A number of white papers from management consultants (and articles in industry publications) have argued that investment advisory firms can benefit from providing more personalized services to their clients. Those recommendations prompt some questions about the desired relationships between advisors and clients — and between advisors and their organizations.
The advisory promise
Potential clients want to feel as if an investment advisor will provide advice and services that are appropriate for their circumstances and beliefs. Therefore, marketing messages and prospect meetings usually are geared to play to the hope that recommended solutions will be tailored to individual needs.
As a result, clients have expectations as to how personalized their experience will be, setting up a potential mismatch in cases where the reality doesn’t live up to the apparent promise. Those kinds of disconnects can come from too much hype in the sales process or the client not understanding exactly what is being offered. Either way, a lack of shared understanding is a poor foundation for a long-term relationship.
The dilemma
For advisory firms and advisors, there is a tension between the individual needs of clients and the desire to operate a business that can meet those needs in an efficient, effective, and profitable manner. Decisions about the trade-offs involved determine both the future of the firm and the nature of the client experience.
Where should the lines be drawn between an assembly-line approach and an artisanal one? What are the professional obligations of an advisor as the primary intermediary between the firm and the client?
The emergence of large RIA firms, which are in most cases conglomerations of smaller entities, has brought those questions into high relief, although they apply to advisory organizations of all sizes and types.
Getting started
The initial meetings with a new client set the tone for the relationship. Those discussions should involve a sharing of information between the client and the advisor, but it is hard for either party to be as open as would be desired, so the quality of those exchanges can vary dramatically.
In most cases, the conversation is led by the advisor, who can dominate the conversation, demonstrating command of the two domains at play — the investment one and the conversational one. A posting from Russell Investments counsels advisors to “Stop talking and start listening,” using these questions as a way to frame the nature of an interaction with a client:
How much of the time did the adviser speak?
How much of the time did the adviser ask questions?
How many words did the client speak during the interaction?
Whether they realize it or not, in their first meetings a client and an advisor are creating a behavioral world that they will inhabit for years to come (if the relationship lasts).
In addition to those discussions — and the gathering of the necessary data and approvals — there is typically some sort of risk-profiling process that is instrumental in triggering categorical approaches to future investment plans. In a CFA Institute Research Foundation brief on risk profiling, Joachim Klement found most risk questionnaires to be “highly unreliable” because they focus on “socioeconomic variables” and “hypothetical scenarios,” while overlooking lifetime experiences, past decisions, and the influence of family and friends, all of which should be used by advisors “to enhance their understanding of client preferences.”
These elements — the communication and behavioral framework that is established between advisor and client, and the slotting of the client as a result of the risk profiling — form the foundation for the collaborative efforts of the two parties.
A reflective arrangement
The standard advisory relationship is between an expert (“I am presumed to know, and must claim to do so, regardless of my own uncertainty”) and a client who has little or no relevant expertise (“I put myself into the professional’s hands and, in doing this, I gain a sense of security based on faith”). Those quotes are from a forty-year-old book by Donald Schön, The Reflective Practitioner. Subtitled “How Professionals Think in Action,” the book is not specifically about investment advisors; it deals broadly with issues faced by professionals in general, including the nature of their relationships with clients.
Much of the book is focused on examples of professional practice that illustrate the frictions that are created when a professional applies a body of knowledge to a specific situation. Should the approach be a formulaic exercise, one of execution, or something more adaptive, more reflective of the specifics of a situation? That question gets to the heart of many investment advisory situations — and to the trade-offs that are made between personalization and systemization in the provision of advice.
As an extension of those ideas, Schön advocated for a “reflective contract” between advisor and client, in which each can share their beliefs and uncertainties in honest and open ways — to build their relationship on communication that is oriented to continual learning and good questions rather than rules of thumb and easy answers.
