 Welcome everyone to the 47th edition of Bogle Heads on Investing. Today we talk about the evolution of the investment advisor industry with two special guests, Michael Kitzes, head of planning strategy for Buckingham Wealth Partners, and Dr. Nicole Boyson, finance department chair at Northeastern University's De'Amour McKinn School of Business. Hi everyone, my name is Rick Ferri and I'm the host of Bogle Heads on Investing. This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501C3 non-profit organization dedicated to helping people make better financial decisions. Visit our newly designed website at bogelcenter.net to find valuable information and to make a tax deductible contribution. And don't forget about our Bogle Heads conference coming up this October 12th through the 14th, featuring many speakers that I've hot on this podcast and more. There are a few seats remaining you don't want to miss out. Visit bogelcenter.net for more information. In this episode of Bogle Heads 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 Kitzes, 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 Adviser Success Podcast and the publisher of the Kitzes Report newsletter and the Nerds Eye View blog at kitses.com. Our second guest is Dr. Nicole Boyson. She is the chair of the finance department of Northeastern University's DMOR, McKim School of Business. She's also serves 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 Advisers. So with no further ado, I'm pleased to have with us today Michael Kitzes. Welcome to the Bogle Heads on Investing Podcast, Michael. Thank you. It's great to be here. I appreciate the opportunity. It's a real pleasure to have you because you are the leader out there in the advisor community. Pardon on. You're the voice, so to speak. And rightly so, on your blog, on Nerds Eye View, and on your website kitses.com for mostly advisors in the advisor community. I know we have a good number of Bogle Heads 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. The information you put out there, everything from taxes to insurance to trust work, I mean, certainly very, very helpful to individual investors and very helpful to advisors. 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? 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. Sure. Well, that's fantastic. Okay, so let's get first into how did Michael Kitzis become? MichaelKitzis.com, Nerds Eye View. Tell us the story of your life. The story of my life. I was born and raised in the Washington, D.C. area. I was the son of two computer scientists. So, like, nerding out on computers and technical stuff from a very early age. 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, you know, we teach you to critically think, but prepare you for nothing in particular, be fruitful adults. You know, 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, you know, somewhat randomly in the financial services industry. 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. Yes. And you turned to me and you said, that was me. I did that in college. Yes, yes. So, I was co-captain of the College Ballroom Dancing Society. And, like, this was way before Dancing with the Stars. Like, 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. Like, life got very busy. 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? 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. I 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 like my grandmother is retired, my 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. Kitts, 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 kind of takes off so the recruiter for the local office and said, by the way, now that we've 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 and he has no idea what he wants to do with his life. I come home on spring vacation and 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 getting back here. So, I interviewed for the insurance company, got the job as I learned many years later 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 like my parents, friends and family that I was supposed to sell life insurance to which made that very challenging. 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. He wrote, when I started my career as a financial advisor more than 30 years ago, I couldn't believe the company that hired me will 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. I was a psych major, theater minor. But this is the way it was and in money cases, I mean, I guess I'll ask you this now. I mean, it still is that way. It still is for a lot of the industry. Read, 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 got 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 the 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 sales person. It was a nice euphemism on my business card to say financial advisor, but I was a sales person. I was literally paid on commission to sell the insurance policies. And like that distinction, the term financial advisor is used very, very widely. Some people who use it literally are in the business of advice. Like they get paid for advice and they charge these for advice and they receive advice. But we also still continue to hire people in the industry. We call them as financial advisors, but they're sales people. That used to be 90% of the industry. 90% of the industry was 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. Natural market, yes. And I was a pilot so go after the pilot. That's why they recruited me because I was financially savvy. I did run an antiques business when I was in college so it must be sort of related. I thought the same thing. I had good grades, I was a hard worker. I was hired for the zip code that my parents lived in. But at least to your credit you realize that and you begin on this other career. It didn't take long for me literally into the first year sitting with the prospect in their home across from on their kitchen table talking to them about quote, advice which was basically selling to them a variable universal life policy. He had accumulated about $300,000 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. 