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Bogleheads on Investing with Michael Kitces and Nicole Boyson – Episode 47

Post on: June 30, 2022 by Rick Ferri

Our Episode 47 features two guests who discuss the evolution in the investment adviser industry over the decades and the conflicts of interest that have occurred.

Michael Kitces is the head of planning strategy at Buckingham Wealth Partners, co-founder of the XY Planning Network, among other companies, the host of the Financial Advisor Success podcast and the publisher of the Kitces Report newsletter, and the Nerd's Eye View blog at kitces.com.

Dr. Nicole Boyson is the chair of the Finance Dept at Northeastern University’s D'Amore-McKim School of Business. Her research focuses on institutional investors, with a current interest in conflicts of interest among financial advisors. She also serves as a co-editor (3 co-editors) for Financial Analysts Journal and is on the board of directors for the Eastern Finance Association.

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Rick Ferri: Welcome everyone to the 47th edition of Bogleheads on Investing. Today we talk about the evolution of the investment advisor industry with two special guests: Michael Kitces, head of planning strategy for Buckingham Wealth Partners, and Dr. Nicole Boyson, finance department chair at Northeastern University's D'Amore-McKim School of Business.

Hi everyone, my name is Rick Ferri, and I'm the host of Bogleheads on Investing.  This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501(c)3 nonprofit organization dedicated to helping people make better financial decisions. Visit our newly designed website at boglecenter.net to find valuable information and to make a tax-deductible contribution.

And don't forget about our Bogleheads conference coming up this October 12th through the 14th, featuring many speakers that I've had on this podcast---and more. There are a few seats remaining. You don't want to miss out. Visit boglecenter.net for more information.

In this episode of Bogleheads on Investing we're going to be talking about the evolution of the investment advisor industry and some of the conflicts of interest that exist with two special guests. Our first guest is Michael Kitces, one of the most prominent thought leaders in the financial services industry. He is the head of planning strategy at Buckingham Wealth Partners, the co-founder of XY planning network, and, among other companies, he is the host of the Financial Advisor Success Podcast, and the publisher of the Kitces Report newsletter, and the Nerd's Eye View blog at kitces.com. 

Our second guest is Dr. Nicole Boyson. She is the chair of the finance department of Northeastern University's D'Amore-McKim School of Business. She's also served as the co-editor for the Financial Analyst Journal, and is on the board of directors for the Eastern Finance Association. Her research focuses on institutional investors, with current interests on investment advisors. Her paper that we'll be discussing today is titled "The Worst of Both Worlds: Dual Registered Investment Advisors." 

So with no further ado I'm pleased to have with us today Michael Kitces. Welcome to the Bogleheads on Investing Podcast, Michael.

Michael Kitces: Thank you Rick, great to be here. I appreciate the opportunity.

Rick Ferri: It's a real pleasure to have you because you are the leader out there in the advisor community, bar none. You're the voice, so to speak, and rightly so, on your blog, A Nerd's Eye View and on your website kitces.com, for mostly advisors and the advisor community.

Michael Kitces: I know we have a good number of Bogleheads that come over and read as well. We appreciate--some of it circulates there--and hopefully helpful ways for everybody who's reading it for themselves.

Rick Ferri: The information you put out there, everything from taxes to insurance to trust work, I mean is certainly very, very helpful to individual investors and very helpful to advisers. I mean I've learned a lot by reading your information and watching you on videos, and also in person at various conferences. And by the way, how many conferences are you doing a year now?

Michael Kitces: Oh man. Well historically it was 50 to 70 events that I  was out for in person. I'm still doing about that many but not everything's in person, on the road anymore. It's more of an even split between in-person and lots of webinars and virtual broadcasts and live streams. Because that seems to be our post-pandemic era.

Rick Ferri: Sure. Well that's fantastic. Okay, so let's get first into, you know, how did Michael Kitces become michaelkitces.com, Nerd's Eye View. Tell us the story of your life.

Michael Kitces: Nah the story of my life. So I was born and raised in the Washington DC area. I was the son of two computer scientists. So like nerding out on computers and technical stuff from a very early age, I was hacking my own computer games on my Commodore 64 when I was six years old. Probably kind of dates me a little. I went to college in the sort of classic New England liberal arts experience, like we teach you to critically think but prepare you for nothing in particular, fruitful adults. 

I went to college as a psychology major, theater minor pre-med student and the only thing I figured out by the end of college was that I did not want to do psychology, theater, or medicine. So I was getting ready to graduate and needed a job and landed somewhat randomly in the financial services industry.

Rick Ferri: Well before we get to that I want to circle back to college because I remember you and I were at a conference together one time and we were walking around and we came across this big hall and they were doing ballroom dancing. And you turned to me and you said, “That was me. I did that in college.”

Michael Kitces: Yes, yeah. So I was co-captain of the college Ballroom Dancing Society and  this was way before Dancing With The Stars. This is all the way back in the 1990s, and yeah, I did a lot of competitive ballroom dancing throughout college, and then after graduation took lessons and was hardcore into it. And then 10 years later got married and now have been married for 11 years. So unfortunately, very little time for it these days. Life got very busy.

Rick Ferri: Obviously you didn't become a professional ballroom dancer. You ended up somehow in the financial services industry. So could you tell us how did that happen?

Michael Kitces: My grandfather, my mother's father, passed away when she was fairly young and so my grandmother suddenly found herself the young widowed single mother of two young girls and needed to provide for them. And so back all the way back in the 1960s she went and had to get a job. And she ended up getting a job as an assistant for a life insurance salesman from the New England Life Insurance Company. She did that for many, many years as my mother and my aunt grew up. And when my mother got married shortly after college to my father, the insurance agent has this moment of--what do you give your secretary's daughter when she's getting married--a life insurance policy, because he was a life insurance salesman.

So he gives my father a life insurance policy. Fast forward 20 plus years my grandmother is retired, this life insurance agent has retired. I am now getting ready to graduate from college and my father gets a phone call from a New England Life Insurance agent that says, ”Mr. Kitces you have a life insurance policy with us. You've had it for many, many years. It looks like no one's been out to see you in a long long time because the original agent has retired. Someone should come out and review the policy.” 

