIC-lo-res.pdf
[11] https://www.ifa.com.au/news/32127-aussie-high-net-worth-investor-numbers-steady
[12] https://www.superguide.com.au/smsfs/how-the-rich-invest
[13] https://www.superguide.com.au/smsfs/how-the-rich-invest
[14] https://www.praemium.com/hnw-investor/
[15] https://thetrust.wsjbarrons.com/intelligence/inside-the-minds-of-americas-wealthiest/?utm_source=wsj-search&utm_medium=CustomContentWSJ
[16] https://www.charles-stanley.co.uk/insights/commentary/high-net-worth-investors-inflation-plan
[17] https://africaneyereport.com/two-thirds-of-investors-changing-investment-strategies-to-combat-inflation/
[18] https://apnews.com/article/inflation-be17487ad8c14a03b4bff9f6c0e0464f
[19] https://worldwealthreport.com/download-report.html
[20] https://www.praemium.com/news-insights/hnw-investors-highlight-the-strategic-advice-opportunity-of-esg/
[21] https://www.pwc.com/us/en/industries/financial-services/asset-wealth-management/high-net-worth-investor.html
[22] https://theintermediary.co.uk/2022/10/73-of-high-net-worth-individuals-invest-in-esg-research-shows/#:~:text=High%2Dnet%2Dworth%2Dindividuals,the%20Saltus%20Wealth%20Index%20Report
[23] https://www.superguide.com.au/smsfs/smsf-statistics#:~:text=The%20latest%20available%20ATO%20figures,market%20disruption%20due%20to%20COVID
[24] https://www.afr.com/wealth/personal-finance/new-smsf-accounts-plunge-as-big-super-fights-back-20230209-p5cjbg
[25] https://www.afr.com/wealth/personal-finance/new-smsf-accounts-plunge-as-big-super-fights-back-20230209-p5cjbg
[26] https://www.afr.com/wealth/personal-finance/six-inheritance-strategies-to-make-your-children-richer-20221123-p5c0ql
[27] https://www.afr.com/wealth/personal-finance/six-inheritance-strategies-to-make-your-children-richer-20221123-p5c0ql

The post How HNW individuals are navigating volatile times and positioning for the future appeared first on AdviserVoice.

Advisers are building deeper, more sustainable relationships and delivering better outcomes for their clients.

What are clients really seeking from their adviser?

The value of financial advice is one of the most discussed, debated, and researched topics within financial services.

Poor consumer understanding of the value of financial advice often translates into a lack of willingness to pay for it, resulting in a community uptake that has remained stubbornly low, in turn putting individuals at heightened risk of poor decision-making in an increasingly challenging and complex economy.

Rising costs and falling adviser numbers will only serve to put advice even further out of reach for many Australians.

As Australians deal with rising interest rates, a cost-of-living crisis and volatile investment markets, the need for expert help in navigating the financial landscape has never been greater, and successfully communicating the value of financial advice has never been more important.

But is the consumer concept of value in advice aligned with that of advisers?

Or is it possible that those advisers who build their proposition around being investment experts are not only misreading what consumers want, but are setting themselves an impossibly high bar to get over? Can advisers do more for the performance of their clients’ portfolios by being more of a coach/mentor and less of a stock picker?

In this article, we will explore the concept of value in advice, examining the latest research on what clients value in advice, and how the adviser value proposition is evolving to be less investment centric and more focused on spending quality time with clients. And how, as a result, advisers are building deeper, more sustainable relationships and delivering better outcomes for their clients.

What clients value most about advice

The value clients derive from advice may not be what advisers expect, with various studies revealing that the functional outcomes of advice (lower tax bills, higher investment performance) were less important than relationship and emotional outcomes.

An ASIC study^[1] of consumer perceptions of the benefits of advice found empowerment, overcoming anxiety and helping transitions to new life stages were commonly cited, along with improved financial knowledge, providing a reality check and establishing goals.

Similarly, research by CoreData^[2] found the five attributes of an adviser relationship most valued by clients were:

• understanding me, my circumstances and my needs
• trust
• ease of communication
• transparency, and
• competence in managing complex financial issues.

In the strongest client/adviser relationships, the adviser isn’t just playing the role of financial coach, they are providing all-round emotional support for clients navigating the ups and downs of life (many of which have financial implications).

