Michael Kitces On AI And The Evolution Of Financial Advice (Rewind) (EP.154)

0:28We all need to make smart decisions with our money. Michael Kitz's that we recorded live at the Wealth Management Edge Conference last year. Michael's blog, Nerds 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 this conversation, we discuss the evolution of financial advice in the wake of technological advancements. So if you are a financial advisor or you use one, This conversation is full of great history and perspective. As always, you can find detailed show notes and links to resources mentioned throughout the episode at thelongterminvestor.com.

1:12And with that, here is my conversation with Michael Kitzes.

1:19Michael, welcome to The Long-Term Investor. Thank you, Peter. Appreciate the opportunity to join you today. Well, you've been a busy man today. We're here at Wealth Management Edge Conference in Hollywood, Florida. You have already spoken twice, and here we are in the podcast booth discussing the world around us yet again. And there's been a really common theme throughout the conference. You can't walk more than five feet without hearing the words AI at any point in time. And when I scheduled time for us to talk, I really did want to talk about the evolution of financial advice, the past, the present, the future.

1:53And I think it would be a shame to not incorporate AI at some point. But I would love just to start out with something I've heard you talk a lot about over the years, which just is that evolution of financial advice. It fits well in context, and I guess we'll come to it a bit, that if you look at the evolution of advice and advisors, like there's always been this interplay of what do advisors do and what can we do with ever increasing more powerful technology, technology, for which I really do just think about AI as another step in that progression as we just keep doing more technology things.

2:26It's like if I go all the way back, you go back to the start of what I'll call the modern era of the financial advisor. You're back in the 1960s, the 1970s, either we sell insurance or we're stockbrokers, like the good old Wall Street stockbroker, which was actually really lucrative. Back then, you could get paid as much as$200 a trade in 1970s dollars to execute a stock trade. It's like$1 ,000 a trade right now. So only people with giant piles of money ever even bought stocks from a stock broker. You had to be rich enough to have a stock broker. And stock brokers would just cold call you with tips because frankly, when you get paid$1 ,000 a trade, it's really quite lucrative to keep cold calling people with money and try to get them to buy the stock of the day.

3:09That was the business. until this change happened in the late 1970s and early 1980s, or sort of a double change. The first was part of the reason why stock brokering was so lucrative back then is the rates were actually set by the regulators. The aftermath of the boom and the bust of the Great Depression, there was a whole bunch of basically like commission gouging during the run-up in 1929 and then the crash in the 1930s. No one paid attention to the Stock Trading Commission when you thought it was going into the sky, and then no one paid attention to the Stock Trading Commission when it was crashing to zero.

3:37So brokers did some bad things. People paid more for trades than they should have. The regulatory response was, we're just going to set the rates by the regulators. Every brokerage firm has to charge the same thing. Completely eliminated commission gouging. Completely eliminated innovation. Because there was no incentive for a brokerage firm to invest into making better technology or better systems to make stock trading cheaper because you were legally barred from charging less than the competition. So eventually, we decided this regulation has run its course. After several decades, It gets to the 1970s.

4:07Stock Trading Commission is deregulated May 1st, 1975. And then a funny thing happened. So this entrepreneur in Northern California, right outside of what we now think of as Silicon Valley, decides he's going to use these newfangled things that are coming out called computers to see if he can disrupt financial advisors selling stocks by using computers instead. So a lot of them know him today. His name was Chuck Schwab. So Schwab was started as basically a technology startup in 1975, right after the deregulation of commissions, to use computers to disrupt the human financial advisor. Ameritrade also came in 1975.

4:47Scott Trade came shortly thereafter. The predecessor, predecessor, but ultimately became E-Trade also started then. There was actually this whole boom of basically tech startups in the mid-1970s through the early 1980s that were basically trying to leverage the arrival of the computer to obliterate the human financial advisor. Why would you need an advisor? We can make this super efficient through technology. So the end point of it was basically the robots actually won. Stock trading costs fell by 90 % in 20 years from the mid-1970s to the mid-1990s because of all the benefits of technology. That's how we eventually got down like$20 a trade by the late 90s.