So the agent comes out and reviews the policy. And then at the end of the meeting the insurance agent takes off his insurance agent hat and puts on his sales manager hat because he was also the recruiter for the local office, and said, ”By the way, now that we reviewed the policy, I just wanted to ask, do you know anybody who might be wanting to come into the industry because our company's hiring.”

My father said, “Funny thing, my son's about to graduate from college. He has no idea what he wants to do with his life.” I come home on spring vacation. My father's like great news, I got you an interview because you need to figure out what you're going to do when you're graduating because you're not coming back here. And so I interviewed for the insurance company, got the job.

As I learned many years later, it was probably less my wonderful potential as a strong student  and willing to work hard, and a lot more that of the zip code that my parents lived in. They were hoping that my parents were from a fairly affluent neighborhood where I would know people with money to whom I could sell life insurance. Unfortunately for them, what they didn't realize was my parents moved to that neighborhood in the ‘70s before there was any money in that neighborhood. I did not have any natural market of my parents friends and family that I was supposed to sell life insurance to, which made that very challenging.

Rick Ferri: Well let me read something that you put on your website about that job, which I found striking, and it goes right into what we're going to be talking about today. You wrote, when I started my career as a financial advisor more than 30 years ago I couldn't believe the company that hired me let me put financial advisor on my business card. The reality was I didn't actually know anything about giving financial advice or economics or money.

Michael Kitces: I was a psych major, theater minor.

Rick Ferri: But this is the way it was. And in many cases, I mean, I guess I'll ask you this now. I mean is it still that way?

Michael Kitces: It still is for a lot of the industry, like at the end of the day they put financial advisor on my business card. My job was not to give advice, which frankly was good because I didn't know anything about money and hadn’t gone to school for that. I didn't learn anything. My training was how to sell the company's variable universal life policy because that was kind of the big thing back in the late 1990s. It was sales training because I wasn't a financial advisor, I was an insurance salesperson. It was a nice euphemism on my business card to say financial advisor but I was a salesperson. I was literally paid on commission to sell the insurance policies. And that distinction, the term financial advisor, is used very, very widely. Some people who use it literally are in the business of advice. They get paid for advice and they charge fees for advice and they receive advice. But we also still continue to hire people in the industry, we call them financial advisors but they're sales people.

Rick Ferri: That used to be 90% of the industry, 90% of the industry was at least you're being hired to sell. I mean when I came out of the military I didn't know anything either. They hired me because I might be able to recruit veterans.

Michael Kitces: Yep, and a natural market.

Rick Ferri: Yes, and I was a pilot so go after the pilots. That's why they recruited me. And I thought I was being recruited because I was financially savvy. I mean I did run an antiques business when I was in college. So it must be sort of related.

Michael Kitces: I thought the same thing, like I had good grades. I was a hard worker. I was like, no I was hired for the zip code that my parents lived in.

Rick Ferri: But at least to your credit you realize that, and you began on this other career.

Michael Kitces: Yeah. I mean it didn't take long for me, literally into the first year, sitting with the prospect in their home across from them on their kitchen table, talking to him about “quote” financial advice. Which was basically selling him a variable universal life policy. He had accumulated about $300,000, a pretty, pretty darn good amount of money 20 plus years ago. He was already well into his 50s. He wanted to retire in 10 years. He was trying to figure out how to get from here to there. And it was like this is what I've got. What do I do? What do I do for the next 10 years to get from here to there so I can retire. Because he was in a practice that was burning him out. 

And I remember sitting across from him and was like I have no freaking idea what you should do. I'm a psych major, theater minor who just got trained in one type of product that I'm supposed to sell you because it's literally supposed to be the answer to every single person I sit across from and I'm just supposed to do that for enough people that eventually some of them will inevitably say yes. And I mean just we're taught in the industry it's a “quote” game of numbers. If you just pitch your thing to enough people eventually some of them will say yes, and you'll get to a sale.

And just this was a crisis moment for me of: my God, this is literally his financial life on the line and I have no freaking idea what I'm talking about, and I probably should. And so that took me down-- now granted I perhaps went a little overkill on it-- like I got my CFP certification and then a master's degree in financial planning and then five more professional designations, than a second master's degree in taxation. So granted, I maybe went like a little bit off the deep end in that dynamic once I went down that path. But just I mean to me, look, financial advice is I really view it as a sacred duty and I’m not trying to be melodramatic. Literally people's lives can be destroyed by finances. Money problems are the number one cause of divorce and marital strife. It's a very common issue tied to suicide. Just, in general, people with more access to wealth tend to have better life expectancies and better health outcomes because of the accessibility that wealth creates to medical care. People's lives and livelihood are literally on the line. You can't screw around with that.

Rick Ferri: You have a conscience. That's the problem.

Michael Kitces: Yes, and for whatever it's worth, I did not get the sale that day. He didn't buy.

Rick Ferri: Let's start out the conversation with the evolution of the advisor industry. You've given talks on this. I've listened to your talks. I think they're very good and you go through four phases. You think we're in the fourth phase now, so why don't you go ahead and tell us how you see the evolution of the industry. And by the way, I've been in it for 35 years so I lived the evolution.

Michael Kitces: Yeah you've lived most of these transitions.

Rick Ferri: Anyway, I might throw in my two cents as we go along. Yeah go ahead and start from the beginning. 

Michael Kitces: Yeah. So the beginning of financial advisors for most of us it was pure product sales. We sold insurance, we sold annuities, we sold stocks, right. Most of the roots of the industry are essentially like it's the stock market, it's the Charlie Sheen Wall Street 1980s model, Wolf of Wall Street model, of stock brokering. And I mean it paid well. If you go all the way back to even to the 1970s, like for big clients we could get paid $200 a trade in 1975 dollars just to sell a stock to an individual client, right. That's--I don't know what number-is probably $1,000 plus today as a ticket charge.

Rick Ferri: That was the fixed commission rate.