This was reinforced by an XY Adviser Survey^[3] which found that on average, Australian advisers spend 45% of their time with their clients talking about non-financial personal issues. That same survey also found these personal, non-financial conversations were having a positive impact on clients, with:

• almost half of advisers (47%) agreeing there was more effective communication between husband and wife, parents and children, or others who may be significant in the client’s lives, and
• 47% feeling their client was living a life closer to their core values, and enjoying what is most important to them.

The advisers surveyed reported a positive business outcome as well, with 52% saying their ability to do a good job at financial planning was enhanced or improved, and 39% agreeing their business had increased as a result. (Unsurprisingly then, 94% of advisers surveyed said their role as coach and counsellor was increasing in importance).

Building relationships means more client ‘face time’

It is clear, if not obvious, that an adviser’s time creates the most value when it is spent building and maintaining trusted relationships. These relationships may be with clients and/or prospective clients and in-person or virtual.

There is no universally agreed upon benchmark as to what percentage of an advisor’s time should be face time, although some industry observers believe it should be as high as 80%.

Australian research by Virtual Business Partners^[4] showed a positive correlation between adviser face time and income, with the highest-paid advisers spending over half their time in client meetings, and around a third on business development (and just 4% on investment management).

The challenge in spending more face time with clients

While upping client face time is clearly in the interest of both the client and the adviser, it is easier said than done.

Advisers have many demands on their time. As well as staying on top of product changes, tax laws, Centrelink rules, superannuation regulations, and of course increasingly challenging investment markets, they also have to devote time to:

• professional development
• compliance, and
• general administration.

And, if they are a practice principal as well as an adviser, those demands will also include:

• managing staff
• marketing and client communication
• technology, and
• general management of the business, including profitability, proposition development, and process design.

An impossible balance to achieve?

Advisers need to balance the need to spend more time building client relationships with the often competing needs to drive down costs, maintain and build their technical knowledge, stay abreast of market developments, remain compliant, and continue to deliver high-quality investment advice and outcomes.

Whilst at first glance this may seem an impossible balance to achieve, it is actually one being successfully achieved every day by Australian advisers, through the power of outsourcing.

Outsourcing by advice practices

Outsourcing has been used by successful advice practices for many years.

Examples range from automation, through to ‘internal outsourcing’, where practice management functions are allocated away from advisers, to outsourcing to external third parties.

Adviser Ratings data shows the growing popularity of external outsourcing, with the average practice now having the equivalent of one outsourced staff member for every six internal team members^[5].

Functions commonly outsourced to third parties include specialised capabilities such as:

• paraplanning
• compliance
• technology management
• client administration, and
• marketing.

Offshoring some of these functions is common.

The main economic benefits of external outsourcing are derived from:

• freeing up the adviser to spend more time building and maintaining client relationships
• realising cost savings by tapping into scale benefits offered by larger external providers
• outsourced functions being performed to a higher standard, leading to better client outcomes and greater client satisfaction
• lower error rates and less rework.

Paraplanning

Paraplanning is highly time intensive, and hence outsourcing this function, either to a specialist within the practice or to a third-party external provider, is one of the most obvious ways to create more client-facing capacity.

Some estimates suggest the average SOA takes 10 hours to produce, meaning every single outsourced SOA frees up the equivalent of 2 hours every day.

Irrespective of whether you outsource in-house, or go fully external, the cost saving can also be significant too, with the paraplanner salaries typically lower than the cost of advisers. Some offshore providers of paraplanning are able to offer a further cost saving, in some cases around 30% lower than the cost of an Australian-based paraplanner^[6], creating even higher savings potential (although managing offshore service providers may be more time intensive, thus eroding some of the benefits).

Externally outsourcing paraplanning also introduces more flexibility in your resourcing, making it easier to scale up in times of high demand, without the risk of having an under-utilised resource during quiet periods.

Outsourcing administration and specialised tasks

Other functions that are ripe for outsourcing include:

• those requiring highly specialised expertise beyond the capabilities of small practices (such as marketing, social media, design, and technology), and
• non-client-facing, high-frequency, low-value, repetitive tasks such as application forms, bookkeeping, and preparing client paperwork.

The benefits of outsourcing administrative tasks can be especially significant for smaller practices, and this adviser perspective is fairly typical:

“We realised early on that we can’t do it all, so we outsourced. Using an outsourced admin service to supplement our Australian staff has saved us so we can spend time on more technical work. Using a virtual assistant for social media builds our presence and is now a reliable source of referrals for us.”^[7]

Outsourcing of investment capabilities

The potential benefits of outsourcing are equally applicable in a field as complex and dynamic as investment management, although adviser willingness to outsource investment management has historically been lower compared to other business functions, for a number of reasons, including perceptions around the loss of control, cost, and the idea that investment management is their ‘secret sauce’.