5:22And then it went down further from there. But obviously, we're still here as financial advisors. So as it turned out, Technology didn't actually kill the financial advisor. It just killed the business model at the time, which was like, I'll sell you stocks from my boiler room inventory if you want to go back to the movies of the time. And we kind of moved up the value chain. We said, like, sure, you can use a discount broker with computers to buy a stock. I will find for you a great stock picker. And the whole industry went into the mutual fund business. So, like, mutual funds went from a tiny cottage industry to multi-multi-trillion dollars in basically just the decade of the 1990s alone.

5:57because the financial advisor model was being eviscerated by technology and we had to reinvent a new one. And so we did. From the industry end, kind of built bigger and better firms. I would argue from the consumer end added a lot more value. I mean, at the end of the day, helping you find a professionally managed mutual fund was a lot better than selling like the stock of the day that our company had to move from inventory that may or may not have been a terribly good stock. So like consumers benefit, industry builds bigger and better firms because of this technology catalyst. We're having like a great heyday.

6:26And then there's another technology wave because the internet shows up. And suddenly E-Trade's now running commercials. Like, why would you pay a financial advisor? You can buy and sell stocks and mutual funds from your crib. It's so easy a baby can do it, right? We may remember like the TV commercials of the time, the E-Trade, the infamous E-Trade baby, all built around like this. There's a new leap forward in technology. Why would you need a financial advisor? You can use the technology to buy all this stuff. And you could. I could buy it myself. I could read like Kiplinger Money Magazine that were giving me like top five mutual funds to buy on my online investment account if I wanted to go further.

7:01Well, now the internet is here. Morningstar.com, Yahoo Finance, big charts, like the companies of the era have shown up. And all of a sudden, you don't need a financial advisor to get a mutual fund anymore. So once again, you get to one of these, the technology is disrupting the financial advisor, except of course, we are still here. We all do solid businesses. And so what happened instead is like the technology didn't kill the financial advisor. It forced another one of these shifts in the business model. Anybody can buy a mutual fund online thanks to the internet. I will create for you a diversified S allocated portfolio.

7:32And we went into this whole like holistic portfolio management business. Once again, I would argue like added more value to consumers, created more of a value proposition, right? Like a whole diversified portfolio is a much better offering than just buying the hot mutual fund, which itself was much better than just selling the stock of the day. So we're moving up the value chain as advisors. Consumers are getting helped more. Consumers that don't want an advisor are just getting more and more technology to do it themselves online. And so we continue down this road. Then we got to another moment of this about 10 years ago.

8:04The robo-advisors show up. Why would you need a diversified asset-allocated portfolio? You can just get a robo-advisor to do it at a fraction of what traditional financial advisors charge. And so once again, we started seeing a shift. Advisory firms increasingly now have been less investment management centric, more holistic wealth management. You have dollars, it needs to land somewhere, it needs to be well-tended. That still tends to be part of it. But now we're also talking about financial planning and tax advice and estate planning, retirement planning, and all these other areas. The advice is getting more holistic.

8:37We run a bunch of advisor research studies on our platform. We can literally see advisors are actually getting more comprehensive. Their plans are literally like more comprehensive than they were five and 10 years ago. Like we can see the shifts underway. This happens almost like clockwork every 10 to 20 years where technology takes some kind of jump forward. It's supposed to disrupt financial advisors, right? Going on the back, like why need a financial advisor? We have Lotus 1, 2, 3 now. And every time it comes, it sort of plays out in two separate channels because oversimplifying a little. We can kind of segment just sort of people overall, like our human psyche mentality into one or two games.

