Weekend Reading for Financial Planners (Mar 4-5)

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 March 4th/5th:

Donald Trump's Labor Department Proposes Delaying Fiduciary Rule (Lisa Beilfuss & Michael Wursthorn, Wall Street Journal) - This week, the Department of Labor published its OMB-approved proposal to delay the fiduciary rule. Unlike prior reports that it would be a 180-delay, though, the actual proposal turned out to be a mere 60-day delay, that would push the applicability date for the new rule from April 10th to June 9th. Notably, though, the proposal itself is still that: just a proposal. It will now open for a 15-day comment period ending March 17th, after which the DoL has to process the comments, and then go back to OMB again for final approval; experts are projecting that at best, it means the delay won't even be official until the week before the original April 10th applicability date. And even then, it's still not certain the rule will actually be delayed; as one commentator has pointed out, the final version of the proposal was dubbed "economically significant", which is important because it imposes a requirement for a cost-benefit analysis to be done just to justify the delay, and if the DoL and OMB don't dot their i's and cross their t's, consumer advocacy groups like the Consumer Federation of America may be able to sue the DoL to block the delay as being done in an "arbitrary and capricious manner". On the other hand, paired with the short comment period for the delay itself, the new proposal from the Department of Labor also solicits comments for a 45-day period regarding President Trump's Executive Memorandum directing the DoL to reconsider the rule, which ostensibly would be used to follow up with another proposal to further delay, alter, or even attempt to rescind the rule during the 60-day-delay period (if it happens in the first place). Or at least, to potentially re-propose another delay, tacked onto the end of the initial 60-day delay, as a part of re-proposing yet another new/different version of the rule. Still, given that the industry has complained throughout that the Department of Labor acted "hastily" in rolling out the fiduciary rule in the first place, it's now challenging for the DoL to quickly roll out proposals that would delay or amend the rule before it takes effect for at least some period of time. And with the reality that even in the best of circumstances, the delay won't be official until literally a week or two before the April 10th applicability date, some are suggesting it's already "too little too late", as financial institutions are already fully developing their fiduciary compliance systems and processes anyway at this point, just in case the rule actually stays after all.

TD Ameritrade Jumps Into Price War With Fidelity and Schwab (Suzanne Woolley, Bloomberg) - A "pricing war" erupted this week between the major discount brokerage (and RIA custodian) platforms. First, on Monday, Fidelity lowered its online trading commissions on stocks and ETFs from $7.95/trade to $4.95/trade (and also reduces its options fee from $0.75/contract to $0.65/contract). Then on Tuesday, Schwab responded by matching the pricing, cutting its own trading fees from $6.95/trade to $4.95/trade as well (and also matching the Fidelity fee cut on options contracts). Margin rates were also cut at both firms. And then on Wednesday, TD Ameritrade responded as well, cutting its transactions fees from $9.99/trade down to $6.95/trade (though it is maintaining a $0.75/contract option trading fee); while notably, TD Ameritrade kept its pricing higher than competitors, CEO Tim Hockey did note to the media that there may be lower pricing in the future once the pending acquisition of Scottrade has closed, and the company did separately announce last week that it is cutting the trading fees on DFA funds down to $9.99/trade (while competitors Schwab and Fidelity still charge $25 and $30 - $50, respectively). Notably, while the price cuts may seem modest on a relative basis, at just a few dollars per trade, the relative impact is substantial – the Schwab charge amounts to a 29% price cut, the Fidelity change is a 38% price cut, and TD Ameritrade's change is a 30% price cut as well; in fact, the anticipated impact is so severe, TD Ameritrade's stock crashed almost 10% on Tuesday as the Fidelity and Schwab price cuts were announced, and Fidelity and Schwab are each expected to lose out on a whopping $120M of 2017 profits as a result of the cut. In fact, at some point the question arises as to whether or how the major custodians and discount brokerage firms will generate revenue at all, as the race to zero continues; ultimately, it's likely to come down to the companies' ability to offer other ancillary (revenue-generating) services instead... which helps to explain the growing push from the companies into everything from proprietary ETFs to "robo" services (as fee-based wrap accounts provide stronger and more steady revenue than increasingly commoditized transaction-based trading fees).