But investing is highly regulated, highly complex and expensive. It is also challenging to do well and is becoming increasingly treacherous. As the complexity, cost and challenges of investing continue to grow, research suggests adviser reluctance to outsource investment expertise is declining. In the US for example, the proportion of registered investment advisors outsourcing investment management grew from just over one quarter (27%) in 2020 to just under one-third (32%) in 2022⁸.

At the same time, those who do outsource reported extraordinarily high satisfaction levels:

• 98% of outsourcing advisors said it allows them to deliver better investment solutions to their clients, and
• 91% said their growth of assets under management had accelerated since outsourcing⁹.

In Australia, this trend underpins the popularity of model portfolios and managed accounts, which allow advisers to outsource the detailed construction and day-to-day management of client portfolios.

• a decade ago, 16% of Australian advisers were using managed accounts with their clients^[10]
• this had grown to 44% of advisers by 2020 and 53% by 2021^[11]
• advisers are now recommending them to 60% of their clients, seeing funds in managed accounts grow by 22% over the 21/22 financial year, to $135 billion.^[12]

Managed discretionary accounts have proved especially popular, with the outsourcing of the discretion to make portfolio changes underpinning a significant efficiency and compliance benefit, as an individual SOA or ROA is not required every time a transaction takes place on the portfolio.

Recent research by Investment Trends^[13] suggests the use of managed accounts was giving advisors 15.7 hours, or two days, back every week, in reduced client administration, compliance and communication.

In the words of one adviser:

“We’ve been using managed accounts now for nearly five years and it’s been a game changer for us in terms of efficiency, transparency, client education and most importantly, the outcome for the clients have improved. This freeing up of time and resources has enabled us to form deeper connections with our clients by focusing on what is really important to them.”^[14]

The other reason not to tie your own value-add to investment performance

When markets tank, and performance is volatile over an extended period of time (i.e., the conditions we face now), any negative or below-expectation investment performance will reflect directly on you and the value of the expertise clients are paying you for (even though the circumstances are out of your control). This does not make for positive, sustainable relationships, or career satisfaction!

A superior client experience

If advisers are saving time – and possibly costs – by outsourcing, it is important to invest those savings where they will deliver the most benefit, and happily, this appears to be the case. For example, Australian research has found 68% of managed account users say they now have more time to focus on helping clients with their goals^[15].

In addition to spending more time helping clients with specific decisions at any given time, advisers can also invest more time in educating clients (individually and as a group), and improving their understanding of the financial principles and practicalities of growing wealth. This can be especially valuable in intergenerational wealth transfer scenarios, where many clients value the opportunity to impart knowledge and a sense of financial responsibility onto their children, helping set them up for a more secure future.

Another key reason to build a proposition around spending more time with clients is that it can deliver better outcomes, including improved investment performance.

Helping clients manage their behavioural biases and stay on track during periods of stress is especially valuable, and indeed a number of studies^[16] have concluded that behavioural coaching can add 1-2% net annual return to a client, around twice that attributed to asset allocation, and 6 times that from portfolio rebalancing.

Conclusion

Clients place more value on the emotional and relationship benefits of advice than they do on functional benefits, such as investment performance. Unsurprisingly, research shows that those advisers who spend more face time with clients generate higher revenues.

With so many other demands on their time, the main pathway to creating more client-facing capacity is to outsource onerous business functions. Functions ripe for outsourcing include paraplanning, marketing and client administration. And, despite historical reservations that it was central to their own value proposition, investment management is also increasingly being outsourced, especially through the use of managed accounts.

As a result of outsourcing, advisers are able to spend more time, educating and mentoring their clients and helping them remove emotion from investment decisions at times of high stress. Clients in turn are benefiting from superior service and investment outcomes, reinforcing to them the value of advice.