Michael Kitces: That was the fixed commission on a big trade. It was scaled to the size of the trade. That would be a big one, but

Rick Ferri: Every firm at the same rate.

Michael Kitces: Every firm at the same rate by law because FINRA back then, the National Association of Securities Dealers had fixed it at a set rate. It was part of the aftermath of the Great Depression. There was a whole bunch of commission gouging in like the boom and the bust of the ‘20s and the ‘30s. Nobody paid attention to what they were paying when stocks were going to the moon in 1929 and then no one paid attention to what they were paying when stocks were going to the ground in 1931. So there was a bunch of commission gouging when people were just desperate to buy and sell and the regulatory response back in the ‘30s was well, we're just going to set all the trading commissions at a fixed rate that every brokerage firm charges.

Good news, it got rid of all the gouging. Bad news, it obliterated all the innovation because no one reinvested into making brokerage more efficient because you were legally barred from competing on price. So by the 1970s we decided this regulatory structure has run its course. It's time to let it go. We deregulate the stock trading commissions and a startup in northern California, right outside of Silicon Valley, says, “You know, hey, like it’s the 1970s, these things are coming out called computers. I think we could use computers to replace financial advisors. Why are we paying all these stock brokers so much money, a computer could do this.

Rick Ferri: Discount brokerage firm.

Michael Kitces: And a lot of people are familiar with the company because the guy that said this was named Chuck Schwab, and Schwab was founded the month after the deregulation of trading commissions. Basically to create, call it robots of the era, to eliminate human financial advisors. As it turned out it didn't kill advisors, we're still here. But it did obliterate stock trading commissions. We went from $200 a trade down to $20 of trade by the 1990s. Obviously over the past 20 years we took it from $20 all the way down to zero. So it did kill the stock brokering model and it forced us all to shift. And so as financial advisors we shifted into a new environment. We said well anybody can sell you a stock, I will find a great stock picker. We went into the mutual fund business and said we'll get you mutual funds with great managers.

And a huge growth cycle, the mutual fund industry alone in the 1990s grew from less than half a trillion dollars to five trillion dollars. It was a 10x growth cycle. If you think the ETF shift has been big in the past 10 years, the mutual fund shift in the 1990s was actually bigger, when you adjust for the market size at the time, all driven by technology that was obliterating the financial advisor business model. So we were all reinventing ourselves from stock brokers peddling stocks into mutual fund sales people. Still on the sales person side.

Rick Ferri: There was actually something else going on too. It was the wrap fee account. This was started in the 1980s and really took off in the early 1990s. In fact Shearson Lehmann which became Smith Barney started a whole division that did this. CFAs, Phds all get together and they're going to go out and they're going to pick the managers that are going to outperform the institutional managers and we are going to let you, who might have a couple of hundred thousand dollars, hire these very top-notch managers and charge you only 3% wrap fee.

Michael Kitces: Very, very generous of them, and who cares, stocks were making 14% a year back then. It's who cares if the house gets a 3% vig. You're making only 11% net, it's still great.

Rick Ferri: So phase two is this mutual fund, or manage money separate account management / mutual fund concept. And then what happened after that.

Michael Kitces: The internet showed up. All this discount brokerage becomes online brokerage. E-trade runs all of their wonderful commercials, like you know, buying mutual funds is so easy a baby can do it. And they had the picture of the baby day trading stocks and mutual funds from the crib. All of a sudden you could buy mutual funds and more practically Schwab again being one of the leaders in the space launched their One Source program where you could get almost any mutual fund in a giant supermarket with no commission. I mean we would do them as no load funds.

But the load is the commission that the advisor or mutual fund sales person gets, and so a no load mutual fund marketplace essentially meant the internet brokerage companies were giving away a hundred percent what advisors did for no commission, when our money came from commissions. Which created the next crisis of business model for advisors and shifted us to where a lot of us are today, which was this huge shift into the assets under management model. So anybody can pick a mutual fund on a brokerage platform. I will create for you a diversified asset allocated portfolio of all of it, brought together aligned to your goals, in your time horizon and consistent with your tolerance for risk. And for this aggregate service of everything brought together I will charge you merely 1%, lower than the 3% that Shearson Lehman was going to charge you for the wrap account.

And so you see this sort of explosive growth over the past 20 years in the rise of assets under management and once you're building assets under management we tend to build them with ETFs to the point that now you see the entire mutual fund complex in net decline. That's the tail end of when we started shifting away from the model in the late 1990s when the internet showed up, a natural outcome is now we're mostly in an AUM model charging these standalone 1% assets under management fees, and the whole mutual fund sales complexes is in a net outflow.

Rick Ferri: Yeah I see the ETF evolution as giving the brokerage industry, the traditional Merrill Lynch, UBS, Wells Fargo brokers the ability to do this wrap fee. Now it's to compete with the independents who left. But I left the brokerage industry in 1999 to go and become one of these advisors and the ETF, evolution of the ETF has allowed the wirehouses, traditional wirehouses  to kind of backtrack and get into that business and compete head on head.

Michael Kitces: Some of it is part of the evolution of that model itself right? Just even from the advisor's end, right? As I’m sure more than a few listeners have observed as well, like at some point I can just buy an asset allocated mutual fund on my own or can do this with a handful of Vanguard funds and pretty much get this done. It's like why am I paying you Mr. Advisor. So one version of this goes down the road of sort of deeper financial planning advice which we'll probably come back to in a few minutes.

The other version of this is well I'm going to manage your asset allocation more effectively, more proactively, and one of the big shifts to me that's happened just over the past 10 years is a lot of financial advisors have essentially become active managers of ETFs and that's become one of the big models in our space. So we used to buy the mutual funds and say the fund is the manager, I just picked them. Now we're often building with more passive vehicles or the ETF is structurally more passive vehicle, but a lot of advisors are actively managing the ETFs and not trying to necessarily justify if it's right or wrong. Frankly some of them probably do it okay and a bunch of them probably not so much, because we have a lot of other things we're doing as well.