SEC Issues RIA Standing Letter Of Authorization [SLOA] Custody Guidance (RIA In A Box) - Last month, the SEC issued a No-Action Letter in response to a request from the Investment Adviser Association for affirm that the common use of Standing Letters of Authorization (SLOA) between RIAs and their clients – permitting the advisory firm to transfer assets between the client's investment and other outside accounts – would not trigger the so-called "Custody Rule" under Rule 206(4)-2 of the Investment Advisers Act and force the advisory firm to obtain surprise independent audits. Notably, the response from the SEC was that an SLOA will trigger the Custody Rule, and going forward should be reported as such in response to Item 9 of Form ADV, but relented in stating that the SEC would not aim to enforce against an advisor who failed to obtain surprise audit exams in certain circumstances, where: 1) the client signs an initial instruction to the RIA custodian initially authorizing transfers to a specific third-party; 2) the client explicitly authorizes, in writing, for the investment adviser to direct transfers to that third party (either on a specified schedule, or "from time to time"); 3) the RIA custodian still performs appropriate signature verifications, and provides a prompt transfer-of-funds notice to the client after each transfer; 4) the client has the ability to terminate or change the instructions with the custodian; 5) the investment adviser has no authority to change the identity of the third-party details; 6) the investment adviser maintains records showing that the third-party is not a related party or located at the same address as the investment adviser; and 7) that the RIA custodian sends the client an initial and subsequent annual notices to the client confirming and re-confirming the SLOA instructions. Notably, the SEC has also updated its Custody FAQ to affirm that an SLOA to transfer assets between a client's own accounts across different custodians does not trigger custody at all (i.e., the aforementioned SLOA trigger of the Custody Rule is still only when client funds can be transferred to a third party account, not the client's own outside accounts).

SEC Chair Wants To Roll Back 'Accredited Investor' Distinction (Kenneth Corbin, Financial Planning) - Under current law, if an investor wants to invest into private placements like venture capital or a hedge fund, the client must be an "accredited investor", which means having individual income greater than $200,000 (or household income over $300,000/year), or a net worth of $1M (excluding the primary residence). However, Acting SEC Chairman Michael Piwowar suggests that the accredited investor rules are no longer relevant, and may even harm the small-time investors it was meant to protect by limiting their access to high-risk/high-reward investments that at least some may wish to take, especially as a diversifier to balance out the rest of the non-accredited investor's portfolio (just as small-cap stocks are more volatile and risky but have been found to be an effective diversified across an entire portfolio). On the other hand, there's still a fundamental challenge that private placements are often opaque and difficult to evaluate and may have higher fees and lower liquidity; in fact, after Piwowar's comments on Monday, the initial response of the financial advisor community was negative, with more advisers suggesting that if anything, the net worth limitation should be raised, not lowered, when it comes to "exotic" investments. On the other hand, even some supporters acknowledge that if the ultimate goal is to ensure that complex investments aren't put into the hands of "unsophisticated" investors who may not fully appreciate their risks, that income and net worth requirements are not necessarily a very good proxy for investor sophistication.

Wealthy Clients Might Be [More] Vulnerable To IRS Audit (Ben Steverman, Bloomberg) - As budget cuts continue at the IRS, with the number of IRS enforcement agents down 28% in 5 years, the number of audits has been dropping as well, and as a result the IRS is retargeting its efforts on more "target-rich" environments to squeeze more dollars out of each audit, which means more scrutiny for the wealthy. In point of fact, the IRS has already been running a "Wealth Squad" (the Global High Wealth Industry Group), which scrutinizes the finances of the very rich, including not only his/her Form 1040, but also companies/investments that he/she owns (and might be shifting income to). But now the IRS is launching 13 new "campaigns" focusing on particular areas where the IRS suspects it can catch tax cheats and bring in additional revenue, from potential abuses of energy tax credits, to the way housing developers do their accounting, the ways that affluent US taxpayers repatriate offshore assets,  and so-called "basket options". Notably, though, most audits are not going to be full-blown tax audits that review everything, and more much more likely to be an "audit lite", where the IRS asks for substantiation of a particular tax credit or deduction – with the IRS increasingly asking (by mail) for proof to support "suspicious-looking" charitable donations or questionable hobby losses. Overall, though, the IRS audit rate last year was just 0.7%, though it was almost 2% for those with incomes over $200,000 and nearly 6% for those with incomes over $1,000,000.