——–

References:
[1] https://download.asic.gov.au/media/5243978/rep627-published-26-august-2019.pdf
[2] https://www.fidelity.com.au/insights/investment-articles/the-value-of-advice/
[3] https://www.xyadviser.com/financial-advice-reimagined/
[4] https://intl.assets.vgdynamic.info/intl/australia/documents/resources/adviser/2020_aus_fin_advice_landscape.pdf
[5] https://www.adviserratings.com.au/news/where-do-paraplanners-fit-in-the-future-advice-puzzle/
[6] https://www.planlogic.com.au/2021/11/10/the-numbers-behind-in-house-vs-outsourced-advice-production/
[7] https://www.professionalplanner.com.au/2023/03/the-2-best-things-ive-done-to-improve-my-business/
[8] https://www.thinkadvisor.com/2022/09/21/more-rias-outsourcing-investment-management-survey/
[9] Ibid.
[10] https://www.professionalplanner.com.au/2022/03/most-advisers-now-using-managed-accounts-research/
[11] Ibid.
[12] https://www.professionalplanner.com.au/2022/09/managed-accounts-grow-another-22-during-fy22
[13] https://www.professionalplanner.com.au/2022/08/managed-accounts-giving-advisers-two-days-back-a-week/
[14] https://www.professionalplanner.com.au/2023/03/the-2-best-things-ive-done-to-improve-my-business/
[15] https://www.fsadvice.com.au/blogs/how-advisers-use-managed-accounts-in-australia-and-overseas-for-better-businesses
[16] https://www.xyadviser.com/financial-advice-reimagined/behavioural-advice-alpha/

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What are the practical steps to articulating value that clients derive and are prepared to pay for?

Defining the value of advice has never been more important

The term ‘value proposition’ is one financial advisers hear and read about frequently, and for many years now, the profession has been urged to do a better job of articulating the value of advice to consumers, in order to increase its uptake.

The mass exodus of advisers from the profession in recent years has created a massive supply side constraint – there simply aren’t enough advisers to meet even modest levels of demand – to the extent that many advisers are rushed off their feet without even trying.

But this is a false dawn, as advisers stare down three emerging disruptive forces:

• the slow but sure rise of robo advice and artificial intelligence
• the looming intergenerational wealth transfer, and
• the potential entry of large and new players into the advice space, as a result of the Quality of Advice Review (QAR).

In this context, it is imperative that advisers revisit their value propositions, to ensure they are aligned with their capabilities and target markets, and to ultimately ensure they can make their practice as ‘future proof’ as possible.

In this article, we will explore the concept of the value proposition as it pertains to financial advice. We will examine the client perspective on the aspects of advice they value most, and look at how advisers believe they need to deliver value. We will also provide practical tips on how advisers can construct and articulate their value proposition in a way that can help strengthen client relationships, make it easier to justify their fees, and make their practice more sustainable in an uncertain future.

What is a value proposition?

In simple terms, your value proposition is a statement of the value you provide, to whom, and how you do it uniquely and well. Put another way, why should clients choose you, and why should they pay your fees?

A strong value proposition should be:

• compelling and relevant to your target customers
• differentiated from your competitors, and
• supported by proof points.

Tied up in the concept of a value proposition is the idea that you can’t be all things to all people and expect to succeed – you need to have a clear idea about what customer segment you are serving and then align your entire offering to their needs.

An easy way to understand this concept is to consider brands like Aldi, Jetstar, and IKEA. They are all brands for whom low prices are central to their offer. But they also have a clear idea about what their customers value, and what they are prepared to trade off.

With IKEA, there are only a few store locations, and you need to build your own furniture.

There are generally long queues at the checkouts.

At Aldi you are buying ‘house brands’, there is less choice, and you have to pack your own bags and pay for a trolley (and return it to get your money back).

With Jetstar you have to pay extra for catering, checked baggage, or to choose a seat.

All these elements allow the price to consumers to be shaved to the bone.

What is the value of financial advice?

One of the challenges advisers face in creating a meaningful value proposition is understanding the value clients actually derive from financial advice.

As tempting as it is to think in terms of the functional elements and outcomes of advice – such as investment returns, tax savings, a financial plan, or a diversified portfolio – these are generally not where clients themselves derive the most value. They are also not particularly differentiating or compelling.

Linking your value strongly to investment performance will also be problematic, especially during times of volatility and uncertainty (such as now!).

So then, what is the client perspective on the value of advice?

There is an extensive body of research^[1] suggesting clients place more value on the emotional – rather than functional – benefits of advice. The process of articulating goals, creating a plan to achieve them, and monitoring progress against those goals has been shown to have a significant and positive psychological impact, beyond mere investment returns.

A number of recent Australian studies shed light on the aspects and outcomes of advice that are most valued by clients.