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? He was in a practice that was burning him out. I 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 say yes inevitably and like I mean just were taught in the industry like it's a quote game of numbers. If you just pitch your thing to enough people eventually some of them will say yes and just like this crisis moment for me of my god like 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 the 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 like look financial advice is I really view as a sacred duty and like I'm not trying to be melodramatic like 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 the accessibility that wealth creates to medical care like people's lives and livelihood are literally on the line like you can't screw around with that. You have a conscience that's the problem and yes and for whatever it's worth I did not get the sale that day he didn't buy. Let's start out the conversation with the evolution of the advisor industry you've given a talks on this listen 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 live the evolution. You've lived most of these transitions. I'll throw in my two cents as we go along. Go ahead and start from the beginning. The beginning of financial advisors for most of us it was pure product sales. We sold insurance, we sold annuities, we sold stocks most of the roots of the industry are essentially like it's the stock market. It's the Charlie Sheen Wall Street 1980s model or the Wolf of Wall Street model of stock brokering and I mean it paid well if you go all the way back to the 1970s for big clients we could get paid $200 a trade in 1975 dollars just to sell a stock to an individual client. That's like a thousand plus dollars today as a ticket charge. That was the fixed commission rate. That was the fixed commission on a big trade. It was scaled to the size of the trade. That would be a big one. Every firm had the same rate. Every firm had the same rate by law because FINRA back then the National Association of Securities Dealers had fixed it at a set rate. It was like part of the aftermath of the Great Depression. There was a 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 got rid of all the gouging. Bad news obliterated all the innovation that was inefficient because you were legally barred from competing on price. So by the 1970s we decide 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. Like why are we paying all these dark brokers for such money a computer could do this. Discount brokerage firm. 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 trading commissions basically to create you know call it robots of the era to eliminate human financial advisors. As it turned out like it didn't kill advisors we're still here but it did obliterate stock trading commissions like you know we went from $200 a trade down to $20 a 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 brokerage model and it forced us all to shift and so as financial advisors we shifted into a new environment we said well you know anybody can sell you a stock I will find for you a great stock picker. Like we went in the mutual fund business and said well I'll get you mutual funds with great managers and huge growth cycle. The mutual fund industry alone in the 1990s grew from less than half a trillion dollars to five trillion dollars. Like it was a 10x growth cycle and 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 was obliterating the financial advisor business model so we were all reinventing ourselves from stock brokers peddling stocks in a mutual fund salespeople still on the sales person side. There was actually something else going on too it was the RAPFI account and this was started in the 1980s and it really took off in the early 1990s in fact Shereson Lehman 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% RAPFI Very, very generous of them I guess stocks were making 14% a year back then it's like who cares if the house gets a 3% vague you're making 11% net it's still great So phase two is this mutual fund or manage money separate account management slash mutual fund concept and then what happened after that The internet showed up all this discount brokerage becomes online brokerage eTrade runs all of their wonderful commercials buying mutual funds is so easy a baby can do it and they have the picture of the baby day trading stocks and mutual funds from the crib all of a sudden like you could buy mutual funds and sort of more practically like 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 we knew 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 said meant the internet brokerage companies were giving away 100% what advisors did for no commission when our money came from commissions which created kind of like 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 like anybody can pick a mutual fund on a brokerage platform I will create for you a diversified asset asset allocated portfolio of all of it brought together your goals and your time horizon and consistent with your tolerance for risk and for this aggregate service of everything brought together I will charge you you'll merely 1% lower than the 3% that she 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 and net decline that's kind of the tail end of we start shifting away from the model in the late 1990s when the internet showed up natural outcome is now we're mostly in an AUM model charging these stand alone 1% assets under management fees and the whole mutual fund sales complexes and net outflow I see the ETF evolution as giving the brokerage industry the traditional branch UBS Wells Fargo brokers the ability to do this wrap fee in other words to compete with the independents who left 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 traditional wire houses to kind of backtrack and get into that business and compete head on head and some of it is part of the evolution of that model itself even from the advisors end as I'm sure more than a few listeners have observed as well at some point I can just buy an ass allocated mutual fund on my own I can do this with a handful of Vanguard funds and pretty much get this done why am I paying you Mr. Advisor one version of this goes down the road 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 like the ETF are 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 come and say look you've 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 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 to 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 is 2% with your mutual fund portfolio it's 1.2% with mine 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 we're feeding on our own the advisors 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 