Co-pay for Financial Advisors?

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I think everyone can agree that making money is not easy, but what is even more difficult is managing it. One area within the financial services sector that is ripe for disruption is the multi-trillion dollar wealth management business. Even with all the gee-whiz technology of the internet, there has yet to emerge a company that has made a serious dent in this space. Of course, there is mint.com which aggregates all your financial data and then provides recommendations to you but doesn’t really help with the wealth management piece.

The idea of having a wealth manager, financial advisor or private banker looking after your money sounds very alluring. Typically, these managers charge you based on the assets under management (AUM) they supervise, so if they charge 1% and you have USD 1,000,000 you will be paying them USD 10,000 a year. The fees range from .5% to 2.5% and that is just the management fee, there are also the fees that the products they recommend charge. This multi-layer fee structure is what most startups want to disrupt.

One of the most respected wealth managers is Goldman Sachs Private Wealth Management. Never heard of them? There is a reason, you need a minimum of USD 100 million in liquid investments to even open an account. They don’t need to advertise because they get many of their clients from the various deals they advise on around the world – M&A, private equity, restructuring and public offerings. So, who are some of the new kids on the block challenging the old boys network of Wall Street?  Betterment, FutureAdvisor, Personal Capital and Wealthfront.

Betterment, Personal Capital and Wealthfront all charge a percentage of the AUM – Betterment (.15%), Personal Capital (~.80%) and Wealthfront (.25%). FutureAdvisor charges a fixed cost whether you have USD 10 or USD 10 million, the most expensive plan is USD 195 a year.  All these ventures want to re-create mint.com for the wealth management space by relying heavily on technology and try to minimize the amount of human interaction with an advisor.

Of all of them, I believe Personal Capital might have a shot since it still relies on a traditional advisor but it’s fee structure is essentially the same as existing wealth managers. Having a slick user interface with great graphics might work for mint.com but in the wealth management space having access to an advisor on demand is really the core of the business. Working on a clients overall asset allocation is only one piece of the pie. So, is there a better model?

The existing old school wealth managers charge a hefty percentage and provide advisors whenever a client calls and even provide access to specialists for areas such as taxation and succession planning. The clients are happy but pay a heavy price. The new age websites want to limit access to advisors and use technology to streamline the advice. However, by taking a page from the health insurance playbook and implementing a co-pay system it might bridge the gap. A quick recap of the insurance industry co-payment system:

A type of insurance policy where the insured pays a specified amount of out-of-pocket expenses for health-care services such as doctor visits and prescriptions drugs at the time the service is rendered, with the insurer paying the remaining costs

A co-pay system could provide the happy balance between a wealth management firm and its clients. The management fee would be similar to the monthly/yearly insurance premium you would pay. Then if you have a specific question you would request access to an expert advisor and pay a small fee for the advice. If the advice generates additional fees for the management firm then great, if not then at least it would be able to partially cover the cost of the meeting. The co-pay system might be a radical idea but then again the industry is ripe for disruptive change.

Financial Regulations in Reverse

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There is a constant debate between financial services firms and government regulators over financial market regulations – over regulate them or let them run wild and free. If there are no financial regulations in place, you end up with what we have today – a highly unregulated derivatives market. The unregulated derivatives market led to the financial collapse of 2008 and the massive destruction of wealth, yet as of today there are still no guidelines in place to regulate this highly toxic market. On the other end of the spectrum is completing choking the market with financial regulations and deterring business.

In between is that fine line that needs to be in place for markets to be efficient, transparent and trustworthy. In an emerging market like India, the regulators should be first and foremost focused on protecting the consumer. Secondly, in order to attract first time consumers the regulators should be promoting a culture of openness, simplicity and easy to understand language for financial products.

However, over the past 3 months the Indian regulators seem to be going in reverse and making it more difficult for first time consumers to make decisions. They appear to be adding more financial jargon to the process and potentially scaring off first time consumers. For most consumers in India, there are 3 government regulators that have oversight over the bulk of their money:

– IRDA (Insurance Regulatory and Development Authority) – insurance sector
– RBI (Reserve Bank of India) – banking industry
– SEBI (Securities and Exchange Board of India) – oversight of the equity/debt markets

About 3 months back the IRDA essentially shot itself in the foot when it announced new guidelines for websites that aggregate insurance information. Overnight the guidelines killed the business models for insurance aggregators. Personally, if I’m shopping online for insurance I want to be able to compare the various products and understand the pros/cons of the various offerings. However, with the latest IRDA ruling it has banned these websites from providing “opinions” on products or ratings. For first time consumers a rating is such a quick way to decide which product is better. Instead you force the consumer to read through jargon filled insurance material and in the end they will probably not buy anything because its difficult to decipher.

Likewise, SEBI recently introduced new guidelines for the type of information that mutual fund companies can provide in their marketing materials across all mediums – print, TV and web. Specifically, mutual funds companies can no longer provide a rating from someone such as Morningstar, Value Research or S&P. In addition, rankings or testimonials are also off limits. Once again this is moving in the wrong direction, a star rating is easy for someone to understand like a hotel rating – 1 star vs 5 star. Of course, consumers could just goto the websites of Value Research or Morningstar and get the star ratings and rankings themselves.  But, that assumes a first time consumer would know about Value Research or Morningstar which I doubt.

The flip side is that these rankings and ratings were leading some consumers to skip researching these new products altogether. My feeling is if consumers are that stupid to part with their money that easily, then no amount of change in regulations will curb that kind of behavior.