A 2019 study^[2] by CoreData asked a random selection of advised clients which factors they used to assess the quality of their relationship with their adviser. The ranked responses are shown in Table 1 below.

More recently, the FPA’s inaugural Value of Advice Index^[3], launched in October 2022, identified the top 10 key benefits clients realised from their advice relationship, as shown in Table 2.

The research referenced above makes crystal clear the importance of the relationship aspects of advice, and advisers investing in the relationship management element of their proposition will undoubtedly reap rewards in terms of both client acquisition and retention.

Importantly, relationship management is very hard to replicate, by either competitors or robots, meaning advisers who focus on the hard-to-automate human side of their proposition are more able to inoculate their practices from future competitive threats.

Robo v human

A US study of advice clients, released in 2022, found an overwhelming affinity for the human touch^[4]. More than 90% of investors who worked with a human adviser said they wouldn’t consider switching to a robo-adviser, while at the same time, 88% of robo-adviser users said they would consider switching to a human adviser in the future.

To the extent that the take up of robo-advice in Australia lags the US significantly, it seems reasonable to assume that local investors would exhibit a similar preference.

Intergenerational wealth transfer – opportunity, or risk?

The much-discussed intergenerational wealth transfer is underway around the world. According to research by Griffith University^[5], the amount of wealth that is ripe for transfer in Australia over the coming years is around $3.5 trillion. Around half a trillion sits with people aged 80 and over, with transfer therefore imminent.

While this should represent an enormous opportunity for advisers, it is actually shaping as an existential threat, partly because of the complex dynamics of parent-child relationships, and partly because of the different financial behaviours and attitudes that characterise younger clients.

US research^[6] suggests around two-thirds of ‘inheritors’ will discard their parent’s advisers, either appointing their own or exiting the advice system altogether. Concern over the potential loss of this wealth is echoed in the recent finding that 59% of UK financial advisers fear the health of their entire business is at stake^[7].

This challenge will not be addressed via a proposition focused on investment performance; it requires more focus on building relationships with younger generations within client families.

Advisers are looking to add value beyond asset allocation

Unsurprisingly, investing time and effort into building client relationships, rather than the functional, aspects of their proposition has been made the top priority by many advisers.

A 2020 global survey^[8] that asked financial advisers to identify the top 5 skills they needed to improve on found that relationship-building, communication, and client decision-making were all top priorities.

Advisers are rethinking their core proposition

There is clear evidence advisers are recognising what is truly valued by their clients, with US research confirming a continued decline in the share of advisers who view investment management as their primary business proposition. The 2021 survey⁹ by FlexShares found that only 33% of advisers identified investment management and research was their primary business proposition. This compares with 45% of advisers in 2016 and 56% in 2014 who identified investments as their central value proposition.

The biggest influence on investment performance is behavioural

Even allowing for the importance of investment performance as an enabler of clients achieving their life goals, the ways advisers add value to that performance are not necessarily what many would think.

Extensive research^[10] has suggested that behavioural coaching and financial education – helping clients avoid short term, panicked, poorly informed, and even irrational investment decisions – can add 1-2% net return to a client, around twice that attributed to asset allocation and six times that from portfolio rebalancing.

Building your proposition by identifying the source of value

The creation of your value proposition is the culmination of a process where you consider what is important to your clients, and what is important to you.

Rather than assuming what is important to your clients, the best way is to ask them, via some sort of online or face to face research. This research doesn’t need to be complex; you can start by asking a few simple questions of new and existing clients:

1. How would you describe your long-term financial goals?
2. Why did you engage a financial adviser?
3. What criteria did you use when searching for an adviser?
4. Why did you choose me?
5. Would you recommend me to a friend or colleague? Why? Why not?
6. At a BBQ, how would you describe what you value about our relationship?
7. Have I met your expectations?

Revisiting your target market and offering

A key component of your value proposition is who you are uniquely positioned to create value for – your target market.

Futureproofing your practice may well mean going down a more specialised path, allowing you to be much more focused in who you can help. This can help your marketing and messaging be more targeted, and can also help you focus and align your service offering and client experience to the needs of that audience. For example, products and services and access channels you would offer a retiree would differ to those you offered a small business owner, or a high-net-worth client, or a millennial.

