EP 102: AI and the Evolution of Financial Advice with Michael Kitces [LIVE]

by | May 31, 2023 | Podcast

Michael Kitces is one of the industry’s leading experts on all things financial advice and financial planning. In this live episode recorded at Wealth Management EDGE, Michael explains the evolution of financial advice and how AI might impact the profession going forward. 

Listen now and learn:

  • The evolution of financial advice from the 1960s to present
  • Ways consumers benefit from financial advisors moving up the value chain 
  • How AI might impact the financial advice profession 

Listen Now

Show Notes

Welcome to the long-term investor. Last week, I had the pleasure of interviewing Michael Kitces live at Wealth Management EDGE. 

His blog, Nerd’s Eye View, is routinely recognized as a top resource for financial advisors as he is one of our industry’s go-to experts on all things financial advice and financial planning.

In our conversation, we discuss the evolution of financial advice in the wake of technological advancements. If you are a financial advisor or use one, this conversation is full of great history and perspective. 

Here are my notes from our conversation.

The Evolution of Financial Advice (2:00)

At Wealth Management EDGE, it was hard to go anywhere without people hearing AI come up. Michael notes that there’s always been an interplay between what advisors do for their clients and what they can do with more powerful technology – and AI is just another step in this progression.

Michael beautifully explains the evolution of financial advice.

Back in the 1960s and 1970s, being a stockbroker was very lucrative as people paid as much as $200 to execute a stock trade, which comes out to roughly $1,000 a trade in today’s dollars. 

So really only the very rich could afford to have a stockbroker, and getting paid so much for trades made it quite lucrative to cold call people with money and try to get them to trade. 

Brokerage fees were set by regulators (in response to commission gouging during the Great Depression), so everyone was charging the same high fees. But there was no incentive for brokerage firms to invest in making better technology or better systems that would result in cheaper stock trading because they were legally barred from charging less than the competition.

In 1975, the stock trading commission was deregulated, and a series of start-ups surfaced that were using computers to reduce the cost of trading stocks.

The first was Charles Schwab, followed by TD Ameritrade, then Scottrade, and then a firm that eventually became E-Trade. 

The idea was to obliterate the human financial advisor with computers. After all, why would you need an advisor to trade stocks when it can be done with super-efficient technology?

As you are probably well aware, the robots won, with stock trading costs falling by 90% in 20 years. These days, a great deal of stock and ETF trading is commission-free.

But technology didn’t kill off financial advisors, it just killed off their existing business model.

Financial advice adapted to move up the value chain. No longer did you need a broker to buy you a stock, so brokers changed their value proposition to finding customers “a great stock picker.” And, thus, the whole industry went into the mutual fund business, which grew from a tiny cottage industry to a multi-trillion-dollar business in the 1990s.

Michael argues that the consumer benefited because, at the end of the day, helping a customer find a professionally managed mutual fund was a lot better than selling the stock-of-the-day that the brokerage firm had to move out from their inventory (with little regard for whether those stocks were good to own).

So consumers benefit while the financial advice industry built bigger and better firms because of this technology catalyst.

Then the next wave of technology shows up: the internet.

Suddenly E-Trade is running commercials saying it’s so easy a baby can do it, so why pay a financial advisor to buy stocks and mutual funds? Investors could simply buy a Kiplinger or Money magazine that shares their top five mutual funds to buy, then go online to make the transactions themselves. 

Then you get Morningstar.com and Yahoo Finance, giving investors access to even more tools for those interested in doing it themselves rather than hiring an advisor.

Again, this wave of technology (the internet) disrupts the financial advisor business, but it doesn’t kill off the financial advice profession although it did force another shift in the business model. 

Because anyone could buy a mutual fund online, the value proposition for financial advisors became the building of a diversified asset allocation portfolio. The consumer benefits again because a diversified portfolio utilizing strategic asset allocation is a much better offering than simply buying the hot mutual fund, which was much better than just buying the stock-of-the-day. 

As we continue down this road of advisors moving up the value chain in response to technological disruption, about ten years ago robo-advisors show up offering a diversified asset allocation portfolio at a fraction of the cost of traditional financial advisors.

The response from financial advisory firms has been a shift away from being investment management-centric to a more holistic wealth management approach. We’re talking about financial planning, tax advice, estate planning, retirement planning, insurance, etc.

Michael’s platform runs a number of robust advisor studies and they can see financial advisors are shifting to a more comprehensive approach.

So what we’ve historically seen every ten to 20 years is technology takes a leap forward and is supposed to disrupt financial advisors, but then financial advisors respond by moving further up the value chain.

And every time technology advances, there are broadly two groups of consumers that are impacted. There’s one group that likes to do it themselves because they enjoy the work, so they eventually find a way to access the benefits of these technological advances on their own. 

The second group of consumers have a delegator mentality and would prefer to not have to figure everything out, so they continue to hire a financial professional, but these days they are receiving a far more comprehensive offering than ever before.

This ongoing pattern of technological advancements is very positive for consumers, regardless of what group they fall into, and it’s likely to continue into the future.

The Lack of Barriers to Entry for Giving Financial Advice (11:00)

Although technology has forced financial advisory firms to increase their value, the barrier to entry for using the title “financial advisor” remains embarrassingly low.

Michael reminds me, though, that the regulatory roots for financial advisors have been about regulating what is implemented at the end of the advice process.

