Are you pursuing the wrong market?Article added by Ed Morrow on June 16, 2010
Ed Morrow

Ed Morrow

Middletown, OH

Joined: October 29, 2005

Many financial advisors are aspiring to become wealth managers. There are various other terms used for this market and service segmentation, such as: assets under management, lifetime or life planning, private banking, or family office services. Those with an estate planning focus may use the terms legacy or inter-generational planning, but the primary compensation may still be from asset-based fees. Each term will have slightly different connotations in the way the advisor perceives the market and how he/she intends to pursue this market.

This may be a serious error. It doesn't seem like that can be true. Being a wealth manager ought to be more rewarding, satisfactory and prestigious than providing services to just "average" people. We will explore the risks and obstacles in the wealth manager approach, but first, let's explore what initially attracts financial advisors, including stock brokers and insurance agents, to this market.

Assets under management. This is the pot of gold at the end of the rainbow. Unfortunately, it can be nearly as elusive as driving swiftly to where the rainbow appears to arc back to the earth. As you approach it, the end of the rainbow keeps moving. Perhaps this is why few persons ever strike it rich with little effort.

Percentage compensation. Let's assume that the advisor receives only 1 percent of the client assets under management. $1,000,000 at 1 percent = $10,000 per year.

We can quickly multiply the effectiveness of this compensation basis:

$10,000,000 at 1 percent = $100,000 per year
$50,000,000 at 1 percent = $500,000 per year
$100,000,000 at 1 percent = $1,000,000 per year

Reality adjustment. Few commission-based sales persons achieve an annual income of $1,000,000, and those that do are nearly always very, very hard workers with little time for their families. However, they are often believed to be somewhat lucky or well-connected. I personally know many million dollar producers, and the reasons for their superior sales results are always hard work. Yes, they are often bright and creative, but rarely is sales excellence the result of family connections, falling into a unique market, or being a very persuasive salesperson. The critical factor is nearly always hard work.

Percentages aren't flat. That 1 percent is not likely to be a constant figure. As the size of each account grows, there's pressure for the percentage to decline. The larger the account, the more it will reduce. So, the 1 percent may begin to average out at 0.9 percent, 0.8 percent, or even less. When a client's account reaches $10,000,000, it is hard to justify paying the advisor a $100,000 annual fee.

The client may pay over 1 percent. If the financial advisor is with a broker/dealer and/or uses an asset management firm, the total amount the client pays is not likely to be only 1 percent, but perhaps 2 percent. The maximum amount would be 2.5 percent, but that rate may be charged only for small accounts. The larger the client's true percentage, the more pricing pressure there will be. The media and competitors will send a constant message: "You can get more performance for less percentage." That may not be true, of course, but the perception will generate market pressure to reduce the gross client payment percentage, which of course reduces the advisor's net rate.

RIA status fee reductions. Many brokers and agents become independent registered investment advisors (RIAs). This is somewhat like becoming a trust company without the requirement for walnut paneled offices in a bank tower. But this brings additional problems, and guess who acquires them? The new RIA.

True, there is no "haircut" by a broker/dealer, but the independent RIA is taking on a host of responsibilities:
  • The need for some trustee or custodial services -- which are not free.

  • Legal structure and filing responsibilities with the SEC, state or federal.

  • Periodic audits and the expenses involved with preparation and subsequent remedial actions.

  • The cost and difficulty of obtaining errors and omissions insurance.

  • The absolute status as a fiduciary, with increased liability and performance responsibility.
Now all those services provided by a good broker dealer are looking pretty good --especially the shared liability.

Gross isn't net income.? This becomes a serious problem for the financial planner, stock broker or senior life agent who makes the transition to wealth manager. During the early stage, the former status of being a commissioned salesperson will retain some income. There are likely to be trailing, but diminishing, revenues as well as pre-paid overhead expenses.
However, as the wealth manger extends the size and wealth of clientele, the business expenses increase. Some clients will demand/expect very high tech support services, such as online conferencing and total Internet access to portfolio information by the client, and this usually requires extra staffing.

As the affluence level of the clientele increases, the wealth manager is urged into a more expensive business status and lifestyle. This may include charitable and civic contributions. Active philanthropic involvement is expected of the high profile wealth manager. Likewise, personal lifestyle expenses will increase -- homes, clubs, clothes, jewelry and even vacations in trendy spots -- perhaps with wealthy clients.

One wealth manager was flattered to be invited to have his family join his biggest client on a one-week vacation in Monaco. That meant first class travel for four, and new clothes, jewelry, luxury villa rental and entertainment expense. Plus, one can't visit the world famous casino and not place a few wagers. The cost was staggering, as was the social pressure. Moreover, it set a new level of expectation for his family.

Office overhead also increases. One can't expect to be a wealth manager and have modest offices. This means expensive leases, office furnishings, art work on the walls, and the very latest in technology. Nearby gourmet restaurants and private luncheon clubs may also be appropriate.

Office staffing must increase in order to provide the high quality, instant access expected by those who are accustomed to the finest service. This means having above average persons who also project the "right image," and that can be expensive, especially when employment longevity is desired.

Of course, all these issues require time, attention and the principal ingredient, money! And cumulatively, this can be a lot of money, which only compounds the impact of lower net percentage fees.

Calculating your net. What will overhead expenses be? Forty percent to 50 percent. Don't be lulled into thinking you can do it for less. Law firms and accounting firms that cater to the affluent clientele consider their operations to be very well managed if they can keep overhead to 45 percent -- leaving 55 percent for principal payout. There is no logical reason to believe that when you manage the wealth of the wealthy you can do any better.

Foregoing commissions. Many advisors moving into the wealth management circle often experience pressure or need to shift to a fee-only approach. This means the loss of commission for insurance products and securities trades. Even if the sales licenses are maintained, the wealth manger is often painted into the "no product sales corner."