Rethinking Retirement Liability (Russ Hill & Sam Pittman, Financial Advisor) - At its core, the question "do I have enough to retire" is about determining whether the prospective retiree has enough in assets to support their future spending. In the world of pension plans, the question of whether there are enough current assets to support future liabilities is determined by a "funded ratio", and Hill and Pittman suggest that a comparable "personal funded ratio" could be applied to individual retirees as well, which includes both current assets and future cash inflows (e.g., pensions and Social Security), against future spending obligations (for both essentials and discretionary/lifestyle spending). However, the concept doesn't quite transfer perfectly, because in a (large) pension plan there are enough participants to accurately predict mortality each year (thanks to the Law of Large Numbers), but in the case of an individual retiree, the time horizon isn't known with certainty; the authors suggest it's the best way to handle this is to weight the impact of future spending obligations by their actuarial likelihood (calculating an "actuarial net present value" of future liabilities, akin to how an immediate life annuity is priced for any individual in particular). The authors suggest that the Personal Funded Ratio may be more appealing than alternatives like Monte Carlo analysis, given its dependence on future market assumptions, although in reality the personal funded ratio will similarly suffer if market returns fail to meet the assumed discount rate used to calculate the present value of assets and liabilities (and if market returns are in line, both models may produce similar results anyway).

Planning For A More Expensive Retirement (David Blanchett & Michael Finke & Wade Pfau, Journal of Financial Planning) - Market valuation and asset pricing studies suggest that forward-looking returns for stocks will likely be below their historical average, at the same time that current yield on risk-free assets is also well below historical bond yields, and the reduced returns in combination mean that retirees may need as much as double the amount of assets to retire as they might have 30+ years ago. Which suggests that not only are today's retirees at risk of running out of money, but that today's accumulators may need to be saving far more than they actually are to be able to generate enough retirement savings in the future, and that those who have legacy goals may also need to save more (and/or spend less in retirement). The fact that longevity in retirement also continues to improve, especially amongst those who are more affluent, further exacerbates the issue as well; for instance, since 2000, the cost to simply purchase an immediate inflation-adjusting annuity to fund a 65-year-old's retirement is nearly 50% higher than it was (and is almost double where it was in the early 1980s). On the other hand, the reality is that because immediate (and longevity) annuities pay mortality credits on top of current bond returns, arguably financial advisors may actually be understating the value of using annuitized income in retirement if stock and bond returns aren't lowered appropriately to reflect the current forward-looking environment.

Get It Right When It Comes To Calculating Returns (Craig Israelsen, Financial Planning) - Most of the time, when financial advisors present return data to clients, it's calculated using third-party tools to calculate the average returns. Which is important, because the "average" return used for performance returns is more complex than merely adding up all the returns for each time period and dividing by the number of time periods. The issue is that this "arithmetic" average – which we're all taught in school – fails to properly account for how investment returns compound over time; the proper way to calculate investment returns is actually to calculate a geometric average, or the average return that would geometrically compound out to the actual final wealth at the end of the cumulative time periods. In a world of zero volatility, the arithmetic and geometric averages will be the same. But once volatility is introduced, they will deviate. And the impact can be material; for instance, from 2000 to 2016, the arithmetic average return of the S&P 500 was 6.16%, but the actual geometric average that reflects that total amount of actual growth was 4.51%/year. And the greater the volatility, the greater the difference: with emerging markets, which had a 32.6% standard deviation (compared to "just" 18.1% for the S&P 500), the arithmetic average return was 11.09%/year, but the geometric average was actually just 6.18%/year! Fortunately, the good news is that Excel actually has a shortcut formula to calculate the geometric mean, aptly called the GEOMEAN function; however, to use it properly, return percentages need to be scaled back to decimals (such that a +10% return is 1.1, and a -5% return is 0.95), and the GEOMEAN formula can then calculate the geometric average of a series of returns listed in the proper decimal format.

IRS Guidance On 401(k) Hardship Withdrawals Clarifies Uncertain Terrain (Greg Iacurci, Investment News) - Last week, the IRS issued a Memo to its Examiners that audit employer retirement plans, providing further guidance on how to audit whether a plan is properly complying with the "safe harbor" rules permitting hardship withdrawals even if the employee wasn't eligible for a withdrawal (and thus, unlike a 401(k) loan, doesn't have to be repaid). To qualify for a hardship withdrawal, which 84% of 401(k) plans offer, the employee must "prove" a substantial financial need to tap the 401(k) account, and that the distribution is necessary to satisfy the need. The guidance affirms that the 401(k) plan administrator can either obtain copies of source documents from plan participants (e.g., estimates, statements, and receipts, regarding the hardship) or a "summary" of the information on the source documents (and then inform the participant that it's important to keep the source documents available in the event of an audit in the future). The latter option in particular is significant, as it confirms that it's reasonable for the 401(k) plan to simply gather information about the hardship event from the plan participant, who can attest that the event has occurred, but the 401(k) plan administrator isn't actually responsible for auditing and "proving" that the hardship event and expenses occurred. Though ironically, for those who have long worried that hardship withdrawals just allow consumers to use their 401(k) plan like a piggy bank for easy access, the fact that plan participants can apparently just attest to the need for the hardship withdrawal (and only "prove" it later, which may never be relevant if they're never audited) could just make the situation worse by making it easier for people to abuse the rules.