9:15There's some of us that like to do things ourselves, give me knowledge and access to tools, and I'm going to get in there and do my thing. Often, because I'm good at it, sometimes it's just like, I like it. I don't like playing with it. And a lot, you know, when we get to the money domain, there's a lot of people like, they like managing their portfolio and watching their assets and stewarding their wealth and doing all that stuff. Then there's a segment on the other end that are essentially a delegator mentality. Like there are other things I would rather do in my life than spending hours and hours and hours on the internet, following my own investments or learning about retirement planning or trying to figure out what the heck the safe withdrawal rate is or whatever else.

9:48I would like to hire a professional, have them tell me what the heck the answer is because I would rather spend my time with my family or kids or traveling or this other thing I'm really into or my hobbies or building my career, whatever it is. We come to it from lots of different domains. Some of us want to do this stuff ourselves. And so every time the technology leaps forward, we get cool new toys to play with. And then there's a segment of us that would really rather delegate and spend our time doing other things. And so those folks keep seeking out advisors who deliver successively more valuable value propositions because we still feel the pressure from the advisor.

10:23And you can't just repackage what the internet does or what technology does for more price. You got to add something in their value. And we always do, like the model has evolved in that direction. I think ultimately very positively for consumers as well. We have to do a lot more to just like justify our existence as advisors, but that means more value gets delivered to the delegators that want to delegate and the do-it-yourselfers get cooler toys to play with in the technology realm. Thus, the technology marches forward. And that basically just, that's how it plays out every time we get these leaps forward in technology.

10:56Well, in taking a very small detour away from the technology side of it, because you're mentioning how we are moving up the value chain and providing more and more value, it also requires better talent and better talent requires dollars. It is hard to attract and retain very talented people. I also know at PlanCorp, we've been doing financial planning for fees since 1983. So we're here in our 40th anniversary year. That's not that new for us. And we are now seeing our other competitors doing it. And as a result, we are giving our advisors behavioral training now as well. And as the cost of talent goes up, I'm kind of curious, do you feel like this current state where there is basically no barrier to entry to giving financial advice is going to have to change at some point, given what the value of advice has become?

11:47I do think there are some shifts that will eventually come in the requirements of what it takes to become an advisor. The regulatory roots for advisors, the word financial advisor is not really regulated as such. Advisors are generally regulated by what they implement at the end of the advice process. So if I give you advice that also involves you implementing some insurance, I need an insurance license with a state insurance regulator. If I implement an investment that ultimately I get paid a commission on, I have to be registered with FINRA because that's the regulator for selling products. If I'm going to manage a portfolio for a fee, I have to be registered with the SEC or estates to get paid a fee for investment advice.

12:28So we don't actually get paid for financial advisor per se. We get paid by what gets implemented at the end. And the challenge to that framework, it's sort of a meta level, is what that means is we don't actually literally regulate advice. We regulate the sales of things that come at the end of advice. And the regulation of sales, just historically since basically forever, is not a terribly high bar, right? The essentials for regulation of sales, not even specific to advisors, but in almost any industry, basically comes down to one of two things. Do you know how to make sure that what you're selling is not blatantly inappropriate for someone?

13:05And do you understand the laws that apply to you when we say you're not supposed to sell things that are not blatantly inappropriate to people. So almost all the regulation gets to some version of how do you understand your customer to not sell them things that are horribly inappropriate? And do you understand the legal rules that apply to you? And this absolutely exists in our financial advisor room. Like when you look at the actual licenses that you need to become an advisor, they are almost all product sales licenses that basically the only requirement is a couple hour exam you take a few weeks to study for and a high school diploma and the diploma is technically optional.

13:41There's basically no standard aside from an exam you spend a couple of hours on that most people can study for in a couple of weeks. That's it. And if you look at that exam, like it literally requires you to know nothing about finances nor advice to a financial advisor on your business card. You need to understand the products that you sell and the regulatory laws that apply to people that sell those products. And so from a sales end, that's not necessarily a bad thing. Like at some point, if people want to buy a thing, we don't need to make this more complex than it needs to be. Like let them buy the thing and have someone sell it to them.