But relative to the mutual fund model, part of the big shift and focus has been the advisor comes and says look, you know you're got a bunch of mutual funds with an expense ratio of 2% because you own C shares, which essentially is 1% to the manager and 1% to the advisor who sold it to you. That's their trail commission. And the advisor comes in and says like well instead of just getting paid 1%  for the mutual company for selling it to you on top of their 1%, I'll manage your portfolio for you for the same 1% but if I’m going manage it for you, I don't need to give them their 1% on top of mine. I'm going to  buy it with a whole bunch of ETFs and I'm going to do this for 10 or 20 basis points of ETF cost and so now my all-in cost as an advisor, you know it's 2% with your mutual fund portfolio, it's 1.2%  with my fee plus the ETFs. I can save you 40% off of your fees.

Not necessarily a cut to us as advisors. I mean that's the reality in the industry. I mean that's why you're seeing so much of this shift within the advisor world towards ETFs as we're feeding on our own, right. The advisors that want to build lower cost portfolios are killing the mutual funds themselves as a way to bring down costs for our clients. I mean you can look at that in a good or bad way. Obviously the cynical version is just we come up with a way to defend our 1% and stick it to everybody else. But the good version of is like hey at least we're like we're proactively trying to earn our 1% by getting every upstream cost structure down as little as we can, and I do think just when you look structurally at the declining expense ratios across the industry right now, it is that shift in the advisor business model that's driving a lot of it.

When I sold mutual funds I didn't get paid for finding a lower cost fund. I got paid for selling a fund that had a good story because that's what sold. You know all the way facts like the Munder NetNet was the big one when I was getting going. In this environment at least for the advisors who are managing portfolios on an AUM basis our incentive as the advisor is to drive at least every other cost down that we can. We'll go through the pressure for ours but at a minimum we try to force every other cost out of the system and because there are so many advisors in the aggregate, again, I think that's part of why you see such growth in ETFs and the whole mutual fund complex in net decline like we're causing it because the fee model puts you on the client side of the table. It's like when I represented the mutual fund company I had no reason to bring down your costs. When I represent you I have every reason to bring down your costs because frankly that's one of the ways I justify my fee as an AUM advisor.

Rick Ferri: So along comes Betterment, Wealthfront, Vanguard and they're going to do the same thing that you just talked about. Not only are we going to drive down costs by having low cost funds in your portfolio but we are going to charge you a low fee and this. This is another evolution that advisors appear to be grappling with right now. Especially the 5,000 pound gorilla which is Vanguard itself. At a 30 basis points PAS program, all of a sudden showing the world that you can have some advice plus portfolio management and you don't need to pay 1%. You pay 0.3%. And so is this a different phase now? Have we then moved to a different phase of advising that might include separation of asset management and advice, and could you talk about that?

Michael Kitces: Yeah we are very much in that  fourth phase transition, right. So round one was stock brokering, and then computers with discount brokerage killed it. Round two was the mutual funds and the online internet environment killed it. Round three was building diversified asset allocated portfolios, and then the rise of robos and the technology as well as just sort of the ability to work with people virtually is now disrupting that and driving this fourth phase to it.

The industry likes to talk about the proverbial 1% but if you really actually look at most advisory firms and just take how much assets they have in total and how much revenue they bill, the average really is closer to about 70 to 80 basis points than it is 1%. There's some discounting, and like I'll handle your kids accounts with charging them separately. And there's some money where you want to hold on to the stock because you've had it a long time. It's I'm not really going to manage it, I'm going to put it in a separate account and we'll oversee it but we're not actively trading it. So the true net fee usually is a little bit lower than 1%.

And so what I think you're starting to see emerge in this dynamic is that the advisor fee is essentially getting disaggregated into sort of three three primary components. What's the raw cost to just build and manage a diversified asset allocated portfolio, and it's not a terribly high number. It's not a zero number. Just there is some staff, there is some labor, there are some systems that have to get built. But that's kind of converging in this 20 to 30 basis point-ish.

Rick Ferri: Yeah 25 basis point’s a good number. 

Michael Kitces: The second component that you're seeing is all of, I'll just probably call it, the financial planning advice, and that varies tremendously by firm and capability because we all use the title advisor but we may not have as much training, experience and knowledge, and advising in actual advice. But that's everything from retirement planning, advising on insurance, advising on taxes, covering estate issues, just getting into cash flow and budgeting and where is your money going. Higher level questions about just is your money actually going towards the things that fulfill you, from a cash flow basis, from how your dollars are invested from what you're trying to pursue. I don't get that from a robo. That's a human conversation and an exploration conversation.

Rick Ferri: Let me jump in here and ask you though, I mean that could be a conversation you have with somebody who has $300,000. It could be a conversation you have with somebody who has a million. It could be a conversation you have with somebody with two million. Somebody who's going to inherit ten million. I mean it doesn't have anything to do really with the size of the portfolio. So how do you reconcile aligning a fee with this advice part of being an advisor?

Michael Kitces: So I'd answer that in, I guess, two primary ways. One, I mean just to acknowledge there is a segment of industry that's starting to decouple that a little bit. That's doing things, I've got a financial planning fee that's whatever my number is, two grand a year, three grand, or five grand a year, or higher for some firms. And then I’ve got a separate fee for just managing your portfolio, and that's 50 basis points or some at least much lower number relative to the proverbial 1%, because the planning stuff scales in a different way than the investment management stuff.  And the fees are decoupling a little, so some of that is happening already.

The other answer I would give to it though, just in practice, so there are two interesting things to me that do happen just as wealth lifts up. One is complexity does start to rise. It's not a perfect proxy. I've had clients with five million dollars whose lives were simpler than people who had $200,000 because of what's going on in their world. But it's actually a pretty decent correlation of the amount of complexity that's going on and the amount of wealth overall that we have. In part just because more wealth is more choices, more at risk, frankly like more predators coming after us trying to sell us crappy things.

