Amazon, Netflix and now Schwab: The risks in subscription models

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Charles Schwab’s decision to switch to a subscription-based financial planning option reflects how the dominant e-commerce model has also contributed to the erosion of the advisor industry’s traditional pricing model.

Successful online retailers like Amazon, Dollar Shave Club and Blue Apron demonstrate subscription-based business models that have helped them become three of the top five most popular retail sites last year with net sales of upward of $2.6 billion in 2016, according to recent research from McKinsey & Company.

Schwab, the low-cost investing pioneer managing more than $3.5 trillion in client assets, is adjusting to that new reality. Customers on its digital advisory service will pay a flat fee of $300 and $30 per month instead of a traditional percent of investable assets. The brokerage says subscription fees will help cater to a younger consumer base that prefers to pay for products on an ongoing basis.

Subscription fees may well be an improvement on the limitations of the AUM model, says James Gambaccini of the Reston, Virginia-based Acorn Financial. The conundrum for financial advisors has always been finding a cost effective way to provide the same level of services and advice for the million-dollar client to those with significantly less to invest.

“Fees tend to be limiting,” Gambaccini says.

The subscription e-commerce market has grown by more than 100% per year over the past five years, according to McKinsey. Subscribers are most likely to be 25 to 44 years old and have incomes from $50,000 to $100,000 — a segment of the wealth management market that has been historically underserved by advisors charging a fee on assets under management.

There is obvious pushback from advisors.

“I am sure they will get a bunch of people who want to pay as little as possible,” says Jon Ten Haagen, founder of the eponymous RIA firm in Huntington, New York. “But, I always say you get what you pay for. You want skill and experience with the markets then you should be ready and willing to pay for it. Everyone is trying to invent the next wheel.”

But, in fact, more than seven in 10 advisors are concerned about charging enough fees and the impact of fee compression on advisory businesses, according to Nationwide’s most recent study of more than 1,700 advisors and individual investors. “A subscription-based model is a good way for the public to pay for access to informed, customized advice over long periods of time,” Gambaccini says.

Subscription fees can even serve clients who have yet to amass significant assets. The San Diego-based Physician Wealth Services deals almost exclusively with recent medical school graduates who have hundreds of thousands of dollars in student loan debt. The clients also have the potential to become extremely high earners.

“You can’t pay an asset under management fee on a negative net worth,” says Kayce Kress, a financial advisor at Physician Wealth, adding that most of her clients can be saddled with up to $500,000 in loans with no financial plan to pay it off. Her clients pay $450 a month on up to half a million in investable assets without the one-time fee many firms charge to create a customized financial plan.

For Anders Jones, CEO of Baltimore-based Facet Wealth, the wealth management industry has operated for too long with a single model that was not a fit for all investors — especially those who only need financial planning and basic investment management. Facet charges clients between $500 and $5,000 per year depending on the services provided, according to a spokesman.

"An RIA can serve mass-affluent investors who until now have been left out in the cold, with the right subscription-based model and technology supporting its CFPs," Jones say.

The Schwab model may just simply resonate louder with younger clients that represent a different generation of investors, says Chris Hutchins, CEO of the digital financial planning firm Grove. His firm charges an upfront fee of $560 for an initial financial plan and $65 a month, he says.

“The subscription model is for the future,” says Hutchins, adding that the large majority of retail investors in the next decade will want to operate in online services and may not have the investable assets traditionally needed. “If you look at Amazon and NetFlix, it just makes sense to them,” he says.

Even more established professionals are making the switch advisory frims that offer a monthly fee, advisors say. Some of them are working professionals with a decade or more of expereience that have stashed away significant amounts of money in taxable investment accounts, says Kress. Those newly wealthy clients are starting to wonder why their fees are rising simply because they are investing more money. Kress cited clients with a few million dollars invested that are leaving their current advisors because of hefty AUM fee up to $40,000 a year or more.

“Are there other services those advisors are providing?” Kress says. “Those AUM fees are going to increase regardless.”

Digital advice platforms have offered similar subscription fee structures with uneven results. The robo advisor Learnvest charged on an ongoing basis for similar services before it was acquired by Northwestern Mutual for more than $250 million in 2015.

“I will be curious to see if Schwab manages to avoid the failings of Learnvest, which was primarily to offer ‘financial planning lite’ to younger consumers,” says Eric Roberge, a registered investment advisor based in Boston. “As it turns out, younger consumers don't want a scaled-down, cheap product.” For Roberge, younger customers are willing to pay for high-quality services, but the industry has been slow to recognize the need to change how they are charged, he says.

More recently, Acorns, which rounds up purchases and puts the spare change toward savings or investments, gained initial success by developing products that appeal to a younger customer base and charge monthly. In May, the micro-investing firm raised $50 million in a funding round led by BlackRock, the world’s largest asset manager, to build out the startup’s portfolio stack with new investment options including IRAs. Acorns now has more than 3.3 million investment accounts and its robo-generated “smart portfolios” cost as little as $1 a month, according to the firm.

The subscription-based model isn’t without risks and many RIAs should give considerable thought to a potential switch, experts say. For one, monthly clients may be more prone to switch advisors meaning firms could potentially lose money on a quick exit from clients.

“There is certainly the risk of lost revenue if a client leaves after only a couple months with the firm,” Kress says. “There is no perfect fee model.”

Firms looking to transition clients to a subscription-based model should be careful not to cannibalize revenue from other fee structures. When Kress transitioned clients at a previous firm, for example, some clients were charged a monthly fee as well as a smaller AUM fee to avoid drastic difference in fees from year to year.

“You do have to be careful about smoothing what the client is paying so they’re not paying less or a lot more,” Kress says. “Don’t fix what’s not broken.”

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