14:14If you start amping up too much regulation on salespeople, you just end up limiting people's access to the thing. Advice though, to me is fundamentally different. Like when you look at anything that traditionally sits in advice realm or like professions that give advice, right? Like law, medicine, accounting, we tend to have a higher bar for advice than product sales, because at some point people are actually putting their trust and confidence into the advice giver, whether it's a legal advice giver or a tax advice giver or a medical advice giver. And because the stakes are very high, as they are across those domains, you really kind of want people to be subject to some standard, even though it is limiting.

14:53You increase costs, you reduce people's access to some extent by putting some barriers to entry in place. But we've generally found for most recognized and established professions, You do want some barriers of entry in place because the alternative is bad stuff happens. And the whole nature of when you hire someone in a domain of expertise, it's almost impossible for the average consumer to know who's actually a good, credible provider. Because if they're that expert in a thing that's that complex, you literally wouldn't have enough knowledge to know. You have to trust and believe that they're capable.

15:26So we try to vet to the extent that we can. But to me, I'm generally not a fan of high levels of regulation. and I'm kind of an entrepreneurial sort and find regulation to be barriers. But there is a level of regulation that is just like, you do want some regulatory barriers to be there. And in the context of your question, 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, very low bar that I don't necessarily think was bad for product sales, but I think is very lightweight for advice. And so what's happening in practice is, If you know, like firms like yours are trying to raise the bar for themselves.

16:04They're using it as a point of differentiation. We actually have advisors with credentials and degrees and have spent time studying this and have years of experience before we unleash them on you as the client. From the business end, like not actually a bad way to differentiate. And a lot of firms are succeeding by saying like, no, no, no, we really have like talented people and we invest into this. From the consumer end, this actually probably wouldn't be a bad area for regulation to maybe make that bar a little bit higher though. Like I don't want a hospital to differentiate on our doctors actually went to medical school.

16:34That should not be how we differentiate. That should be an expectation when you're a doctor. Yet our challenge right now is you certainly don't need anything remotely close to a finance degree to actually be a financial advisor. And that to me is a little bit problematic from like a meta level for the industry. So I do think that over time, we're going to find some pressure to push that regulatory bar up. Right now, the good firms just use that as a way to differentiate themselves. I have no doubt that listeners of our conversation right now are thinking to themselves, well, if AI can pass a master's degree from any major university, then why do people have to actually go out and study this?

17:16Aren't they just going to be able to punch in questions, advisors who maybe aren't trained as well, or are people just going to bypass the advisor and go to a robot for advice. So since AI has been such a big topic here at the event, I'd love to get your perspective on how you see it, having already influenced the arc and the evolution of financial advice or how it might in the future. First of all, at a high level, I'm a tech nerd at heart. I love my tech. I love playing with my tech. I'm bullish on tech in the way that tech plays out in positive ways. But I fundamentally don't think you're going to see any foreseeable future where AI is directly competing against financial advisors for the people who hire financial advisors.

18:00There's a couple of reasons for that. In at least the intermediate term, there's a phenomenon that I've taken to start calling the AI penalty in what we actually expect from AI to be willing to follow it or trust it or adhere to it. So So imagine for a moment, like you got to get across town somewhere to a meeting. And there's this app out where you pull out your phone, you hit a button, and a car just shows up to take you where you want to go. Now, it's a pretty cool service. Does it very cost effectively. Most of us have used this. Like it's Uber, it's Lyft, and so forth. Like I love this. I just hit a button, person shows up to drive me where I want to go, and they do it at a pretty reasonable rate.

18:42So now imagine for a moment as you're walking up to the car to get into the car, like you open the door and you look to the front seat to see if it's like your driver, the way we've all been trained if we use Uber and Lyft. Except you look at the front seat, there's nobody there. It's a driverless car because AI. And so now the question becomes very proximately, like, would you get in this car? And if you actually just look at broad-based consumer data on this, the overwhelming majority of us do not get in that car. A few of us do. We're like, we're technology adopters, and this is super awesome.