Just wearing my advisor hat, I spend a lot of time explaining to clients why the thing is getting pitched to them is crappy, and not actually good. And when you've got more wealth a lot more things often can get pitched at you. Just the raw stakes of some strategies, not necessarily the retirement conversation but good tax planning strategies can just literally have more mathematical impact when there's more dollars at stake. So part of that is why does a five million dollar client get to pay 10x to $500,000 clients. I’m charging a percentage of a portfolio that's 10x the size. Part of that is a proxy for complexity.  There is actually more stuff going on. If you look at most advisory firms, either they do more stuff for their more affluent clients, like there is more services rendered, or you are getting more senior expertise in the planning experience. Smaller “quote” smaller clients may work with slightly less knowledgeable and experienced advisors, not say they're inexperienced. But it's kind of like the law firm thing, like if I'm a small offering client I get the seven year associate.If  I'm  a lot more at stake I get the senior partner who has 37 years of experience and has seen my situation more times than I've been alive.

So there are kinds of gradations that come in both. Advisors usually have a graduated fee schedule. So frankly, like 10x the portfolio usually isn't 10x the fee. It may still be 5x or 7x but it's not perfectly linear. But more services, more experience, more dollars at stake, more consequences for the decision, because there does come a point where if you've got a lot of dollars and you're getting advice from someone, you want to make sure they have something at stake and some skin in the game for the consequences of their advice. And so for better or worse I think that's why you see the model hold up and continue to persist as strongly as it has. 

Now that doesn't speak to a huge segment of people who literally don't need anyone to manage their portfolio. I just want to pay for advice. And obviously that whole assets under management model, that just doesn't work. And so there's the growth of advice only models and subscription models that are planning based on a whole lot of other really cool fee innovation that's happening there for the whole segment that's “I just want to pay for advice. I don't need investment help.” But for the folks that do, where all of that gets bundled together like you know wealth is not a perfect proxy for complexity in dollars that are at stake but there is a piece of that.

Rick Ferri:  One final question. The advisor industry continues to evolve. The asset management industry continues to evolve. Fees continue to go down. People are trying to figure out the model. It doesn't seem like any of the old stuff's going away. I mean there's still commission sales people. There's still insurance people selling whole life insurance.

Michael Kitces: Well like sometimes I just want to buy a product.  And I mean sometimes I really do just want to buy a product and want someone to sell it to me. There is a time I go onto the car lot. I just want someone to sell me the car. I don't need a holistic automotive family consultant. Just sell me--I'm just here to buy a car, like sell me a car--tell me about the features and benefits. Help me make a choice and then take my order. So yeah, sales isn’t going away.

Rick  Ferri: And then also AUM, 1% advising, where the advisor is trying to select ETFs, that you know, adding alpha with tactical asset allocation or smart beta or whatever you're doing trying to add excess return. I mean that's not going away.

Michael Kitces: No it just there will always be a segment of people who are willing to pay for the opportunity for outperformance. You know, lots of debate about whether they're going to find it and we both read all that research, but just, right, it's a human nature thing. There will always be a portion of us that are willing to pay for the opportunity to do better.

Rick Ferri: What I'm getting at here is that the old models have not disappeared. They just overlaid a new model on top of it, and then a new model on top of that, and so we've talked about the latest new model. So my last question to you, because we have a limited time here, is what's the future? If you look forward, what's the good stuff that's happening in the advisor industry? And then well maybe you could start with what's the bad stuff that you see happening going on and then what's the good stuff.

Michael Kitces: Here's the worst of the bad stuff to me right now. The worst, the bad stuff is that the whole industry has figured out the future is advice, the future is just more more holistic advice, because I can get a diversified asset allocated portfolio from a platform for 25 or 30 basis points. So we ain't winning on that, got to find somewhere else to add value. And so the whole industry has figured out the future is advice, and our regulators are very, very behind on this because there is just open broad unfettered usage of titles, like financial advisor by people who are literally not in the advice business. Like their legal job is to represent their company. To sell a product. We see it in the insurance channels. we see it in the brokerage channels. This ubiquitous adoption of financial advisors, financial consultants, in similar sounding terms from people who are just literally legally a salesperson. And usually it says somewhere on their business card, registered representative as such and such, or licensed agent of such and such. Which is a nice way of saying I literally don't work for you, I work for that company in the...

Rick Ferri: In the securities offered through blah, blah, blah.

Michael Kitces: Correct, the brokerage industry figured out the future as advice before the advice industry figured out how to protect their own space. And so the brokerage industry now is so encroached into the advice based talk, with the titles, with the marketing. You go to most brokerage firms' websites, they're talking about the holistic value of all the stuff they do to help your wealth management picture. And their literal legal purpose is to manufacture and distribute product. They are not in the business of advice. That just confuses the bejesus out of the consumer landscape in ways that frankly the brokerage industry benefits from. Which is why they continue to do it.

Rick Ferri: And what do you see as the bright spots?

Michael Kitces: To me, when I look at the bright spots I see a few. Like number one, the big one by far is we are in this transition from sales to advice, and relative to my roots, I know your roots as well, having sat on the sales side of the table. This shift of the industry from sales to advice, what it means to me at the end of the day, is I used to sit across from the client, try to sell them something. And now I sit on the client side of the table and we look out there at the landscape of what we can do that's best and beneficial for them. 

Rick Ferri: So there's also a shift to different non-asset management fee models, where hourly or retainer. Do you see that growing as well?

Michael Kitces: The AUM model is basically just a tiny niche model. It works for a very, very small subsegment of consumers who have a material amount of assets; liquidity to actually hand it to an advisor – so it's not business or real estate or a 401k plan or something else; a willingness to delegate it to an advisor – it's like you don't want to do the portfolio stuff yourself. By the time you take how many people have enough money to meet at a typical advisor minimum, have it liquid and available and not tied up in a 401k plan, have a mental inclination towards delegating in the first place, you get down to something like five to ten percent of all households and the model does not fit literally like 90% of the marketplace. 

And so as I look out this shift is underway towards other fees. That's what, that's how the majority of consumers will need to engage advisors because you want a service you pay from your available income. That's how we buy everything else. Assets under management, it's just this really specialized niche model. It happens to work really well for a segment of affluent retirees that just want to delegate so they can enjoy the retirement and hire a firm that has the expertise to handle it. But that's not most people. And so when I look out in the future l see the AUM model continuing to grow but it will probably be a minority of advisors in a niche in 10 to 15 years.

