Weekend Reading for Financial Planners (Dec 31 – Jan 1)

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth, which provides an evidence-based approach to private wealth management for near- and current retirees, and Buckingham Strategic Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors through the scaling phase of growth.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

Read all of Michael’s articles here.

Weekend reading for December 31st / January 1st:

SEC’s Use of In-House Courts Unconstitutional, Appeals Court Rules (Dave Michaels, Wall Street Journal) - This week, the 10th Circuit U.S. Court of Appeals ruled that the process the SEC uses to hire Administrative Law Judges (ALJ) - using in-house staff for the hiring process, rather than appointing the judges directly by the agency's (more publicly accountable) commissions - is unconstitutional, potentially threatening the legitimacy of its entire "in-house" court system used to decide a growing number of the SEC's regulatory cases. The issue has become an increasingly controversial one in recent years, as changes under the Dodd-Frank Act expanded the range of cases the SEC can send to in-house judges, and sure enough, a series of 2015 WSJ articles showed that the SEC was sending more and more cases to its in-house judges... who in turn were more likely to rule in favor of the SEC. Notably, other court Circuits have affirmed the SEC's process, which means there's a possibility that the issue could ultimately end out in front of the Supreme Court. In the meantime, facing pressure the SEC has already begun to make "tweaks" to its internal in-house court processes to try to ease concerns, though it's not clear that will be enough, as Republicans have been pushing legislation that would allow SEC defendants to opt out of administrative courts (and choose a trial by Federal judge or jury), and the potential for Republicans to unwind parts of Dodd-Frank in 2017 could further limit the SEC's use of its in-house court system in the future anyway.

Bid To Grow Fiduciary Registry Gains Prominent Followers (Ann Marsh, Financial Planning) - This fall, the Institute for the Fiduciary Standard launches its "Best Practices Fiduciary Advisor Affirmation Program", a form of "fiduciary registry" that requires those who join to adhere to the strictest form of fiduciary standards. The registry is intended to distinguish from other forms of "fiduciary" by requiring adherents to minimize or outright eschew most conflicts of interest, unlike the fiduciary standards of both the CFP Board and the Department of Labor, which still allow advisors to receive many forms of conflicted compensation and must merely disclose those conflicts (but not necessarily eliminate them) and still allow "hat-switching" (where an advisor is a fiduciary for advice, and then steps away from their fiduciary obligations and "switches hats" during the implementation phase). And now, prominent financial advisor Dan Moisand, a former chairman of the national FPA and also former chair of the CFP Board's own Disciplinary and Ethics Commission who helped write the CFP Board's original Practice Standards in 1999, has become the first advisor to join the new Registry. Fees to join the registry will be based on the size of the advisory firm, varying from $175 for smaller firms, to $650 for mid-sized ones, and $2,500+ for RIAs with more than $1B of AUM; advisors who are interested can view more information about the new fiduciary registry here.

The Hidden Risk In Your Custodial Agreements (Bob Veres, Advisor Perspectives) - There's a "standard" provision in the Schwab advisory account agreement, which stipulates that the custodian can remit checks, wire funds, and make transfers to accounts of identical registration at other financial institutions, but that the client agrees it will be up to the investment advisers to affirm the identical registration on the receiving account. The issue here is that it means the advisor can potentially control and get access to client funds, as the advisor can't actually request the disbursement, but could 'misdirect' it to an inappropriate account (e.g., an offshore embezzlement account) without any oversight from Schwab as the custodian (as the agreement specifically says the client agrees the custodian may rely on the representation of the RIA). And if the advisor has "control", it means the advisor has custody, which in turn introduces additional compliance requirements and regulatory scrutiny (including hiring an accounting firm to conduct annual surprise audits). Unfortunately, the issue now has hit the SEC's radar screen, and some Schwab advisors are reporting that they're receiving deficiency letters from the SEC after being examined, for failing to report that they have custody and failing to comply with the custody rules (which can be a fairly serious offense). Fortunately, at this point Fidelity's agreement is more limited and doesn't appear to run afoul of the rules - in part because of advisors who have already pushed back on the issue there - but the issue highlights a broader concern as well, that the steps custodians may be taking to protect themselves and their business interests can actual shift risk (or outright regulatory issues) down to the RIA. For the time being, compliance experts suggest that at a minimum, advisory firms create their own internal processes to be able to demonstrate to examiners how their checks and balances on transfer requests help to protect client assets, and in the longer term that advisory firms need to voice these concerns directly to custodians, and/or even consider "voting with their feet" if the issues persist.

