Industry leader’s move sure to be followed by others

A new pricing model is emerging for investment advice to mutual fund investors.

Would you believe free?

The giant Vanguard Group, headed by John Brennan, is taking the lead on a move to free advice for 401(k) and retail customers that will likely force competitors to follow suit.

The advice will come from Financial Engines Inc., the online service in Palo Alto, Calif., founded by William Sharpe, the Nobel Prize-winning economist.

Some plan sponsors now pay for advice for their employees, but industry efforts to get investors to pay for advice have been largely unsuccessful.

Now Vanguard’s move casts even more doubt on whether sponsors will be willing to continue paying.

The nation’s No. 2 fund company will start offering free advice to its 2.8 million 401(k) customers in the second quarter.

The program will be extended to 12 million retail customers later this year. Charges are likely for part of that service, but they have not yet been announced.

Market change

“When you do a big giveaway like the Vanguard program, you’re implicitly throwing in the towel,” says John Rekenthaler, president of the online advice unit at Morningstar Inc., the Chicago investment research company.

“That’s clearly a market change from the last five years,” Mr. Rekenthaler adds. Morningstar offers its own online advice product, ClearFuture, which it sells to plan providers.

Vanguard is one of several companies struggling to price advice services to the public.

Industry experts caution that just because people are unwilling to pay for online advice doesn’t mean they don’t see it as valuable.

“It’s very hard to get people to pay for information on the Internet, but people are surfing the Internet all the time,” notes Mr. Rekenthaler.

Lowell Smith, managing director of Erisa Services at Invesmart Inc., a Pittsburgh retirement services company, predicts that “self-directed brokerage accounts for stocks and bonds,” which increasingly are being offered in 401(k) plans, will present the next major hurdle.

“How do I take this model and create it for a stock and bond portfolio?” he questions.

But contrary to the prevailing belief that online advice will make a big dent in the advice market, Mr. Smith says many in the industry are finding that plan participants want in-person advice.

“Typically, that advice has been relegated to the business owner,” he says. “Now we’re starting to see [that] people really want somebody to sit down with them, maybe after using the online tools.”

Vanguard’s move may also make things uncomfortable for Financial Engines, whose business model is based on selling its service to 401(k) sponsors, who pay the Palo Alto, Calif., advice service a fee for each plan participant.

About 675,000 plan participants at 350 companies now use Financial Engines’ online advice service.

“That’s a clear cannibalization strategy,” Mr. Rekenthaler says.

Referring to plan sponsors who subscribe to Financial Engines’ service, he says, “You have to think they’re saying, `Why am I paying per participant when Vanguard is giving it away for free?”‘

Indeed, the free service could give Vanguard a big edge when marketing its services to plan sponsors.

Seeking help

Vanguard’s announcement earlier this month follows a study recently released by Boston Research Group, a Woburn, Mass., retirement plan consulting company. The study found that plan providers or sponsors may have to provide specific advice free to plan participants.

Boston Research’s nationwide survey of 2,100 401(k) participants found that the lowest level of service satisfaction with the plans is in the area of employee education.

The study was done on behalf of eight of the largest plan providers in the country, although they were not identified.

It found that only 46% of the participants were satisfied with the education they received about managing retirement investments.

“Satisfaction with teaching people investment principles … that was very low,” scoring only 33%, says Warren Cormier, president of Boston Research. Yet teaching general investment principles is typically what most 401(k) education programs focus on.

Like many other surveys on the matter, Boston Research’s study found that plan participants wanted help in making investment decisions. Sixty percent of the survey respondents said it was “very important” for their employer to provide them with access to investment advice.

“They want to know not only investment advice, but, `How much money do I need to retire?’ and `What do I have to do to get there?”‘ Mr. Cormier says. Unlike most other surveys, however, Boston Research’s study found that, paradoxically, very few people were willing to pay for it.

In Washington, Rep. John Boehner, the Ohio Republican who heads the House Education and the Workforce Committee, plans to reintroduce legislation later this spring that would make it easier for plan providers to offer specific advice to participants.

Jeff Maggioncalda, chief executive officer of Financial Engines, predicts that the Vanguard-Financial Engines relationship “will define a massive change in asset management.

“We’re moving from [a business] based on product to one based on advice … Advice has been viewed as an add-on. Vanguard is saying this is a fundamental part of high-quality services to employees.”