Rick Ferri:  Michael it's been wonderful having you on Bogleheads on Investing. Thank you for being on the show today.

Michael Kitces:  Absolutely. My pleasure, thank you.

Rick Ferri: Our second guest is Dr. Nicole Boyson from Northeastern University. I apologize for the quality of the sound on my end because I recorded it in a small room in a library while I was on vacation and the acoustics were not very good. So here we go.

So with no further ado let me introduce Dr. Nicole Boyson. Welcome to the Bogleheads on Investing podcast .

Nicole Boyson: Thank you Rick.  Please feel free to call me Nikki.

Rick Ferri:  Thank you Nikki. I wanted you on the podcast because you are one of the rare academics out there who have studied the advisor industry as an academic. So you have no skin in this game. You don't work for an investment company. You don't work for a mutual fund company. You don't work for brokerage firms.

Nicole Boyson: That is absolutely true.

Rick Ferri: Before we get started on your research in the advisor industry I wanted to hear your background. How did you get to this point where you are today as the department chair for finance at DMSC.

Nicole Boyson: Yeah. So I think the interesting part is I started out as a CPA. So my first job out of undergrad was in public accounting at KPMG Peat Marwick and I worked as an auditor, attained my CPA license, did that for about three years and realized that being an auditor is a pretty good job but it's also a little bit tedious. And so I went to work for one of my clients, it was a commercial bank, and then I moved on to work for another person who does play a role here, who is an investment advisor. He was a fiduciary in some sense, but he also was a broker and so I remember learning about that business. I was 25 years old and thinking this is a really interesting space, right?

It probably took me about six months to understand the fees he was charging, how he was charging them, and I can say pretty clearly that I'm not certain his clients fully understood. So I kind of tucked that away. It's 1996, I went on to leave that job, worked back in public accounting and there I was in the investment advisory space at Ernst & Young and so a little known fact, but the big accounting firms do have some investment advisory space. Some of them are registered and some of them are more giving advice as part of their tax client business. And so I got to learn a little bit about RIAs and what that looked like.

Ultimately turned 30, decided if I was going to go get a Phd it was a good time to do it. So I went off to Ohio State, got a PhD and started immersing myself in academic research and so that was a lot of fun.

Rick Ferri: Okay. So you've been in academics then for more than 15 years.

Nicole Boyson: Yeah more than 20 years. I started my PhD in 1998 and graduated, call it 2002 -  2003, went to work for Purdue for a little while, just over a year and then got my current position at Northeastern in 2004. And so I've been able to kind of move up the academic ranks which has been really wonderful.  You start as an assistant professor, get promoted with tenure, and then was promoted again to be a full professor. Recently took on the department chair role, which as academics know comes with pros and cons. Also co-editing the Financial Analyst Journal, which I'm really proud of and excited about.

And then my research has evolved. I started out being very interested in hedge funds. I started my program in 1998 and for those of you who know about hedge funds, that's when Long-term Capital Management blew up and it was just a really interesting time to study that, and I was also very fortunate to be kind of young in that area. I mean I was young, but the area was young as well and so I was able to do a lot of really cool work with new data sets and try to understand risk and return characteristics. Moved on to start focusing on hedge fund activism, which I would say is probably my key body of work. I worked on that for eight or ten years.

And then the last few years decided to just go back, think about that investment advisory job that I had back in 1996 and I started that project--which we'll talk about in detail--but I started thinking about that project. I'm interested broadly in investing, and institutional investors in particular, and I started looking at mutual fund flows. For whatever reason I was just reading the ICI [Investment Company Institute] report because that's what academics do. And I was reading this report and I noticed that funds where money was flowing into institutional share classes of mutual funds, which are presumably cheaper, and often in my mind, what I thought were going to institutional investors and moving out of the broker sold side.

And having worked for a broker way back when, I thought this is probably good for clients because if brokers are no longer able, and again, brokers are not evil, but the broker I worked for was pretty opaque about the fees he charged. And so institutional funds are cheaper and often sold turns out – I learned this – by registered investment advisors. So I thought this would be good, right? RIAs are fiduciaries. They have their clients best interest at heart and they're selling these share classes that are cheaper and presumably more transparent in the way that they charge fees. So my initial premise was this is a very positive thing, but let's look into it a little deeper.

Rick Ferri: So as the mutual fund flows from the Investment Company Institute annual report, ICI, as you stated, that got you-- I wonder why that is, I wonder what's going on here, this is interesting--well you must also then be interested in the amount of money flowing into ETFs and the amount of money flowing into index funds, in general.

Nicole Boyson: Absolutely. So there's sort of two things that are going on. I mean the one was that within a particular fund, let's pick an active fund, say the MFS Growth Fund. We would see more money flowing into the institutional share class of that active fund than the broker sold class, and so I thought, okay I'm going to write a paper about distribution. And you know I did. So who's distributing these share classes? It's not brokers anymore, right. That was my first thought. The other piece that you mentioned, which does come up in my paper, but is a little more tangential, is what about the composition of the investment.

So there is money flowing out of active into passive. I knew that was happening, being an academic and studying this for years. But also trying to think about then the distribution side of passive versus active, and my paper focuses only on active because my premise, which I know is true is that most of the folks on the brokerage side are not selling passive funds because it's kind of hard to justify your big commissions if you're just selling an index fund. RIA’s sell passive funds, but my point was trying to think about the movement out of brokerage into institutional, within the active space.

Rick Ferri: Prior to this I interviewed Michael Kitces, and I've known Michael for many years, and we've both seen the evolution of the advisor industry. I've been in the business now 35 years and started out as a broker, and then went out became an RIA on my own, and used index funds mostly from Vanguard and a couple of other companies. And now I'm just doing advice only. So I've lived through this evolution. So one thing we didn't talk about was the number of people that are kind of locked into each one of these groups, and I was reading the latest FINRA industry snapshot which you referenced in your paper and found out that there are probably close to seven hundred thousand people who are calling themselves advisors based on FINRA. Now that gets broken down into registered reps who work for brokerage firms, or in your paper, dually registered, and there are about 720,000 of them. And they could be working for big firms like UBS, Wells Fargo, Merrill Lynch.

