What went wrong with the financial advice industry?

The overriding issue is that the financial advice industry has taken inordinately long to change its business models and client value propositions in order to satisfy the needs of modern consumers. In many instances, ‘advice’ is still not central to the client offering. While innovation has helped find solutions to problems in other industries, the financial advice industry has lagged in this regard and now desperately needs to catch up. So, what are these issues, and how can they be addressed?

Changing consumers

Millennials now make up an increasingly significant share of financial advice clients – and they’re very different from their Boomer parents. Their wide use of social media, the need for personalisation at a reasonable cost, and the increased awareness of the various options available to them, all add up to a much more informed and demanding consumer. More crucially, millennials are placing increased importance on meaningful relationships in all facets of their lives, which has been further heightened by the stress and uncertainty of the Covid-19 pandemic.

Gone should be the days of onboarding a client after a few disclosures, questionnaires and a Financial Needs Analysis, and then rapidly executing the most obvious transactions in the shortest possible route to earning the fees. Instead, consumers now insist on deeper levels of relationships and trust, or they will bypass advisors and find ways to do it themselves.

International evidence shows that, when it comes to financial advice, it’s the softer skills in the advice process that appear to matter most to clients. A 2018 Gartner research paper revealed that statements such as “Get to know them”, “Identify needs that they don’t know”, “Prioritise their needs” and “Evaluate the implications of action and inaction” ranked as much more important to clients than statements such as “Facilitate or execute the decisions”.

With tech enabling consumers to build their own customised online portfolios at a fraction of the cost of paying an advisor to do so, it’s the human touch that will make all the difference. If advisors can have open discussions with clients, help them navigate stressful times, and if they reposition themselves as financial ‘coaches’ that help influence and modify their clients’ behaviour in order to achieve tangible results in the long term, only then will they have adapted to meet the needs of these more discerning consumers.

Tarnished reputations

Certain professions have had less than optimal reputations, often when consumers recognise that individuals are more motivated by their personal rewards than by transactions which genuinely benefit their clients over the long term. And it’s no wonder consumers sometimes think this way about financial advisors: a 2020 Kitces report showed that advisors spend only an average of 20% of their working hours in interaction with their clients.

A lack of face-to-face time means a weaker relationship, and less chance that trust is being developed in both the advisor and the advice they’re being given. Moving forward, how do we ensure that client and advisor speak the same language, both literally and metaphorically? How do we simplify the financial advice provided, remove jargon, and ensure that client and advisor are working towards the same goals?

Most industry observers recognise that there is an imperative for change and that it isn’t easy to achieve. The starting-point is to ensure the quality, integrity and professionalism of the people that decide to become financial advisors. If those attributes are intact, then it moves to a scrutiny of the advice process, which needs to be consistently ‘client-centric’ rather than ‘product sale focused’.

Advisors need to take sufficient time to understand their clients’ hopes and dreams, which are historically intangible, and turn them into measurable, concrete financial goals. If advisors co-create implementable plans with their clients, doing a 360 degree about-turn from the traditional product-centric methods, they will find ways to capture the emotional connections of their clients. This is important for longevity of plans and relationships.

The reality and perception of incentives are also critical. Too many advice businesses ‘incent for sales and hope that advice will follow’. The compensation of advisors needs to be really focused on the quality of advice provided, and far less influenced by sales and client acquisition. Leaders need to have faith that good advice will result in happy clients and that increased revenues and profitability will naturally follow.

Increased scrutiny

To counteract many of these problems in the financial advice industry and in order to ensure better outcomes for clients, there has been a raft of new regulations globally. The Retail Distribution Review (RDR) is an initiative that came into effect in the United Kingdom on 31 December 2012, aiming to provide greater clarity about different types of financial services, as well as improve transparency around the costs associated with financial advice.

This is clearly a positive development overall, but it has also caused many advisors and companies to exit the industry, for fear of being fined or losing their licenses. The UK media had been filled with many stories of hefty fines and negative publicity related to companies not delivering adequate outcomes across a range of financial products. For an example, one only has to look at Barclays which exited the middle segment of the UK face-to-face advice industry after RDR was introduced, because they felt that the risks of operating in this sector now outweighed the costs.

In South Africa, our version of RDR and ‘Treating Customers Fairly’ is being introduced in stages via the Conduct of Financial Institutions (COFI) bill which was first published in December 2018. The Bill aims to “protect financial customers, promote the fair treatment and protection of financial customers by financial institutions, and promote trust and confidence in the financial sector”, among others.

This new legislation means that we have to change the pervasive culture of our advice businesses and fundamentally alter the way that companies create products, design and market them. Advisors need to give clear information, and where they give advice, products need to be created so as to perform as customers have been led to expect.

What is challenging is that, while everyone recognises the clear intentions and focus of the new regulations and the heightened regulatory scrutiny that will follow, the steps as to exactly how to comply are far from clear – there is no obvious playbook for advisors to consult.

Profitability in danger

The needs for increased professionalism, more modern technology and compliance with more onerous regulations are driving up the costs of running financial advice teams. In South Africa we certainly wouldn’t want this to get to the point where only the wealthy can afford to use the services of an advisor. We need the economics of being an advisor and owning an advice firm to be attractive, so that there is long-term sustainability of this important industry. Advisors need a larger pool of clients that they retain for longer periods of time.

The only way that we can progress sustainably as an industry is to therefore make the advice process more efficient and cost-effective than it currently is. Using innovative tools that provide an improved client experience, without the associated time and resources required to do this manually, is a good way forward.

All of these issues have primed the financial advice industry, making it ripe for disruption. These changes are not only about improving the financial circumstances of clients and advisors though. Better relationships between advisors and clients also mean that the general public becomes more financially literate and increases their savings rates, bringing with it a plethora of positive consequences, including stronger economies and improved well-being overall.