Weekend Reading For Financial Planners (Jan 7-8)

SEC Meets Strong Industry Resistance On Advisor Outsourcing Proposal

(Mark Schoeff | InvestmentNews)

While investment management was at the heart of the financial advisor value proposition in decades past, advisors today frequently offer a much broader suite of services to their clients. And given the wide range of outsourced investment management solutions (e.g., Turnkey Asset Management Platforms [TAMPs], Outsourced Chief Investment Officer [OCIO] and back-office trading solutions, and model marketplaces for model design and research), advisors are increasingly turning to these platforms while focusing their time on other aspects of the financial planning process and growing their business. At the same time, though, outsourcing investment management does not absolve RIAs (which are subject to a fiduciary standard) of the responsibility to ensure that these outsourced providers are providing the advisor’s clients with an appropriate level of service commensurate with their costs.

Amid this backdrop, the Securities and Exchange Commission (SEC) in October proposed a major new regulation that would go beyond the general requirement that RIAs as fiduciaries must conduct due diligence on their vendors, and instead establish formalized due diligence and monitoring obligations for investment advisers who hire a third party to perform a “covered function”, with the goal of ensuring consumers receive a high level of service when their adviser outsources certain responsibilities (and that the advisory firm is ensuring its outsourced service providers are adhering to their contribution of the advisor’s fiduciary responsibility). Such “covered functions” would be those that are necessary to provide advisory services and could harm clients or the adviser’s ability to serve them if not performed or performed poorly (but exclude purely administrative or clerical functions). Under the proposal, an adviser would have to take several steps before outsourcing a covered function, including assessing potential risks and the service provider’s competence, as well as the service provider’s own subcontracting arrangements to others.

In response to the proposal, the SEC received about 90 letters during the now-concluded public comment period. Comments from investment adviser trade groups were largely negative toward the proposal, often highlighting how the adviser’s fiduciary duty already requires them to conduct due diligence and ensure that outsourcing firms are acting in their clients’ best interests. Another argument noted that the proposed regulation was overly broad, and that the SEC could instead focus on only the highest-risk situations where outsourcing was most at risk to harm client interests. Further, trade groups highlighted the potential cost to firms of complying with the proposed rule, particularly for smaller firms with more limited revenue.

Not all commenters were opposed to the proposal, however. The president of the North American Securities Administrators Association (representing state securities regulators) noted in a comment letter that as advisors themselves are already subject to a detailed regulatory framework, it is appropriate to subject service providers that perform critical functions for advisers to similar oversight. Separately, the Consumer Federation Of America also expressed its support for the regulation, highlighting its potential to promote meaningful oversight over third-party service providers, which would ultimately be for the benefit of consumers.

The SEC will now examine whether to move forward with the proposal and whether any adjustments are warranted. If implemented, the new regulation would reinforce the fiduciary obligation RIAs have to their clients with respect to using outsourcers, but increase the level of formalized due diligence and reporting requirements when using third-party services. Though given the potential breadth of “covered services” (many such providers can be found throughout the Kitces Financial AdvisorTech Directory), a wide range of RIAs (not just those using TAMPs and similar investment management services) would likely face an increased compliance burden from the new regulation…and based on the comment letters to the SEC, it’s not entirely clear whether in practice many advisors were actually already failing to vet their outsourcing providers, and if greater regulation is needed in the first place?

Surging Staff Exits Bedevil Busy SEC

(Sam Bojarski | Citywire RIA)

The SEC has been busy during the tenure of Chair Gary Gensler, having proposed 26 new rules between January and August of 2022, more than double the number proposed in 2021 and more than were proposed in each of the five prior full years. And given the expertise and effort required to move rules from the proposal stage to actually being implemented (from researching and drafting the rule to making adjustments based on public feedback), retaining senior leaders and staffers is likely key to achieving the regulator’s mission.

But an October statement from the SEC Inspector General's Office noted that amid the increased workload, the SEC is dealing with attrition challenges. As of September, the SEC’s attrition rate for fiscal year 2022 was projected to be 6.4%, the highest in 10 years, up from 5.4% in 2021 and 3.8% in 2020. The greatest attrition was seen among senior officers (20.8%) and attorneys (8.4%). While the SEC’s overall attrition rate is similar to that of the Federal government as a whole (6.1%) the specialized nature of the SEC’s work means that the departure of senior officials could drain needed expertise from the regulator.

