A new year inspires reflections and prognostications: What does the passive advisor resemble today, and where are we going next?

First, what is “passive investing”? If ever there were a contest for descriptors that failed to capture what was truly meant, this one might be the champ. But, alas, for the time being, it remains the best-known name for our loosely affiliated group of like-minded advisors. So we’ll go with it for now. In my mind, whoever you are, passively minded advisors uniformly serve investors according to:

• The robust scientific evidence on how best to capture (and keep) the long-term returns that our markets are expected to deliver
• Each investor’s unique goals and personal tolerance for market risk
• Each investor’s highest financial interests, based on a fiduciary relationship

These are more or less the underlying principles upon which I’ve seen all passively minded advisor firms form and grow. From there, it’s been fascinating to see how:

1. Each advisor shapes his or her own unique practice
2. The passive advisor industry as a whole has continued to evolve, naming conventions and all

In this post, I’ll share some of the biggest variations I’ve noticed from one passive advisor to the next. In my next post, I’ll ruminate on industry trends. Hint: Even in our relatively quiet corner, there’s a whole lot of shaking going on.

Who do you serve?

The biggest variation I see among the passive advisor community is each advisor’s specific client base.

• Some of you prefer to serve clients close to home, while others are (or at least hope to become) nationwide household names.
• Some focus on narrow niches. Others of you are less choosey.
• Some of you excel in helping clients who are fearful, perhaps best off investing on faith versus reason if they are to stay the course. Others prefer to work with investors who want to be fully informed and more engaged in the decisions. Still others are agnostic on client personality.

There is no absolute right or wrong, but, in my opinion, the more precisely you can define who you want to serve, whether that’ a wide or narrow base, the easier it becomes to make good business decisions. I find that those who don’t have ready answers to this essential question have to work harder at whatever it is they’re doing to get half as far. It’s a little like the difference between investing with or without a plan.  

What do you offer?

There are huge differences here as well. I believe all RIA firms help investors build and maintain their portfolios, either in a highly customized or more turnkey fashion. But what else?

• Do you seek to specialize exclusively in one or a few key services or do you want to be a one-stop shop for all things “wealth”?
• Do you plan to remain lean and boutique, or become big and broad?
• How many of your services are managed in-house; how many are outsourced?
• When you outsource, do you favor the well-established, big-name relationships; or are you at the vanguard of exploring smaller roads less travelled? Or both?

Again, there is no one, right answer. I’ve seen models in all shapes and sizes on these counts, both successful and, well, not-so-much. To me, the right fit achieves a good balance between the highest use of your talents and interests, and the most important of your clients’ needs.

How do you price it?

The majority of the advisors I serve are strictly fee-only, and seem to price their services approximately (very approximately) in the range of 1 percent or less for $1 million AUM, on a sliding scale downward as AUM increases. But there are legitimate variations:

• Some supplement their fee-only services with stand-alone hourly services such as financial planning or limited investment services for more modest needs.
• Some are fee-based. I see this most often when a firm wants to provide direct risk management solutions (i.e., insurance) as a minor, but complementing part of their otherwise-fee-only offering. 
• Some, especially those with lower minimums, accompany their percentage fee with a flat, annual fee.
• I read about other compensation models that may or may not fit our world. It will be interesting to see what the future holds although, for now, I’ve yet to personally encounter firms that are trying out some of the more edgy ideas out there.

I see a lot of spirited debate about “fair” pricing. Some firms have chosen to focus on rock-bottom fees as a point of distinction. They feel advisory services are generally priced too high, especially since we stress the importance of managing investment costs. Others want to ensure that unreasonably low pricing doesn’t render it impossible to provide the comprehensive levels of service some investors want and need to manage their wealth fully and effectively.

Who do I think is right? Both and neither. Presumably investors can seek out the levels of services and pricing that makes best sense for them. Typically (and logically), the firms with the lowest fees are those who also are leanest on their services. I’d like to believe that our free market economy eventually weeds out those who seek higher fees without offering meaningful, commensurate value-added. In real life, I’m sure there are exceptions, but by and large, just as in our mostly efficient stock markets, that’s what I mostly see happening as I knock about our specific niche within the financial industry. Whether full-service or economy priced, I see most passive advisors acting responsibly with their pricing. Thus, it seems to me there is plenty of room for a range of competitive pricing to match a range of competitive services.

When it comes to portfolio construction, how do you do it, exactly?

In the good old days, I could ask one question and be done with my screening on whether or not an advisor might be a good fit for my particular brand of communication services:

Are you a Dimensional Fund Advisors firm?

That’s still a great and vital question on the list. But the world is a complex place, and no industry survives without growth. To quote Bob Dylan, “He not busy being born is busy dying.” In my next posting, I share my thoughts on some of the most recent and exciting ways I’m seeing our passive investment advisor industry continuing to be born, and thank goodness for that. 

These are my own impressions. You may not agree with all of them, but I hope they offer food for thought. As an investment and/or wealth advisor, you are on the front lines of delivering real advice to real investors, whose very lives depend on what you have to offer. From what I’ve seen, each of you takes  very seriously this frightening, and frightfully important responsibility, dedicating your hearts and minds to the challenge. Each has formed his or her own conclusions, sharing many wise commonalities but also some important and interesting differences. The results are, in my mind, a vibrant network of opportunities, in which both our commonalities and differences combine for a larger strength. If there is a theme to pursue in 2012, it is this: Vive la différence!

PS: If you like what you’ve seen so far, don’t forget to check out our existing custom creations and new 2012 subscription service for passively minded investment advisors!