That represents a challenge for most clients, since they usually aren’t familiar with investments (or the advisor) and therefore are reticent to share their thoughts in an unguarded fashion during the crucial first meetings. And it can be especially hard for advisors, who are used to wearing a “professional façade” and offering confident solutions to fuzzy problems. (They are not alone. In a similar way, it is rare for asset managers to freely share their doubts, challenges, and aspects of their work that they think need to be improved, since they don’t want to introduce cracks in their narratives.)
Some questions from Schön that indicate the characteristics of a reflective professional who is willing to enter into a deep relationship with a client:
Is the practitioner willing to talk about the issue at hand, to consider it from more than one point of view, to reveal his own uncertainties?
Is he interested in the client’s perceptions of the issue?
Is he open to confrontation, without defensiveness?
What is his stance toward his own knowledge?
Does he claim only to “know,” or is he interested in, rather than threatened by, alternative ways of seeing the phenomena that do not fit his models?
The fear for advisors is that being open is a sign of weakness that could diminish the client’s trust. There is a paradox at work, since a display of confidence may engender short-term trust but a reflective, transparent approach is a better starting point for building long-term trust. So an advisor has to consider whether it is worth the risk to foster that kind of relationship.
What gets personalized?
Advisory firms vary significantly by size, resources, and beliefs, so generalizations are elusive. For example, some of those serving very wealthy clients might offer customized concierge services and specialized capabilities that are outside of normal presumptions of what an advisory firm does. That is personalization of a sort. And yet a sole proprietor advisor with a small practice may excel at working closely with clients and providing bespoke investment solutions for them that are beyond what some fancier competitors provide.
Firms may offer a variety of capabilities in house (tax, estate, insurance, lending, etc.), but consider the two core areas of financial planning and investment management. For each of them, advisory firms have formalized processes that they expect advisors to hew to in their work for clients. The appropriate degree of latitude for advisors around those models and practices is the essence of the standardized-versus-personalized dilemma.
Financial planning begins with personalized information from the client, but most of the rest of the process is standardized based upon the capital market assumptions used by a firm, the specific financial models it employs, and the outcomes of the risk-profiling process it uses. Each of those three elements has potential problems, although they are rarely discussed with clients.
An earlier posting talked about some of the issues related to capital market assumptions and Klement’s arguments cited above address the question of the accuracy of risk assessments. In addition, Monte Carlo simulations that promise a financial plan tested by running ten thousand scenarios yield faith in the overall probability-of-success number that is generated, but the embedded assumptions of normal distributions, constant correlations, etc. don’t match the reality of markets. And they don’t adequately capture sequence-of-returns risk, a concern given the tendency for above-average and below-average returns to alternate for long periods (and that the last forty years have been decidedly in the above-average category).
That said, would a seat-of-the-pants approach by an advisor to financial planning be better? Probably not, since advisors are likely biased to believe in financial market success, no matter the conditions — and to realize that optimism is a good sales tool.
A reflective professional would take the middle ground: using the best assumptions and models that are available, but understanding their shortcomings, investigating the implications of them, and communicating the uncertainties involved to the client. Not what most advisors want to do.
The same kinds of issues present themselves on the investment front. At some firms, decisions regarding investments are almost mechanistic, inviting comparisons to robo-advisors, who charge about a fourth of the industry-standard fee of one percent. That differential in fees may be justified on the basis of financial planning advice or behavioral counseling that contributes to better long-term results, but in many cases there is more promise than delivery in that regard, and clients overpay for what they get.
But, again, such simplicity has a lot to offer (if priced right), since it is hard to beat a plain-vanilla investment plan. Advisors can recommend strategies and products that detract rather than add value, so giving them flexibility in implementation means that there is variability (probably on balance to the downside) in results. Of course, it also should be noted that advisory firms themselves can make similar decisions, so sometimes the negative effects of product choices are systematized rather than customized.
Organizations and roles
Since the turn of the century, we have witnessed the industrialization of the advice industry, as diversified financial services companies have intensified their commitment to their wealth management divisions and RIA rollups have gained considerable size through consolidations. The owners of those entities are more focused on scale, consistency, efficiency, and the bottom line than their smaller competitors in what had been largely a cottage industry. The result is a trend toward a systematic approach.