There's also RIAs, registered investment advisors, and this is a considerably smaller number, about 70,000. So basically about 10% of the advisor community are registered investment advisors. And these people, who are paid a couple of different ways, but the main way is through assets under management. I mean they're managing money, they're managing portfolios, and they're charging a fee based on those assets and so it's assets under management. There's also people who are doing retainers and fixed fee and hourly and so forth. But that's a very, very small number. A very small number, maybe maybe less than a thousand even.

And then there are the people that you studied and these are dual registered advisors, and what they are are both brokers and RIAs, and here is where it becomes interesting. And here is where you wrote about in your paper, which I want to get into in detail, and that is that you're able to analyze what they were selling as brokers, and what they were selling or using as fiduciary RIAs, and you found some real conflicts of interest. So could you get into the paper a little bit.

Nicole Boyson: Absolutely. And I think you framed the industry really clearly. And when I think about the industry I think about it that way as well. And so as I was following up on this money flowing into institutional funds and out of broker sold funds, I didn't realize at first that it was actually the same guy, and I’m going to say guy because it's mostly men. But it was actually the same guy who was selling both those share classes to different clients, under the same umbrella of his firm.

Rick Ferri: And this is a dual registered advisor who could sell the broker commission side of the mutual fund and collect an asset management fee by using the other side as well.

Nicole Boyson: Exactly, exactly. And again so if you think about kind of the evolution would be say  in the year, let's just go back to say the year 2000, just to give it a clear number, someone starts, some guy starts working for say a company called Ameriprise, and at that time Ameriprise and all the big dual registered firms, and to be clear what I mean by dual registered firms is that, as you said, they have both a brokerage arm, which is really their legacy business, and then they've got a registered investment advisory arm which is I would call slightly newer. Now many of these firms have been dual registered for a very long time, but the brokerage side of their business was dominant. 

So if you go back to  the years 2000-2004 you'll find about 80% of the revenues coming from the brokerage side of a business. Let's just pick on Ameriprise, and 20% coming from the RIA side. And over time for various regulatory reasons that we can talk about or not, the balance shifted. And so now what you'd find at Ameriprise is probably most new clients walking in the door are being put into RIA accounts, fewer in brokerage accounts. And part of the reason is one, the RIA accounts are going to be charging one or two percent per year to the small clients, which turns out over the long term to be more lucrative for the advisors. And the other reason is that investors probably are-- brokers have gotten a bad name in many cases--So if I'm at Ameriprise I can say, “Hey look, I'm a fiduciary, I'm going to put you in a fiduciary account and I'm going to charge you an annual fee, you know one or two percent, whatever that is.

And so the dual registered advisors, it's at the firm level, right. The firm has both abilities but it's also at the advisor level. So they've got both, right, it's just a matter of taking another test. And so then when a client comes in they can decide, presumably with the client, do you want to be a brokerage client, I'll sell you some load funds, or do you want to be an RIA client where I have do have more responsibility for you, but I'm going to charge you an asset-based fee.

Rick Ferri: And by the way, let me get it back to the numbers. It turns out that about half of the brokers are dual registered, so over 300,000. In fact it's been increasing. The interesting point about your paper, which I found fascinating, was that you have this unique lens then to analyze investment decisions by these advisors, and are they doing what's in the best interest of their clients, given the fact that they could go the commission route or they could go the RIA route and charge AUM fees. The question became are they actually doing what's in the best interest of their clients. So I turn it over to you: are they?

Nicole Boyson: So the overarching conclusion of my paper is no they are not. So I want to be a little bit clear. It's not obvious to me that they are acting in the best interest of their clients, and I'll just list a few reasons why. One really important reason why is that during my sample period, these dual registered advisors within the RIA side of their business were also charging commissions. Now these commissions were small. They came in the form of trail commissions from mutual funds, which for those of the audience here who's not experts on mutual fund structure, this is typically 25 basis points, a one quarter of one percent fee that the mutual fund family is paying to the advisor.

Rick Ferri: Oh is that right. I didn't know they could do that. I thought if you were an RIA and you were charging an asset management fee you couldn't get trailing commissions as well. But you're saying you can.

Nicole Boyson: I thought that for a long time and I had a whole bunch of people tell me you couldn't, but then I read everything I could find and the answer is you sure can. And in fact the SEC tried to crack down on this in 2019, which I'll talk about in a sec, but effectively what was happening then is imagine I'm at Ameriprise and I’ve got a client come in. I’m going to put that client in an institutional share class of a mutual fund. But many of those institutional share classes are also paying this 25 basis point trail commission. And it was not at all clear, nor was it happening that the Ameriprise advisor would say, “Okay I was going to charge you 1% but because I get this trail I’m going to charge you 75 basis points, so that your total fee is 1%”. Absolutely not.

Rick Ferri: So let me ask you about that. Is that a rule or a law? In other words, are they supposed to do that? In other words, if they normally charge 1%, yet they're getting comped from the mutual funds that they're putting money into let's say 0.25% are they required by law to bring it down to 0.75%?

Nicole Boyson: Nope and they still aren't reg BI [SEC regulation Best Interest] didn't change that. They're not required by law. What they're required to do is tell their clients they're doing it. And so this was where the trouble came in around 2019. The SEC knew this was going on with all the big dual registrants and they said, “Hey look dual registrants, we know you're doing this, and we know it's legal, but the problem is you're not properly disclosing it to your clients.”  In other words, what their Form ADV would say is, we may choose mutual funds that pay us a trail commission in addition to your fees. But what they really should have written down was we always do this, or we're going to do this, or most of the time we do this.

And so the problem, interestingly, as I found throughout the paper over and over, isn't so much that they were doing illegal stuff, although there frequently were tons of disciplinary actions, but even the stuff they were doing that was legal and which I would call sort of at least potentially unethical and certainly conflicted, they weren't disclosing it properly.

