What disruptions have the “Free” economy wrought on financial companies and its customers?
Bernard Arnault is now the third-richest man on the planet, having grown luxury brand colossus LVMH by stitching together 70 brands during the last 40 years, such as Louis Vuitton, Dior and Bulgari. LVMH generated total sales of $54 billion in 2018 and continues to opportunistically add high-end brands as they become available. Arnault is now 70, but his appetite for new additions to his stable of luxury brands seems far from complete. In late October, LVMH made an unsolicited $14.5 billion bid for the 182-year-old American jeweler Tiffany. If the deal goes through, it will be Arnault’s largest acquisition ever.
It seems that there remains strong demand for goods and services at the costliest end of the market. However, at the low end of the consumer market, the mass market, many companies seem to be competing in a race to offer their customers products for free. Free shipping, free stock trades, free software, free social media, and free internet content. Free is now a business model.
In the mass market financial services business, the race to zero began in 1975 when regulators abolished fixed trading commissions, disrupting a very lucrative system that allowed stockbrokers to charge hefty fees with little competition. The inevitable race to the bottom in the brokerage business was complete in October, as all major discount brokerage firms instituted no-cost internet trades. The industry has been in upheaval since the beginning of October, when Schwab said it would eliminate commissions on online stock trades, causing its large competitors to follow suit.
The problem with a race to the bottom is that you may win. But it may be worse to come in second in that race, so each large firm moved to offer free trades at the same time.
In an important but not very surprising news story this morning, sources say that Charles Schwab Corp. will acquire TD Ameritrade Holding Corp. to form a new mega-supermarket of financial service offerings. The $62 billion market value Schwab would acquire the $26 billion TD Ameritrade.
Schwab and TD Ameritrade rank as the number one and number two players in the consumer financial services sector formally known as discount brokerage, and will form a mega-company with more than $5 trillion in assets under advisement. While not an earth-shattering idea, the speed of the consolidation at the lowest end of the financial and wealth management services business continues ever faster.
But what does “free” really cost the consumer? And in the financial services business, what are the downsides of free?
Twenty years ago, 31 percent of Schwab’s revenue came from trading commissions; today commission generate barely 7 percent of total revenue. That fall in revenue and profits must be made up from somewhere, and the decline of client service offerings by experienced and capable employees is sure to bear part of the brunt of industry disruption.
With Schwab’s 71 retail office locations and hundreds more TD office locations, there is sure to be dislocation of employees as offices on the same corner consolidate, or customer service phone centers with a large number of employees performing the same jobs are “rationalized”.
The disruption in the discount brokerage business has certainly come as a result of the internet and a consumer desire for access to visit their money on whatever communication device is most convenient, whether smartphone, computer or tablet. The incredible advances in technology industrywide has certainly helped to fuel the merger frenzy also.
However, due to decades of business evolution, the huge financial supermarkets are no longer financial services firms, but rather are now technology companies that happen to be in the financial services business. Huge and continuing investments in back office and trading technology has made it easier and more efficient to service the average brokerage client, and that technology has also allowed customers to perform most tasks themselves in service of their own accounts. And as technology companies, any person working for these large firms that does not directly bring in revenue or new customers has become a cost center and is ripe for replacement with technology.
Discount brokerage for decades was a profitable business, as even after commission deregulation discount brokers still made most of their profits from individual consumers making their own stock, bond and mutual fund decisions and trades inside their architecture. Prior to the internet, humans were still needed on the other end of the phone to educate, explain and transact trade orders for customers. Even at a discount broker, a human voice on the other end of a phone was always available. But now in the days of free commissions you get what you pay for. Free comes with a large cost, the elimination of the human factor.
Although financial supermarkets have robust websites complete with much content, information and educational materials, in the end you are on your own. With razor-thin profit margins and rapidly declining revenue, paying humans to interact with clients is now a flaw in the profit system. The human touch will surely go away.
It may be appropriate for a 22-year old to invest his small savings or new 401k with a financial technology company. At that age, the three most important investing tenets are to start investing early, to invest consistently over time, and to not attempt to time the market. At that age, investing in an inexpensive index fund at a firm such as Schwab MegaBroker may make a lot of sense.
However, as a client advances in age, wealth and the complexity of his circumstances, the human touch must make a return to the equation. As we age, we must consider retirement planning, estate planning, the creation of a will and providing for our family members in the case of the death of family leaders. And we cannot perform this important work at a firm that charges nothing, as that is exactly what an investor will receive.
Luckily for wealth management clients, the advances in technology and back-office systems have allowed trusted wealth advisors to leave large and traditional advisory firms to set up their own advisory shops, where they can focus on serving loyal clients and their families.
A client’s account can remain in custody at a large firm like Fidelity or Schwab, which allows the advisor to worry about a client’s long-term wealth management plan, and not about building a complicated back-office technology system. Wealth management is local, personal and relationship based, and small wealth advisory firms can now offer the best of both worlds: the world’s best technology backbone combined with the face to face, personal service of your local advisory team.
Interestingly, those folks who buy $7,500 handbags from LVMH do not value free trades. They value and pay for continuous and sophisticated financial planning and advice, with a trusted advisory team that they have known for years. An advisor who knows each client and family on an individual basis. An advisor who understands the unique financial situation, hopes and dreams of each client. An advisor who will be there in good times and bad, and that will pick up the phone if the stock market declines 20 percent in a week, and who will remind a client of the wisdom of their diversified long-term wealth management plan.
While the inexpensive offerings of financial supermarkets may seem attractive to small investors, the costs down the road of making investments on your own or of not properly planning for your financial future may be much higher than you can conceive.