19:11And like, you know who you are because you're always the one that has the cool new gadgets in your circle of family and friends. Like, you get in the car. The rest of us do not. We're just not there for, I think, a couple of different reasons. I mean, part of it is just some of us outright have questions on the technology. Like, is it really there? Is it really there? Is it really that good? There's some weird effects that start coming from just 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. You can hear it in the language.

19:44You can die in a car accident, but you get killed by a driverless car. If I'm steering, the accident may happen. But if the driverless car was just steering me, that was like a third-party externality that killed me. And I do not want to lose that level of control. At least if I've got my hands on the wheel, I can try to save myself at the last minute. Now, at some point, the data will pretty unequivocally show the technology probably actually detects it better than we do. But still, I don't mind the car that has the little warning. I don't even mind the car that detects that someone in front of me is slowing down.

20:16So the car automatically hits the brake faster than I could hit the brake. But I don't want to just sit as a passenger in a car that has no driver. It just starts wigging us out. And what that means from a practical perspective is most of us are probably not going to trust the car until it is not just as good as people. It actually has to be exponentially better than people. So much so that we are willing to surrender autonomy and control in exchange for that dynamic. And that's a really high bar that even as much as AI is compounding in cool ways, I'm not so sure how close we are. Even when we get there, we get to another problem, which is, okay, when the technology gets there, we're not just going to get into an AI driverless car.

20:56We're going to have a choice from 17 different AI driverless cars. And then you have to figure out which one is actually good and safe. 16 of them might be good. The 17th will still kill you. Are you sure the one you're going to get into is not the 17th? what have you done to determine this? Have you vetted it? Have you analyzed it? Like, are you really confident that you're getting into the safe driverless car? So now you go right back to where we were. Tech savvy, do it yourself. First can be like, I have analyzed all 17 cars. I have a spreadsheet of them and I've read all of them in the math.

21:25These three are the best. These other like 14 or 13 are okay. This one's like the death trap you never want to get in. And then like some of us will feed off of those people who are our friends who just tell me which one's the good one because I want to figure this out on the internet. But most of the rest of us just come back to like, I'm not putting my life on the line to figure out which of the thing is is actually safe. I'm just going to get behind the wheel and drive it myself. Or I'm just going to hire a chauffeur that I trust and have them drive me around. And I'm right back to the fact that I still want the Uber with the human driver because I don't even want to have to take the time to figure out which of the 16 driverless cars are safe and the 17th one that's a death trap.

21:58I'd rather just have another human being because failing anything else, the fact that the driver doesn't want to kill themselves is a pretty good check safe on me that we're going to be safe in this car as well because their self-preservation is my self-preservation. And so there comes 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. And again, when you get to kind of a split of mentalities, the do-it-yourselfers are going to figure out what technology to use to do it.

22:27But the reality is they pretty much wanted to use the technology anyways. And everybody else, basically like the people who tend to delegate and hire advisors tend to still find, yeah, I'd actually rather just find an advisor and have them do this for me than have to figure it out on a continuous ongoing basis, which is why desktop computers didn't knock advisors out. The internet didn't knock advisors out. Robo advisors didn't knock advisors out. Every single one of those is the same thing. There's this big leap forward in technology that can do all this stuff, but you have to figure out which is the right technology tool or platform or website or computer vendor or whatever it is to use.

23:01And the people who like doing that to just keep playing with the new fancy tools and more power to them. But those of us that like to have someone else figure this stuff out for us tend to still come right back to the same place. And so that's why I say those of us who don't want to have to figure all that stuff out for ourselves, like, can I just hire someone to get this figured out for me? As advisors, like, we're going to get hired to figure out what's the right AI tool to help you do your financial plan analysis. We don't get replaced by people who use AI tools to do their financial planning analysis.