A quick test of how well aligned your proposition is to your target market is to ask yourself the following questions:

• Do you have existing clients in this segment?
• Do you understand their unique needs?
• Do you understand the language they speak?
• Are you comfortable engaging with them?
• Do your premises and branding reflect that target audience?
• Do you have the right technical knowledge to offer the types of advice they need?
• Does your business have the right resources to operate in this market?
• Do you have the right referral sources?
• Do you have clients who fall outside your target audience, and if so, how viable is it to keep serving them?

Finally, write it all down

Formalising your value proposition has many benefits.

It gives you clarity and focus, helping you build your practice and client experience around that proposition, and making it clear what type of clients to turn away.

It can be shared with staff, and given to referral partners so they understand the type of clients to refer, and just as importantly, those not to refer.

It can guide your market facing language, in terms of your branding, your content, and your website.

Formalising your value proposition may be done at two levels – a summary level, and an expanded, client-centric level.

To construct the first level, you need to consider:

• Who you help (target audience).
• How you help them (service offering).
• The positive outcomes and value they derive from your advice.

As an example, this may result in a statement looking like:

“We help over- 50 middle-income earners co-create a retirement plan that will deliver confidence and clarity in their retirement incomes, so they can live a retirement that is comfortable, fulfilling, and stress free”.

While this high-level statement can prove useful for staff and referral partners, and to guide strategy, crafting your market facing messaging to be more customer-centric may require you to expand on this.

An example can be found in the work of US adviser, Mitch Anthony^[11], who articulates the six key value propositions of financial planning from a ‘Return on Life’ rather than a ‘Return on Investment’ perspective:

• Organisation: We will help bring order to your financial life, by assisting you in getting your financial house in order (at both the ‘macro’ level of investments, insurance, estate, taxes etc, and also the ‘micro’ level of household cash flow).
• Accountability: We will help you follow through on financial commitments, by working with you to prioritise your goals, show you the steps you need to take, and regularly review your progress towards achieving them.
• Objectivity: We bring insight from the outside to help you avoid emotionally-driven decisions in important money matters, by being available to consult with you at key moments of decision-making, doing the research necessary to ensure you have all the information, and managing and disclosing any of our own potential conflicts of interest.
• Proactivity: We work with you to anticipate your life transitions and to be financially prepared for them, by regularly assessing any potential life transitions that might be coming, and creating the action plan necessary to address and manage them ahead of time.
• Education: We will explore what specific knowledge will be needed to succeed in your situation, by first thoroughly understanding your situation, then providing the necessary resources to facilitate your decisions, and explaining the options and risks associated with each choice.
• Partnership: We attempt to help you achieve the best life possible but will work in concert with you, not just for you, to make this possible, by taking the time to clearly understand your background, philosophy, needs and objectives, work collaboratively with you and on your behalf (with your permission), and offer transparency around our own costs and compensation.

Summary

At a time when the advice profession faces several looming disruptive threats, it has never been more important for advisers to define and articulate their own value proposition.

To resonate with clients, a proposition must take the perspective of the value they see in advice, rather than be assumed. A common mistake is to express the value of advice in functional outcomes, such as investment performance or tax saved, or the production of a financial plan, whereas the areas clients value – and are prepared to pay for – are more likely to be emotional.

A growing number of advisers recognise this, and are seeking to prove they can add value beyond asset allocation, investing more time and resources in the client relationship aspects of their skills and offering.

The advisers who do this well will be rewarded with improved strategic clarity, client loyalty, and practice sustainability.

——–

References:
[1] https://www.xyadviser.com/financial-advice-reimagined/
[2] https://www.fidelity.com.au/insights/investment-articles/the-value-of-advice/
[3] https://fpa.com.au/news/australians-who-engage-a-financial-planner-have-a-better-quality-of-life-fpa-launches-inaugural-value-of-advice-
[4] https://smartasset.com/financial-advisor/human-advisors-vs-robo-advisors
[5] https://www.afr.com/wealth/personal-finance/how-to-get-the-great-wealth-transfer-right-20191205-p53h7b
[6] https://www.investmentnews.com/the-great-wealth-transfer-is-coming-putting-advisers-at-risk-63303
[7] https://www.ifa.com.au/news/32268-why-advisers-fear-intergenerational-wealth-transfers
[8] https://www.im.natixis.com/resources/2020-financial-professionals-survey-executive-overview
[9] https://www.thinkadvisor.com/2021/02/04/landscape-change-for-investment-outsourcing/
[10] https://www.xyadviser.com/financial-advice-reimagined/
[11] https://www.netwealth.com.au/web/resources/insights/how-to-write-a-compelling-value-proposition/

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