How A White Label ETF Provider Works (Cinthia Murphy, ETF.com) - While the bulk of ETF assets are with major established issues like iShares and State Street, a growing crop of third-party providers like ETF Managers Group are offering private "white-label" solutions to help independent advisory firms or asset managers launch their own ETFs. The third-party white label approach has become popular, because of the material hurdles involved in getting regulatory approval and the necessary compliance structures in place to launch an ETF - starting from scratch, it can take up to 2 years and $2M to $3M in upfront costs. By contrast, the private white-label option can get an ETF launches in about 75-90 days (as a traditional '40 Act ETF), and a cost around $75,000 - $100,000 (and then an ongoing operational cost of about $250,000/year). While those costs aren't cheap, for an asset manager confident in their ability to market and distribute an ETF solution for their investment management process, the cost is at least "manageable" - if 25bps of the ETF expense ratio is allocated for the operational expenses, it takes "just" $100M of ETF assets to break even. In fact, the white label operators will normally just subtract their costs directly from the collected expense ratio of the ETF, which means there's no out-of-pocket for the asset manager or advisory firm beyond the setup costs, once the assets reach the break-even threshold (though there will be additional costs if the ETF has to be shut down later). Though obviously, it's still up to the asset manager or advisory firm to actually market and "distribute" the fund to bring in assets, as the white label solution doesn't market the ETF but merely creates and manages the ETF vehicle itself.

3(38), 3(21), 3(16): Do 401k Advisors Really Know The Difference? (John Sullivan, 401k Specialist) - With growing scrutiny on advisors' fiduciary duties in 2017, as the updated DoL fiduciary rule takes effect, a major question in the world of ERISA 401(k) plans is "who, exactly, IS the one with the fiduciary duty?" Where the buck stops depends on how the ERISA plan and its advisors are structured: with a plan relying on ERISA Section 3(38), the fiduciary duty is delegated to the investment manager, who has full discretion; with ERISA Section 3(21), the plan retains its obligations as a fiduciary, but may also obtain investment advice for a fee, which means the investment advisor also has fiduciary exposure (potentially even if the advice is non-discretionary); and with ERISA Section 3(16), the duties are split, and the 3(16) fiduciary takes on administrative reporting and disclosure fiduciary obligations, but the plan still retains fiduciary investment obligations (unless those are separately delegated as well). Given these dynamics, the question is where the marketplace will go in 2017 and beyond; the most straightforward for the plan is to hire a 3(38) fiduciary that simply fully delegates responsibilities (but retains responsibility responsible for its process in how it selects a 3(38) manager), though in practice it may not be cost effective for small plans, and larger ones often want to stay more involved; alternatively, the plan may decide to hire a 3(21) fiduciary to at least share the fiduciary exposure, though it's not clear whether advisors will be happy to share the "co-fiduciary/potential-co-defendant" role, or simply retain its investment obligations but delegate out the administrative fiduciary responsibilities to under ERISA Section 3(16).

Is RightCapital The Right Fit? (Joel Bruckenstein, Financial Planning) - The most popular financial planning software solutions are Advicent (NaviPlan), eMoney, and MoneyGuidePro, and newer "financial planning lite" solutions like Advizr and Goalgami Pro have come forth in recent years as simpler (and often cheaper) alternatives; by contrast, new financial planning software maker RightCapital is trying to fall in between, with a simpler and easier interface than today's most popular (and most complex) solutions, but still with the underlying robustness to handle the needs of mass affluent clients. Notably, while most planning software is divided into being either "goal-based" or "cash-flow-based", RightCapital actually allows the advisor to choose which approach they prefer as a software setting - the primary difference is that a cash-flow-based plan assumes that any/every year's excess income/cash is invested in a taxable account, while the others simply assume the only dollars that are saved are the ones actually marked for saving (and that the remaining excess is spent). Other unique features of RightCapital include: the ability to show asset allocation as static over time, or with a glidepath that changes as the years go by (though the glidepath is fixed and cannot be modified at this point); scenario-based retirement plan analysis (e.g., what happens to the plan if there's a Depression), and charts to illustrate the sources of retirement income (e.g., Social Security, taxable accounts, IRAs, etc., including the use of annuities with guaranteed withdrawal benefits); and relatively in-depth tax analyses, including not only projecting tax liabilities, but illustrating tax-sensitive liquidation strategies (e.g., from taxable accounts first and then IRAs, vs pro-rata across accounts), and also illustrating the benefits of doing systematic partial Roth conversions to fill up lower tax brackets. In addition, RightCapital also has client portal capabilities, where clients can link their accounts via Yodlee to create a net worth statement, in addition to viewing their current plan (if the advisor grants access). Pricing is $75/month or $99/month with Yodlee integration included; further details directly at RightCapital.