What about the rest? If providing wealth management to the wealthy is losing some of its bloom of promise, what does that leave?

Imagine if you will, that the population of the United State is somewhat like a pyramid. It is not so precisely shaped and angled as the pyramid of Cheops. In other countries, this pyramid of wealth may be currently somewhat distorted. But as the changes in industry, technology and the benefits of free trade continue their expansion even to the farthest reaches of Asia, Africa, and Eastern Europe, population distribution will also begin to resemble that of the U.S. and Europe.

The shape of the U.S. population by income is actually more like a pear, with a smaller base, a large middle segment and a very small component at the top.

Asset versus income distribution. The U.S. Census Department measures and tracks income, rather than net worth. But for most households this would arrive at a similar distribution with a few exceptions, e.g. many farmers have disproportionaly more assets than the net income they would report. The following chart separates the U.S. society based on 2004 income data, the most recent available -- for 113 million households and a population of about 295 million -- average household size is now 2.6 persons.

U.S Household Income Distribution
Source: U.S. Census Bureau, based on 2004 data
PercentTotal Number
U.S. Households
This Group's
Minimum Income
This Group's
Average Income
Total Income Earned
by this Population Group
1.51,699,000250,000438,338744,736,000,000
1.21,325,000200,000219,882291,343,000,000
3.23,595,000150,000168,707606,501,000,000
9.811,194,000100,000119,4101,336,675,000,000
21.123,897,00060,00078,6571,879,666,000,000
41.446,876,00020,00038,6631,812,367,000,000
21.724,559,0000-20,00010,965269,306,000,000
100.0113,146,00060,5286,848,000,000,000
  • The top 1.5 percent of U.S. households, 1,699,000, has an average income of $238,338. This represents 10.9 percent of all income earned by individuals.

  • The next 1.2 percent of U.S households, 1,325,000, has an average income of $219,882, which represents only 4.2 percent of all income earned.

  • The next 3.2 percent of U.S. households, 3,595,000, have an average income of $168,707 and collectively this represents 8.8 percent of all income.

  • The next 9.8 percent of U.S. households, 11,184,000, have an average income of $119,410 which collectively represents 19 percent of all income.

  • The next 21.1 percent of U.S. households, 23,897,000, have an average income of $78,657, which collectively represents 27 percent of all income in the country.

  • The largest group, that with an income ranging from $20,000 to $40,000, has an average income of $38,663. But collectively, it accounts for 26.5 percent of all personal income in the country.

  • The lowest group, with income under 20,000 represents 21.7 percent of our society. However, this lowest quarter is accountable for only 3.9 percent of all income in the U.S.
The top three groups account for 5.9 percent of our population -- a total of 6,619,000 households. This group is not uniformly distributed. It is bunched in several areas:
  • Highly-compensated, employed persons. These will be found in larger cities, especially state capitals and in the northeast and western coastal perimeter.

  • Retired persons with above average wealth, to be found in the popular retirement areas such as Florida and the Southwest.

  • These persons are already being aggressively pursued by banks, brokerage firms, accountants and financial advisors.
The next two groups, those with income between $60,000 and $150,000 represent 25,091,000 households. They earn $3,216,341,000,000, or 46 percent of all the personal income in the country. For many financial advisors, they represent a far more valuable market:
  • They are to be found in every area of the country.

  • They are not so likely to have an existing relationship with a qualified financial advisor.

  • Some are aggressive savers and investors and have far more money available than their earned income might suggest.
Actually, there is probably an excellent opportunity for financial advisors who focus on the largest group of our society -- the 46 million of households that account for 1.8 trillion of earnings. However, this group, which has an average income of $38,663, must be marketed to differently:
  • They will not be as accustomed or inclined to paying a fee for planning. Therefore, the presentation must be carefully structured and the fee kept to an affordable level.

  • There is very little competition within this group from truly qualified advisors who are well-organized.

  • Many in this group are on a career path that will find both their earned income and accumulated wealth increasing. If well served, they will remain loyal to the financial advisors who diligently provide planning and product service.
Examine the demographics. Ask yourself whether or not you believe in the commissionable products. Most importantly, you need to answer this question: With which group of society do you have the most in common and do you feel most comfortable with?

The wealthy constituency. Wealthy investors are 67 percent more likely to already have advisors, according to the seventh annual Wealth Survey by Phoenix Investment Partners, a unit of the Phoenix Company of Hartford, Connecticut.

Wealthy was defined as those with $1 million or more in assets, and most of this group wanted to achieve a position of "comfortable standard" by age 57.

Of those wealthy investors who have advisors, many think that their advisors aren't proactive in their planning approach and are hard to reach. Although 73 percent of those surveyed said they received investment advice from their advisors, just 49 percent said they received help with asset allocation. Meanwhile, 47 percent said they received help with retirement planning, and 33 percent said they received help with tax planning.

Wealthy investors are most concerned about retirement security, estate planning and their relationship with advisors.

Many of those do not give their current advisors stellar ratings, according to the survey.

"Clients are looking for an advisor with a planning approach, and once they find a person, they are very loyal to them," said Walt Zultowski, senior vice president of research and concept development at the parent company.

Consider growing into wealth. Rather than immediately pursuing the top two or three income categories ($150,000 or more), perhaps you might feel more comfortable and enjoy greater success with the next two or three categories ($20,000-$150,000 of income), helping them purchase products wisely, invest regularly, and allow time for these practices to grow into wealth -- for your clients and for yourself.

Loren Dunton, widely held as the founder of the financial planning movement, believed its primary responsibility was to serve all the public with an eye to help clients wisely spend, save, invest, insure and plan for the future. You may find it wise to consider a wider market.

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