If an advisor gives you advice that involves you implementing some insurance, that professional needs an insurance license with the state insurance regulator. If he or she implements an investment that results in them earning a commission, they have to be registered with FINRA because that’s the regulator for selling products. If someone manages a portfolio for a fee, they have to be registered with the SEC to get paid a fee for investment advice.

Advisors don’t actually get paid for financial advice per se, they are paid by what gets implemented at the end. The challenge with that framework is that we don’t actually regulate financial advice.

The regulation of sales in almost any industry basically comes down to two things:

  • Do you know how to make sure that what you’re selling is not blatantly inappropriate for someone?
  • Do you understand the legal rules that apply to you when you’re not supposed to sell things that are blatantly inappropriate for someone?

Most people calling themselves “financial advisors” only need to spend a couple of hours over the course of a few weeks to study for a fairly basic exam. That’s it.

And if you look at those exams, they literally don’t require you to know anything about finances or advice. They simply focus on understanding the products you sell and the regulatory laws that apply to people selling those products.

Advice is fundamentally different.

When you look at professions that give advice like medicine, law, and accounting, we have a higher bar for advice than product sales. Because the stakes are very high across those domains, you want people to be subject to some standard.

Because financial advice has come from product sales roots, almost all of it is still regulated under a product sales framework, which is a very low bar. While that isn’t necessarily bad for product sales, it’s very lightweight for advice. 

Some firms, like Plancorp, raise the bar for themselves as a point of differentiation. And it’s great to hire talented people that have credentials, degrees, and years of experience prior to working with clients.

But you wouldn’t want a hospital to differentiate by saying “Our doctors actually went to medical school.”

That shouldn’t be a differentiation, it should be the expectation. That’s the challenge for the financial advice profession. There ought to be a higher bar for giving financial advice and not just a way for good firms to differentiate themselves.

The Impact of AI on the Financial Advice Profession (17:00)

Michael doesn’t see any foreseeable future where AI is directly competing against financial advisors for the people who hire financial advisors. 

In the intermediate term, there’s a phenomenon that Michael calls “the AI penalty” in which people may not be willing to trust it or follow it. 

The example he gives is that you’ve hailed an Uber from your phone, but when it shows up, you realize nobody is in the front seat and it’s a driverless car….Would you get in?

Broad consumer data suggests that the overwhelming majority of us do not get in that car for a few reasons.

Part of it relates to some questions on the technology…Is it really that good?

There are also some weird effects that come from the autonomy control dynamics. We as human beings do not like being in situations where we are not in control, especially when the stakes are high. We don’t mind our cars giving us warnings when it detects someone in front of us is slowing down. We don’t even necessarily mind when it hits the brake faster than we could if we are about to crash.

But when it comes to relinquishing full control, we’d prefer another human (if not ourselves) have their hands on the wheel to save us at the last minute (even if the data unequivocally shows that the technology is better than we could be).

Eventually, we will all get comfortable with getting into a driverless car, but then another problem arises. Now there are 17 different AI driverless cars and you have to figure out which one is actually good and safe. 16 of them might be good, but the 17th will still kill you.

Are you sure the one you’re getting into is not the 17th car? What have you done to determine this? How have you vetted it? How did you analyze it? Are you really confident that you’re getting into a safe driverless car? 

There will be a group of tech-savvy do-it-yourselfers who works through all the different options in spreadsheets and gathers information on the internet to identify some good choices as well as some of the death traps to avoid. 

But many people won’t want to put their life on the line figuring it out, so they will get behind the wheel themselves or hire a chauffer they trust – so we’re right back to wanting an Uber with a human driver.

And so we come back to this point where it’s still actually easier and more comforting to find a human that’s just in this with me than it is to have to figure out which technology is safe and which is not. 

The same analogy has applied to financial advice with every technological advancement.

The do-it-yourselfers will figure out how to use the new technology and the people who prefer to delegate will continue to hire advisors.

Desktop computers didn’t knock out advisors. The internet didn’t knock out advisors. Robo-advisors didn’t knock out advisors. 

AI will develop a lot of great tools to use for financial planning analysis. For advisors, it’s just another tool in the toolbox. It’s hard to imagine a financial advisor refusing to use a computer or the internet. Similarly, one day it will be hard to imagine a financial advisor refusing to incorporate AI into the way they deliver advice.

While the abilities of AI will continue to advance, human beings will remain wired as social animals. We will continue to prefer being in a herd to some extent and have some level of interaction with other people. 

Human interaction also helps with accountability. Michael gives an example related to all the research on weight loss and exercising. The greatest driver of change isn’t the coolest and most amazing technology, it’s human accountability. It’s the friend you agree to jog with at 7 am every morning because you don’t want to be the person that leaves their buddy standing alone on the corner.

Because human accountability is a bigger driver of change in our behaviors than any level of technology, the human dynamic of using a financial advisor is very powerful. 

The last thing to remember is that AI today is mostly a really cool calculator. It can’t discover the problem for you. You have to figure out what to ask it. 

Advisors like Michael and I have had thousands of conversations with individuals to diagnose the actual problems and issues. These conversations can take multiple hours that recur over weeks or months or sometimes even years before we can evaluate what we’re trying to accomplish.

In our experience, most people have trouble identifying the real problems and pain points of their financial lives. AI isn’t a tool to help you figure that out.

Despite the exponential growth in computing power over the past several decades, the advice business is booming and bigger than ever. Not only are financial advisors staying in business, but they are creating more value and advice using technology.


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About the Podcast

Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence. 

Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.

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