4 Ways to Grow the Financial Planner Talent Pool (Caleb Brown, Investment Advisor) - One of the major challenges in developing the next generation of financial planning talent is that, as much as CFP Board registered programs have grown within undergraduate institutions, there's still a long ways to go; in total, there are now financial planning degree programs at 227 different institutions, but there are over 3,000 four-year degree-granting colleges in total, which means we've still only reached about 6% of all schools, and even within those schools students aren't always aware of the programs. In addition, even when students do find the programs and study and major in financial planning, they aren't necessarily pursuing financial planning jobs after graduation, in part because of perceptions that there are other opportunities for "better" higher-paying jobs out of college (though notably, in reality, the average salary for entry-level accountants was $48,447 last year, which is consistent with a $50,000/year median compensation for an associate financial advisor in the latest advisor compensation benchmarking data). And even when students come into financial planning careers, there's often confusion and concern over whether there is a forward-looking career track opportunity and what it might look like (which makes financial planning less appealing as a career decision), or students end up in day-1 sales jobs as an insurance agent or stockbroker and get burned out on the professional altogether. So how can the situation be improved? Brown suggests four tactics: 1) advisors should get involved with their alma maters to help encourage the administration to consider adding a CFP program (if they don't already have one) or be a speaker to help promote financial planning to the existing program; 2) be clear about salary expectations and opportunities for new advisors (because they're actually pretty good!); 3) try to build a vision of how your firm will grow and evolve over time, so you can paint a picture for your prospective or new planner about what their upside potential is over time; and 4) push for expanding not only financial literacy programs, but ones that promote the CFP marks, as a means to help young people understand and become aware that there increasingly really is a career opportunity as a financial planner that isn't just predicated on selling insurance or investment products.

Career Path Advice For Young Planners (Dennis Moore, Journal of Financial Planning) - Given both the evolving nature of the financial planning profession, and the fact that any particular new financial planner's career only unfolds over time (i.e., not everyone even knows what their future niche or focus will be, when they're just getting started), Moore suggests that the best strategy for young/new financial planners is simply to focus on constantly learning and growing and moving forward (rather than trying to fix the path and the end goal itself too early on). The starting point is seeking out internships while still a student, which can give you real-world experience on what financial planning is really all about in practice; in fact, even if you don't end up enjoying the internship, it's still valuable because it helps you understand what you don't enjoy and don't want to do with your future career, and as a result Moore recommends finding several internships over the span of several years in college if at all possible. Upon graduating and finding an initial job position as a paraplanner or associate planner, Moore urges young financial planners to take initiative in their firms and try to stand out by offering suggestions for improvement; recognize that not all (or any) of your ideas will necessarily be implemented, but again the learning process itself of making suggestions and trying to explain them is a good skill to practice, and even if the ideas themselves aren't implemented most advisory firm owners will still notice the demonstrated effort that you're thinking and trying to bring value. Other tips that Moore offers include: hone your communication skills (whether it's with clients and prospects, or co-workers and colleagues, your ability to communicate effectively will have a major impact on your career trajectory); find a mentor (e.g., through the FPA's MentorMatch program); and get involved and volunteer with professional organizations (e.g., FPA or NAPFA) to further practice your skills and begin to develop your personal network.

How Young Financial Advisors Can Invest in Themselves (Rianka Dorsainvil, Investment Advisor) - Financial success involves making investments into your future, and Dorsainvil points out that success as a financial planner similarly involves making self-investments into your own future. This means investing into your education as a financial advisor, including not only earning the CFP marks and maintaining your CFP CE credits, but going beyond the bare minimum and looking at post-CFP educational programs too, along with informal education like attending at least 1 financial advisor conference every year, and reading books and industry news. And don't forget to invest in your future brand by establishing your professional presence through creating social media accounts, which give you an opportunity to connect and network with colleagues (and potential clients, too!). In addition, Dorsainvil notes that (new) financial advisors should be cognizant to keep their own financial house in order, too; don't get so sucked into providing help for clients' retirement plans, that you neglect your own. This is important not only for the sheer credibility with clients of being able to demonstrate that you practice what you preach, not only for the ability to someday retire, but because your ability to live within your means and save money also makes it feasible to navigate job changes or the possibility of someday launching your own advisory firm as well. In fact, consider getting a financial planner for yourself as a financial planner, because there's nothing wrong with having a professional financial advisor to help hold you accountable to your financial goals!

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.