you can look at that 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 it is like hey at least we're proactively trying to earn our 1% 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's sold all the way back to like the munder net net was the big one when I was getting going in this environment for the advisors who are managing portfolios on 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 and net decline we're causing it because the fee model puts you on the client side of the table and that's one company I had no reason to bring down your costs when I represent you I have every reason to bring down your cost because frankly that's one of the ways I justify my fee as an AUM advisor so along comes Betterment, Wealthfront, Vanguard and they're going to do it 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 we are going to charge you a low fee and this is another evolution and that advisors appear to be grappling with right now especially the 5,000 pound gorilla which is Vanguard at 30 basis point PAS program all of a sudden showing the world that yeah you can have some advice plus portfolio management and yeah 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 yeah we are very much in that fourth phase transition 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 kind of 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 kind of 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% like there's some discounting like all handle your kids accounts with charging them separately and like there's some money where you kind of want to hold on to the stock because you've had it a long time so like I'm not really going to manage I'm going to put in a separate account and like we'll oversee it but we're not actively trading it so like 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 primary components what's the raw cost to just build and manage a diversified asset allocated portfolio and you know it's not a terribly high number like just there is some staff there is some labor there's some systems that have to get built but you know that's that's kind of converging in this 20 to 30 basis point ish yeah 25 basis points a good good number you know the second component that you're seeing is all of I'll just probably call it the financial planning advice and you know 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 and 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's your money going higher level questions about just is your money actually going towards the things that fulfill you you know from a cash flow basis from how your dollars are invested from what you're trying to pursue like I don't get that from a robo like that's that's a human conversation and exploration conversation 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 somebody with has 2 million somebody who's going to inherit 10 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 so I'd answer that in I guess so 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 like you know I've got a financial planning fee that's whatever my number is two grand a year three grand a year 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 like 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 you know the other answer I would give to it though just in practice so there are two interesting things to me that does happen just as wealth as wealth lifts up one is complexity does start to rise it's not a perfect proxy like you know I have had clients with 5 million dollars and their 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 because where my advisor at I spent a lot of time explaining to clients why the thing is getting pitched them is crappy and not actually good and when you've got more wealth a lot more things often can get pitched at just the raw steaks of some strategies not necessarily the retirement conversation but you know good tax planning strategies can just literally have more mathematical impact when there's more dollars at stake so you know part of that just part of that like you know why does a 5 million dollar clients get you know 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 like there is actually more stuff going on if you look at most advisory firms they do more 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 in the planning experience you know smaller smaller clients may work with slightly less knowledgeable experience advisors not say they're inexperienced but you know it's kind of like the law firm thing like you know if I'm a small law firm client I get the 7 year associates I'm a you know lot more at stake I get the senior partner who has 37 years of experience and like has seen my situation more times than I've been alive so so there are kind of gradations that come in both advisors usually have graduated fee schedules so frankly like 10x the portfolio usually isn't 10x the fee it may still be 5x or 7x but like it's not it's not perfectly linear but more services more experience more dollars at stake more consequences for the decision you know there cause 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 some something it's case it's taken and some skin at the game for the consequences of their of their advice and so I just for better or worse like I think that's why you see the model hold up and continue to persist as as strongly as it has now that doesn't speak to a huge segment of people who'd like literally don't need anyone to manage my portfolio like I just want to pay for advice and obviously like that whole assets under management model like that just doesn't work and so there's the growth of like 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 like I just want to pay for advice I don't 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 a perfect proxy for for complexity in dollars that are at stake but there is a piece of that one final question the advisor industry continues to evolve the asset management industry continues to evolve fees continue to go down yes people that trying to figure out the model it doesn't seem like any of the old stuff's going away I mean they're still commissioned sales people there's still insurance people selling you know insurance whole life insurance sometimes I just want to buy a product like and I I mean sometimes I really just want to buy a product and want someone to sell it to me like there is a time like I go on to the car lot like I just want someone to sell me the