A New Tool To Visualize Retirement Planning (Bob Veres, Advisor Perspectives) - Bill Bengen's original research on the so-called 4% safe withdrawal rate has become well entrenched amongst advisors, yet ironically there are still no good retirement planning tools to actually illustrate the research, and how it might be applied to an individual client's circumstances. To fill the void, a new software solution has emerged, called the Big Picture App, which draws on monthly historical data from 11 different asset classes since January of 1926 and allows the advisor to illustrate client outcomes with the client's specific asset allocation, time horizon, and spending goals. And the output actually helps to show how the success rate varies, depending on how those assumptions vary - for instance, that the client's probability of success will increase from 63% to 81% if they can cut their expense ratio from 1.7% to 1.1%. Notably, the makers of this new retirement solution also produce a "Big Picture" investment chart that shows the returns of historical asset classes over time (akin to the familiar Ibbotson Morningstar mountain chart of historical market returns) using CRSP data; in fact, the app is essentially just a way to illustrate how those returns would impact a retirement plan, but in the process makes it an especially good tool to illustrate both the 4% rule, and the impact of asset allocation on long-term retirement income sustainability. Notably, though, the Big Picture App is specifically using monthly historical data to analyze how often the client's plan works out and determine a probability of success, rather than a forward-looking Monte Carlo analysis; depending on your own retirement projection preferences, that may be viewed as a limitation of the software, or a big plus. Pricing for the solutions is $30/month and includes a physical copy of the historical returns data poster as a bonus, and further details on the Big Picture App are available here.

The Untethered Advisor (Diana Britton, Wealth Management) - For a growing number of advisors, the fact the clients often move once they retire (and sometimes before that for job or family reasons) means that more and more of an advisory firm's clientele might be nowhere near where the firm is physically located. Yet the good news is that with investments into technology tools like videoconferencing capabilities to maintain the "virtual face-to-face" relationship (or simpler screen-sharing solutions like ScreenMeet), and the adoption of good client portals, the clients are retaining. However, those investments into the ability to serve clients virtually are producing an "unexpected" side effect: it's becoming increasingly easy for the advisor themselves to become "untethered" from their offices, and serve their clients wherever they go as a location-independent virtual financial advisor. And the trend is now starting to show up in the data: in the past year, RIA In A Box found amongst its own base of advisors a 21% increase in the number of RIAs who registered in states where they do not have a physical presence, and some are predicting that even when firms do have clients in the area, that most will soon prefer to meet virtually, if only to save the time and hassle of driving/commuting to the advisor's physical office location. On the other hand, the challenge of operating as a virtual advisory firm is that without "local geography" as the advisor's competitive advantage, it's necessary to come up with new ways to differentiate and stand out amongst the crowd of other online human and digital advice solutions.

Beyond Robos (Ryan Neal, Wealth Management) - As the direct-to-consumer robo-advisor movement slowly but steadily dies off, the presumption amongst financial advisors is that they're once again "safe" from the threat of financial technology. However, Neal points out that the threat of robo automation is different than what may come next: full-scale Artificial Intelligence (AI), which some suggest will ultimately have a far greater potential threat to expertise-based professionals (including financial advisors). Notably, there are "weak" forms of Artificial Intelligence around already, from Google's predictive searches to Amazon's product recommendations; the real question is whether or when we progress to "strong AI" that can perform tasks of comparable complexity to humans (and the risk of "super AI" where the computers are more intelligent than what the human brain can accomplish). Right now, the push is to adopt weak AI to financial services, and to improve its capabilities to approach strong AI depth; for instance, IBM Watson, the question-answering computer system that processes natural language and beat out the best human Jeopardy champions, now has a wealth management division specifically trying to apply Watson's capabilities to financial services. Notably, even the head of Watson's wealth management team suggests that at this point, the still-evolving technology is more likely to augment financial advisors and make them more efficient, rather than displace them; nonetheless, the question remains of whether the compounding growth of AI may eventually reach the point where human financial advisors are more directly impacted, just as AI is already entering previously-thought-to-be-safe professions like medicine (where AI is being used to detect cancer in X-rays and CAT scans better than human doctors) and law (where AI is being used for legal research).