And that mentality trickles down. After all, owners of smaller advisory firms are being pestered about their interest in selling, and many are taking advantage of cash-out opportunities that are beyond what they could have imagined a few years ago. What kinds of firms are most attractive as acquisitions, those that have a wide range of implementation or more freewheeling ones?
Customized advice and the kind of reflective relationship advocated by Schön are more time-consuming, and therefore less bottom-line-friendly.
Decisions about customized versus personalized services alter the role of the individual investment advisor, who is the critical link between a client and the firm. Is an advisor expected to implement advice created by others or to be involved in creating the advice? Is it an investment role or a relationship role? What are the advisor’s obligations to the client in terms of assuring that the firm’s recommendations are in fact appropriate?
And what are the advisor’s obligations in terms of moving the firm forward? One theme of the Schön book is that a reflective practitioner is willing to question and improve the organization’s methods and recommendations — “is essential to the process by which individuals function as agents of significant organizational learning,” even though that can present “a threat to organizational stability” at times. Do you want an advisor who is active in trying to improve things, or inert, carrying out what is predetermined by others?
While these questions — and this whole posting — have been presented in black-and-white terms to have you think about the ends of the spectrum, implementation is usually in tones of gray. What do you want the advisor’s role to be and why?
While we’re at it, we should throw in the topic of the moment and ask what the effect of artificial intelligence will be in terms of these questions and on an advisor’s responsibilities (if that position is still around in a few years).
A new world is already being marketed. Here’s the beginning of a recent unsolicited email from a vendor:
In today’s experience economy, clients expect bespoke engagement tailored to their unique needs. One-size-fits-all approaches no longer suffice. But efficiently scaling personalization across a complex book of clients poses challenges.
The solution lies with artificial intelligence.
A useful paper by Andrew Lo and Jillian Ross, “Can ChatGPT Plan Your Retirement?: Generative AI and Financial Advice,” offers some perspective on the challenges involved in using AI:
The financial sector has always been an eager consumer of technological advances that reduce cost and increase efficiency. But the pace of financial innovation is a function not just of technical capability but also of trust and reliability.
One section in the paper deals with the roles and responsibilities of advisors; the concepts of ethics, trust, and fiduciary duty; and observations about the emergence of robo-advisors and the experiences clients have had with them to date.
Regarding the current crop of large language models:
An LLM can roleplay a financial advisor convincingly and often accurately for a client, but even the largest language model currently appears to lack the sense of responsibility and ethics required by law from a human financial advisor.
Nevertheless, the authors see a bright future for AI-based advice:
The simplest extrapolation suggests a transformation of retail investment, in which every holder of investable wealth will make locally optimal investment decisions towards their life goals, a full democratization of finance.
The debate goes on
In a LinkedIn update, Michael Kitces wrote,
Potentially controversial take with the ongoing industry buzz of tech that builds hyper-personalized portfolios: Most clients don’t actually want “personalized” portfolios.
What they want, according to Kitces and a poll he conducted online, “is simply to feel heard and understood.” If they do, they are fine with a model portfolio provided by a firm if “that’s what we really believe and can show is the right path for them to achieve the outcomes they desire.”
A number of advisors offered their opinions in response.
Decision making
Ultimately, a firm must decide where it stands on the issues laid out here, which define the expectations for the organization, its advisors, and its clients. It also should have on its research and development agenda an examination of emerging technologies and how their evolution could change the fundamental nature of the firm and of the industry.
Of more immediate concern for many is how to deal with increased demand from clients for alternative investment products and the concerted marketing push to advisory organizations by the sponsors of those products. (That was the topic of this 2022 piece.) By their nature, those vehicles prompt a variety of decisions regarding the personalization or uniformity of advisory services that a firm chooses to provide — and how it wants to position itself in the market.
Published: May 9, 2024
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