car like I don't need a holistic automotive family consultants like just just sell me like 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 and then take my order so yeah like sales isn't going away and then also AUM 1% advising where the advisors trying to select ETFs that adding alpha with tactical asset allocation or smart beta or whatever whatever you're doing trying to add accessory to it I mean that's not going away no it just there 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 you know we both 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 what I'm getting at here is that you know 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 and so we've talked about the latest new model so my last question to you because we have limited time here is so what's the future you know 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's that you see happening and going on and then what's the good stuff here's the worst of the bad stuff to me right now the worst of the bad stuff is that the whole industry has figured out like the future is advice the future is just more more holistic advice because I can you know get a diversified asset like a portfolio from a platform for 25 or 30 basis points so like we ain't winning on that gotta 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 open 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 like ubiquitous adoption of financial advisor financial consultants in similar sounding terms from people who are just literally legally a sales person and usually it says somewhere on their business car like registered representative of 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 securities offered through blah blah blah correct the brokerage industry figured out the future is advice before the advice industry figured out how to protect their own space and so the brokerage industry now so encroached into the advice space top with the titles with the marketing you go to most brokerage firms website and 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 like 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 and what do you see as the bright spots 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 on the sales side of the table this shift of the industry from sales to advice like 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 official for them so there's also a shift to different non-asset management fee models where hourly or retainer do you see that growing as well the AUM model is basically just a tiny niche model it works for a very very small sub-segment 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 telling this to delegate it to an advisor so like you don't want to do the portfolio stuff yourself by the time you take how many people like have enough money to meet a typical advisor minimum are have it liquid and available not tied up in a 401k plan have a mental inclination towards delegating in the first place you get down to something like 5 to 10% of all households and like that's it 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 the that's how the majority of consumers will need to engage advisors because just you know you want a service you pay from your available income like that's how we buy everything else assets under management is this 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 I you know I see the AOM model continuing to grow but it will probably be a minority of advisors in the niche in 10 to 15 years Michael it's been wonderful having you on vocal heads on investing thank you for being on the show today absolutely my pleasure thank you 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 vocal heads on investing podcast thank you Rick please feel free to call me Nikki 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 firm that is absolutely true 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 yeah so I think the kind of interesting part is I started out as a CPA so my first job out of undergrad was in public accounting at KPMG Pete Marwick and I worked as an auditor you know 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 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 like 25 years old and thinking this is a really interesting space right you 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 took that away like 1996 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 kind of 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 clients business and so I got to learn a little bit about RIAs and what that looked like ultimately turn 30 decided if I was going to go get a PhD it was a good time to do it so I went off went to Ohio State got a PhD and started immersing myself in academic research and so that was a lot of fun so you've been in academics then for more than 15 years? 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 North Eastern in 2004 and so I've been able to kind of move up the academic ranks which has been really wonderful started 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 is as academics know it comes with pros and cons also co-editing the financial analyst journal which I'm really proud of and excited about and then yeah my research has evolved I started out being very interested in hedge funds I started my program in 1998 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 8 or 10 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 in institutional investors in particular and I started looking at mutual fund flows for whatever reason I was just reading the ICI 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 we're 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 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 good idea but let's look into it a little deeper. So what was 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. 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 the MFS growth fund we would see more money flowing into the institutional share class of that active fund then the broker sold class and so I thought okay I'm going to write a paper about distribution and you know I kind of 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 are 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 sell passive funds but my point was trying to think about the movement out of brokerage into institutional within kind of the active space prior to this I interviewed Michael Kitzes and I know 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 reference in your paper and found out that there are probably close to 700,000 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 duly registered and there is 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 there's 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 and they're managing money they're managing portfolios and they're charging the fee based on those assets and so it's assets under management there's also people who are doing retainers and fixed fee hourly and so forth but that's a very, very small number maybe less than 1,000 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 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? 