So what the SEC did was they had this thing called the share class disclosure initiative. And they said,”Hey all you guys who are doing this, you need to come clean. You need to tell us, the SEC, how much you were doing this and you need to reimburse clients not because you were overcharging them but because you didn't tell them you were overcharging them.”

Rick Ferri: How many firms are we talking about? In your paper you mentioned Raymond James. Can I name off a few more like LPL Financial.

Nicole Boyson: Oh of course, yeah. There are hundreds of dual registrants. The top 10 which you'll see in my paper manage something like 75% to 80% of the assets.

Rick Ferri: Okay, they found this across the board and all these dual registered firms

Nicole Boyson: 100 dual registered firms ended up being involved with this disclosure initiative, and the number is still kind of happening, but I believe the initial was something like 97 came forward and then three of them the SEC had to go after on their own. And effectively the deal that the SEC cut was we won't charge you any civil penalties, what we'll make you do is pay these folks back. And going forward, improve your disclosures. 

Rick Ferri: Well it wasn't illegal, it's still not illegal. They're still doing it, they just have to disclose it somewhere that they're doing this.

Nicole Boyson: What I will say is fascinating about that, is my look at some Form ADV's post this incident-- so this got all kind of wrapped by 2020-- most of the firms now are not doing it right. So now if you read the Form ADVs they realize that the next step for the SEC probably would be to make something like this illegal, or at least much more hard to do. And so what most of them are doing is – they say clearly in their Form ADV we're not going to do this if we can help it. If we really like the fund and it has a 25 basis point trailer, these are called 12b-1 fees also, we will rebate it. 

And so I will say that this has been the most encouraging thing that's come out of this initiative. Has nothing to do with my paper, but what I did see happening was when the SEC cracked down on this, but effectively it did seem to help and so they seem to be doing it less. I'm sure it's still happening. The handful that I looked at that kind of got busted seem to have gone the straight and narrow on that.

Rick Ferri: Well let me ask you about the larger firms, the wirehouses like the Merrill Lynch's,  Wells Fargo and all that. That well, they weren't involved in this, were they?

Nicole Boyson: They were absolutely, all the big firms.

Rick Ferri: Interesting.I want to go back. I want to circle back to the conflicts of interest. And I just hit maybe three or four points on conflicts of interest.  

Nicole Boyson: So the very obvious conflict there is that you would choose products that paid the highest possible commission. So you would look at the menu of all the mutual funds out there and pick the one that paid the highest possible commission without regard to whether that product was good for your client. And so I think that conflict is very obvious. You might choose a variable annuity, which again, some variable annuities are fine. They have lower fees. But the historical model of variable annuities is that they paid the biggest commissions, and if you were a broker that was where you got your biggest bang for your buck.

And the second one. One conflict that was really common in the brokerage space, they would use the term churning, meaning that they put you in a product and then three years later sell you out of that product, put you in a new product that had another big front load commission, right. And so without getting in the weeds on mutual funds, effectively if you just think of I get paid a commission every time I trade, and this would be true with trading stocks as well, which paid really hefty commissions back in the ‘80s. I'm going to trade as much as possible and certainly that's rarely good for any client. Even just from a pure tax perspective, it's probably not a good idea.

And then the other thing that you and I had chatted about in the past was this idea about certain fund families would say if you have a certain number of dollars with us, the commissions are lower. So a client with a million dollars would pay a very low commission. So what the broker would do is say well not going to just use one fund family. Let's divide you up into six fund families so that they could maximize their commission across the total that was being invested.

Rick Ferri: I have seen a few, not many, and I review accounts basically daily. I have seen a few brokers – just broker-only not doing AUM – who have actually done the right thing for clients. They will put a million dollars in one fund company to get the break point. I'll look at the account statement and I'll see this and I'll say, “Wow I rarely see that.” I really, basically most of the time I see this thing broken up so that the broker gets higher commissions by breaking it up into different fund companies. But I actually have seen on a few occasions in my career where a broker has actually done the right thing. So it's just because you are a broker doesn't mean that you're doing this. I'd say that a lot of brokers are, but there are some that are really acting much more like a fiduciary than the AUM advisors who even though they are fiduciaries, I have to say that I have seen a lot of people not acting in the client's best interest, even though they're charging AUM.

Nicole Boyson: Yeah so my paper really is kind of silent on the AUM versus commissions. When I compare to the RIA – so I have dual registrants then I have independent RIAs that aren't affiliated – I can compare their fees and the only thing I can tell you is that the dual registrants charge higher percentage fees to their retail clients but then a lot of the independent RIAs don't take small clients, so oftentimes stuck between a rock and a hard place.

Rick Ferri: What about fees for advice not linked to commissions and not linked to assets under management.

Nicole Boyson: I think that when you decouple the product from the advice that clearly is going to reduce conflicts because for obvious reasons, right. If you're not getting paid based on assets, or if you're not getting paid a commission based on a particular product your independence is going to be more of a straight line and fewer conflicts. The conflicts that could occur there would just be you talk to them for an hour and charge them for two, but that's more fraud than it is a conflict, right.

Rick Ferri: Well Nikki, thank you so much for joining us today and appreciate all of the work. I know it's very difficult digging up this information when the industry really doesn't want you to have it. We greatly appreciate your insight and thank you again for joining us.

Nicole Boyson: Yeah, thank you so much it was a great time, and I'll keep you posted on my findings as I, as I get through that work.

Rick Ferri: This concludes this edition of Bogleheads on Investing. Join us each month as we interview a new guest. In the meantime visit Boglecenter.net, Bogleheads.org, the Bogleheads Wiki, Bogleheads twitter, listen live each week to Bogleheads Live on Twitter Spaces, the Bogleheads Youtube channel, Bogleheads Facebook, Bogleheads Reddit. Join one of your local Bogleheads chapters and get others to join. Thanks for listening.

About the author 

Rick Ferri

Investment adviser, analyst, author and industry consultant



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