Questions You Need to Ask About the Future of Your Business (Julie Littlechild, Absolute Engagement) - A significant personal transformation in our lives virtually always begins with a question; it might trigger an immediate epiphany, or slowly burn over time as you mull it over, but ultimately it's the questions we're asked (or that we ask ourselves) which help us to think differently and envision a future that's different than the reality we live today. Accordingly, Littlechild poses a series of interesting questions, intended to challenge us as advisors to think about what we're doing, and whether it really satisfies and engages us; as a starting point, do you even have a good understanding of the kind of clients, work, and role that energizes and inspires you (and if not, maybe you should think about it!)? And if you do have at least a general understanding, have you formalized it into a target clientele, solution, and role for yourself that will take you to a more fulfilled and engaged place? If you're still not quite certain what it is that really engages you, consider which 10 clients you enjoy working with the most (and what's common to them), and when was the last time you were completely energized by the work you were doing (and what was it about that work that made it so engaging)? If there's a misalignment between what you're actually doing and what engages you, consider what it will take to change - do you need to adjust the business itself, the services provided to clients, or your role in the business? For those who want to delve deeper, Littlechild provides a 3-page worksheet to go through the full series of questions, and suggests that once you do it, book an appointment with yourself in a week, after you've had time to mull over your answers, and start thinking about what you'll actually look to change in 2017.

The Downside Of Work-Life Balance (James Clear) - An interesting way to think about the challenge of work-life balance is what's known as the "Four Burners Theory": your life is represented by a stove top with four burners, each symbolizing a major quadrant of your life (family, friends, health, and work), and in order to be successful you have to cut off at least one of your burners (or to be really successful, cut off two). Of course, that's a very unhappy way to view what it takes to succeed, and naturally leads us to look for ways to bypass it and be successful even while keeping all four burners running. For instance, we might try to lump together family and friends by doing big social events, or merge together health and work by getting a standing desk. Yet pursuing those paths ignores the fundamental point that the Four Burners Theory illustrates: life is full of trade-offs, and trying too hard to balance them all really can limit your ability to maximize potential in any given quadrant. So what should we do about this? Clear notes that there are no magic answers, but at least suggests three ways to think about it: 1) Outsource the Burners (while you probably can't eliminate responsibility entirely, spending money to delegate various tasks or responsibilities in some of the quadrants can help free up time for the others, potentially increasing your happiness and wellbeing); 2) Embrace the Constraints (i.e., instead of lamenting how there isn't enough time in the day to do everything you want, recognize the constraint and try to figure out how best you can maximize the value and effectiveness of your limited time for each burner); or 3) the Seasons of Life approach (where instead of trying to balance everything at once, you balance over the long run by breaking your life into seasons/stages where you focus on each burner, such as embracing work and career ambitions in your 20s and 30s, then shifting to focus on family as you have kids in your 30s and 40s, then revive more friendships in your 50s as the kids go off to school and family time frees up, etc.). But the starting point is simply the self-awareness to recognize the Four Burners limitation... so consider, which burners have are you currently cutting off (intentionally or not)?

How Financial Advisers Can Get Unstuck In The New Year (Nicole Newlin, Investment News) - One of the fundamental challenges of being a successful financial advisor is that as the practice grows, eventually it takes more and more time to service clients, and the toll of doing ongoing menial office tasks and client support work kills any time, energy, or focus on continuing to be an entrepreneur that builds the business. For advisors who have hit that personal growth wall and are looking to get "un-stuck" in 2017, Newlin suggests taking a fresh look at the business itself from three perspectives: 1) Structural (have you surrounded yourself with the right staff and strategic partners, and are you really able to use and rely upon and delegate to them effectively?); 2) Strategic (what is the trajectory of the business, and what is the trajectory of your role in the business - and do either need to change?); and 3) Personal (where is your time and energy focused, are you spending your time effectively, and do you need to change what you're doing to be happy?). Of course, the reality is that no practice is going to be "perfect", and most advisors will recognize at least a few issues in looking over the business from these different perspectives. So the next question is what you're actually going to do about it - Newlin suggests that rather than trying to throw out everything and start over (which usually isn't realistic anyway), just target one or two major areas to tackle, dive in and fix those first, and once the situation in that area begins to improve, tackle the next area. In other words, the path forward to getting "unstuck" isn't necessarily about a major breakthrough, but taking the time to make the adjustments that incrementally improve the practice going forward; the real breakthrough is recognizing that you can improve your situation, and making the commitment of time and focus to begin making those adjustments in the first place.

I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.