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 as I was kind of following up on this money's 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 and this is a dual registered advisor who could sell the broker commission side of the mutual fund and collected asset management fee by using the other side as well. 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 some guy starts working for say a company called AmeriPrize and at that time AmeriPrize 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 like the year 2000, 2004 you'll find about 80% of the revenues coming from the brokerage side of a business let's just pick on AmeriPrize and 20% coming from the RIA side and over time for various regulatory reasons you can talk about or not the balance shifted and so now what you'd find at AmeriPrize 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 1% or 2% 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 or brokers have gotten a bad name in many cases so if I'm at AmeriPrize 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 1% or 2% whatever that is and so the dual registered advisors it's at the firm level 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 I'll show you some load funds or do you want to be an RIA client where I do have more responsibility for you but I'm going to charge you an asset based fee and by the way let me get 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 got 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? 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 for mutual funds which for those of the audience here who's not experts on mutual fund structure this is a typically 25 basis points a one quarter of one percent fee that the mutual fund family is paying to the advisor 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 I thought that for a long time and I had a whole bunch of people you couldn't but then you know I 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 you know imagine I'm at a merit prize 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 merit prize advisor would say okay I was going to charge you one percent but because I get this trail I'm going to charge you 75 basis points so that your total fee is one percent absolutely not 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 one percent yet they getting comped from the mutual funds that they're putting money into 0.25 are they required by law to bring it down to 0.75? Nope and they still aren't Reg B.I. 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 they frequently were there are tons of disciplinary actions but even the stuff they were doing that was legal in 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 because not because you were overcharging them but because you didn't tell them you were overcharging them how many firms are we talking about in your paper you mentioned Raymond James can I name off a few more like LPL of course yeah there are hundreds of dual registrants the top 10 which you'll see in my paper manage something like 75-80% of the assets okay they found this across the board and all these dual registered 100 dual registered firms ended up kind of 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 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 what I will say is fascinating about that is my look at some form ADVs post this incident so this got all kind of wrapped up in 2020 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 you know hard to do what most of them are doing is they are 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 12 these are called 12 B1 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 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 kind of like gone the straight and narrow on that well let me ask you about the larger firms the wire houses like the Merrill Lynch's Wells Fargo and all that they weren't involved in this were they were absolutely all the big firms hmm 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 and conflicts of interest 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 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 like the historical model of variable annuities is that the biggest commissions and if you were a broker that was where you got your biggest bang for your buck 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 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 and so if you were to tell which paid really have to commissions back in the 80s I'm going to trade as much as possible and certainly that's 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 know you and I had chatted about in the past was this idea about certain fund families would say you know 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 to 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 I have seen a few not not many and I review accounts basically daily I have seen a few broker 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 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. What about fees for advice not linked to commissions and not linked to assets under management? I think that when you decouple the product from the advice that clearly is going to reduce conflicts because for obvious reasons 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 I guess that could occur there would just be you talk to them for an hour and charge them for two but those are that's more fraud than it is a conflict 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 greatly appreciate your insight and thank you again for joining us. Yeah, thank you so much it was a great time and I'll keep you posted on my findings as I get through that work. 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 Join one of your local Bogleheads chapters and get others to join Thanks for listening.