Ric Edelman: Free Trading Will Crush Commissioned Brokers

March 30, 2017 at 08:42 PM

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Here today, gone tomorrow: both commission-based brokers and companies that simply weren't built to succeed in the 21^st century, a world driven by innovative, rapidly expanding new technologies. That's what prominent financial advisor Ric Edelman forecasts in an interview with ThinkAdvisor.

In his new book, "The Truth About Your Future: The Money Guide You Need Now, Later and Much Later" (Simon & Schuster), the executive chairman of Edelman Financial Services argues that exponential technologies — those undergoing fast, aggressive growth, such as artificial intelligence, nanotechnology and bionics — are disrupting investing by enabling the birth of enterprises that are displacing and replacing old-school firms. Think Uber and Airbnb.

In the interview, Edelman, whose RIA manages $18.7 billion in assets, discusses the most promising exponential technologies in which to invest, as well as when free trading — made possible by digital technology — is likely to be a reality (very soon).

Edelman, whom Barron's has ranked the country's No. 1 independent advisor three times, also offers his prediction for the fate of the Labor Department's fiduciary standard rule.

As for commission-based brokers, he believes that even if the DOL rule fails to be imposed, fully half of them will leave the industry because of the growing prevalence of competing advisors that hold to the fiduciary standard.

Here's good news: FAs have only a 42% probability of being replaced by automation, Edelman says, quoting an Oxford University study. Meanwhile, in Japan, the Henn-na Hotel is staffed almost entirely by robots. Even the cleaning and food service staffs are androids.

Edelman, 58, is so enthused about exponential technologies that he spearheaded the introduction of BlackRock's iShares XT exchange-traded fund, which invests not only in technology developers but equally in companies that use advanced technologies to generate growth. The fund is routinely included in all Edelman investment recommendations; 90% of the firm's clients now own it.

The RIA has 157 advisors in 42 offices nationwide serving 32,600 clients. Edelman's nationally syndicated radio show has been broadcast for 25 years.

ThinkAdvisor recently spoke with Edelman, 58, who was on the phone from company headquarters in Fairfax, Virginia. He discussed how learning about exponential technologies can indeed lead advisors to make some smart investment decisions. Here are excerpts from our interview:

THINKADVISOR: What do you consider the most promising investment opportunities in exponential technologies?

RIC EDELMAN: The two most exciting areas are companies that develop nanotechnology and those that develop sensor technology. Nanotech, the notion of making things smaller, is at the root of the overwhelming majority of technological innovation — the basis on which all other tech gets built. The smaller you make things, the cheaper and better performing they become.

What's special about sensor technology, more commonly known as robotics?

In order for a robot — a computer that moves — to be useful, it has to know its environment. Sensor technology's goal is to give a computer "senses" [e.g., "sight"] so that it's capable of moving and interacting with the environment. For example, without sensor technology, there wouldn't be self-driving cars.

"Increased connectivity will result in more volatility in financial markets as more people trade [securities] using their phone," you write. When will it be free to trade online?

Within the next two years, and that will very likely result in an increase in trading volume, which will lead to increased volatility.

Free trading? What will happen to advisors who work on commission?

They'll be gone — out of business. They largely are already. You've seen the price wars that are going on in stock trades. They're already down to $5 a trade; pretty soon it's going to be zero. In fact, it won't be long before you'll be paid to open an account. Firms will pay you to do business with them. This is part of exponential technologies: Technology wants everything to be free. It's called demonetization.

But you write: "Nowhere is there more excitement about exponential technologies than on Wall Street."

Wall Street recognizes the economic and financial opportunities that exponential technologies afford. The most exciting companies that have been developed over the past 50 years have almost all been technology-based: Microsoft, Apple, Amazon, Uber and so on. In the oil industry, fracking is a technological innovation that's uncovered vast oil reserves [previously] undiscovered or unreachable.

So where does Wall Street come in specifically?

Such innovative companies require capital. Wall Street is in the business of providing capital. And Wall Street investors generally are the beneficiaries of these investment successes.

The word that best describes the impact that exponential technologies will have on investors is "disruption," you write. Please discuss.

Innovation brings disruption. There's nothing new about that. Buggy manufacturers were thrown out of business by the invention of the automobile. But now we're seeing disruption with much greater frequency and impact. Kodak went bankrupt because [virtually] no one was using film photography anymore. In 2012, Instagram — using technology that Kodak invented — was sold for $1 billion. Craigslist and Monster.com have put newspaper classifieds [virtually] out of business. All that is disruption.

So what does this mean to investors?

If you invest in a company that was built for the 20^th century, you run the risk of having that company fail in the 21^st century. It's widely expected that more than half the Fortune 500 companies will not exist in 10 years. On one hand, that's very scary for investors; but on the other, it's very exciting because the new companies that come along will replace the old-line businesses.

Why is it essential for financial advisors to keep on top of the new technologies?

Advisors who fail to stay current with exponential technologies are probably not going to be in business within the next 10 years, not only from an investment management perspective but from a practice management perspective because advisors need to be users of state-of-the art technology.

What are some fintech innovations that are applicable to the industry directly?

Payment transfers, digital currency, the blockchain and many more. Financial service companies themselves will be massive beneficiaries by adopting these revolutionary technologies.

You believe that the blockchain will "revolutionize every aspect of money." How and why?

Because blockchain is an authentication system instead of a trust system. So much of what we buy is based on trust; we're constantly trusting vendors. For example, we buy a car, and it's delivered in a month. But the trust-verification element is very cumbersome, time-consuming and expensive. Blockchain eliminates all that because you know when you engage in the transaction that you have 100% certainty it's a legitimate transaction. This allows it to occur much faster, which dramatically reduces the cost.

Is it the younger demographic that's driving new companies to replace the old?

Not always. It depends on the product and end user. In the areas of neuroscience and medicine, the end consumer tends to be older Americans in need of health care. They're the ones that buy the pharmaceuticals or medical implant devices or treatments designed to cure major illnesses and deadly diseases.

You write that the Food and Drug Administration has approved research to determine if metformin, a drug used to treat diabetes, can slow or stop degenerative diseases and heart conditions. So, is Bristol Myers Squibb a good company to invest in? They make metformin.

That's the [type of] key question investors have to answer for themselves. It's not enough took at the developer of a technology. You must also look at the companies that are using it to grow their own businesses. For example, Domino's: Who would think a company that makes pizza would be technologically innovative? Yet they receive more than half their revenue digitally: People order pizza through their mobile phones. Domino's is even developing technology to enable you to order pizza just by looking at your phone without having to type anything.

The idea behind your iShares XT exchange-traded fund is that users of these technologies are just as important when it comes to investing as the developers. Correct?

Yes. The unique element is that unlike other tech funds, which invest only in technology developers, the XT invests equally in companies that are users of technology.

What's the timeframe for exponential technologies and products to emerge?

Some are of course already operating the marketplace; for instance, Uber and Airbnb. Others will launch over the next couple of years. Some will take 10 to 20 years. It's not a light switch; it's more of a metamorphosis. But compared to the 75 years it took for there to be 100 million uses of Alexander Graham Bell's telephone, Pokemon Go accomplished the same thing in 18 days. The smartphone is only 10 years old, and virtually all American adults have one.

What analytic tools used in financial planning will be improved by artificial intelligence?

Projections, the analysis in client scenarios for tax implications and the income distribution capabilities of a portfolio, among others.

You write that because of new, rapidly advancing technologies "massive revisions" for estate planning will become necessary. Why?

For one thing, you'll need to review your estate plan to make sure your digital life isn't lost [after death]. For example, online banking and sites that store photographs, like Facebook and Pinterest, and other social media sites, are password encoded. When you die, nobody will have access to them unless you provide for access in your estate plan by indicating those passwords.

What investment opportunities does the business of data brokerage offer?

Your personal information is data. When it's aggregated with that of everybody else's, it's called Big Data. Data brokers collect this data and sell it to other companies. Many firms around the world are engaged in the development or usage of Big Data.

Exponential technologies will bring housing and health care costs down sharply, you say. When will that happen?

It's already beginning to happen. Emergency rooms are now touting their [short] average wait times. Urgent care clinics are in shopping centers. Employers are providing clinics onsite, and they're far more ubiquitous today.

Will prescription drug costs drop?

Sure. We already have the first FDA-approved 3-D printed drug on the market: Spritam, which treats epileptic seizures. Ten or 15 years from now, with a 3-D printer in your home, you'll print your own drugs. They'll be virtually free.

Thinking, creativity, communicating and managing will be the skills most valued in the future, you note. Many jobs to be eliminated are low-level blue collar ones. How can people who ordinarily hold such employment qualify for jobs requiring the above skills?

The reason they're not in those jobs today is because of a lack of economic opportunity and education. It's not the lack of ability. That's why education, training and lifelong learning are important.

Turning now to the Labor Department's fiduciary standard rule and President Trump's intentions. Do you think the rule will be killed?

Yes.

What should FAs do — adhere to the fiduciary standard anyway?

Yes because the cat's out of the bag: Consumers are now increasingly familiar with the word fiduciary and increasingly demanding that their advisors act as fiduciaries. So whether the law requires it or not, the marketplace will.

How will that change the mix of FAs in the industry?

Half the advisors will leave because of the fiduciary standard. Whether the DOL rule is in place or not isn't the point: The marketplace will demand this behavior, and consumers are going to be increasingly unwilling to purchase expensive, risky, illiquid investments that are generally touted only by commission-based brokers.

How do you think the Trump presidency will affect the financial industry overall?

Very favorably because he's a businessman at heart. He has substantial business interests. He's not going to do anything to damage his own net worth — just the opposite. If motivated by nothing than self-interest, he's going to have a business-friendly administration. And he recognizes that economic growth is good for the country.

What's been the impact of his presidency on Wall Street so far?

We've seen the stock market skyrocket since his election. Corporate America and Wall Street are thrilled, and they're going to continue to be happy because of the economic, tax and financial policies he'll be introducing. Trump's anti-regulation position is being interpreted as an opportunity for increased corporate profits.

Many Americans are upset with President Trump's behavior and style of governing. Is Wall Street ignoring his untraditional presidential M.O.?

Yes. Wall Street has an extraordinarily short attention span and an extraordinarily narrow focus — neither of which is good, by the way.

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