Ironically, the SEC’s robust agenda under Gensler could be contributing to the attrition, as the SEC’s heightened enforcement posture could be increasing the demand for attorneys at private law firms (that prepare legal challenges to the rules and support firms in complying with them) and the experience of current SEC officials could make them attractive targets for these (typically higher-paying) positions. To help address the attrition and increased workload, the SEC requested an increase of 454 positions for fiscal year 2022 in its Congressional Budget Justification (though given the often-lengthy government hiring process, it could take a while for any new staff members to be onboarded).

Altogether, given the SEC’s impact on the operations of investment advisers (from setting rules to conducting examinations) and its current adviser-related rulemakings (e.g., a proposed rule regarding outsourcing services and the enforcement of its new marketing rule), staffing troubles at the regulator appear to have the potential to slow the pace of implementing and enforcing its agenda, both for investment advisers specifically and the financial industry as a whole.

Why Financial Planning Needs More Specialists

(Jacqueline Sergeant | Financial Advisor)

When starting a financial planning firm, it can be tempting for an advisor to hold themselves out as a generalist in an attempt to make their services attractive to the widest possible audience. But given the wide range of ways that advisors can add value and the near-impossibility of being an expert in all of them, many advisors instead choose to focus on certain areas to attract an ideal target client.

This theme was reflected in a recent advisor panel organized by The American College of Financial Services (which offers a range of advisor-related designations and certifications). For instance, one firm shifted its focus to advanced retirement planning as a result of an influx of retirees moving to its area. For larger firms, another option is to have specialist teams in different planning areas; for instance, one team could focus on tax planning while another is an expert in portfolio management. An alternative structure could be to have teams that focus on different types of clients; for instance, one team could focus on the needs of high-net-worth clients while another specializes in the needs of clients who receive stock compensation. And for a firm just getting up and running, having a specialization can not only attract clients whose needs match the advisor’s expertise, but can also give the advisor more confidence in presenting their value proposition (and fee).

Ultimately, the key point is that at a time when having a broad-based knowledge of financial planning issues is becoming more common among advisors (as part of the requirements for CFP certification), advisors can stand out by being able to ‘go deeper’ into the needs of an ideal target client. Which can not only allow the advisor to run a more efficient practice, but also improve the long-run growth prospects for their firm as well!

Your 401(k) Isn't Enough: To Invest For Retirement, Build Friendships And Hobbies

(Anne Tergesen | The Wall Street Journal)

When financial advisors talk about investing for retirement, it is usually in the context of financial investments like stocks or bonds. But while having sufficient financial resources can be an important part of a happy retirement, it is far from the only contributor. In fact, research from the Harvard Study of Adult Development suggests that the quality of an individual’s relationships as they age plays the largest predictor of longevity and happiness later in life.

Compounding is one of the keys to investment growth, not just with regard to financial investments, but also personal ones as well. For instance, while a new friendship can be enjoyable, one that has lasted for decades can provide even more joy to each individual as their shared memories and experiences grow over time. This, combined with the importance of friendships for health and happiness in retirement, suggest that ‘investments’ in friendships during middle age can lead to significant compounded returns as we grow older.

Unfortunately, middle age is often one of the busiest periods in life, as individuals often balance busy careers with raising children and caring for aging parents. During this period, it can be easy to let previous friendships lapse, and building new ones can be challenging given the time commitment (as one study suggests that a casual friendship can take up to 60 hours to establish, with close friendships taking an average of 200 hours to develop!). This suggests that reaching out to friends from an earlier time could be a valuable investment, as much of the ‘work’ has already been put into developing the relationship. And when it comes to making new friends, finding groups with shared interests (perhaps through a hobby, or even at a financial planning conference perhaps?) can be a good way to meet new potential friends. And when it comes to current friendships, maintaining a ‘friend routine’ (e.g., having a set time to meet for dinner or speak on the phone each month) can help prevent them from fading away as a result of a crowded schedule.

In the end, while it can be tempting for advisors and their clients to view a ‘successful’ retirement as one in which the client has sufficient financial resources to meet their lifetime spending needs, the client’s overall wellbeing is dependent upon much more than dollars and cents. So while Monte Carlo analysis might not be available for a portfolio of friendships, helping clients explore ways to build and maintain their social relationships can also pay significant dividends throughout their lives!

Which Social Security Claiming Strategy Generates The Highest Legacy Value?

(Wade Pfau and Steve Parrish | Journal Of Financial Planning)

The decision of when to claim Social Security benefits is one of the key choices for individuals as they approach and enter retirement. While there are significant benefits to delaying Social Security (e.g., monthly benefits will be 77% larger in inflation-adjusted terms for those who claim at 70 instead of 62), many individuals decide to claim earlier for a variety of reasons. In some cases, these early-benefits selections are related to the individual’s personal situation (e.g., they need the income to support their spending needs or they have a medical condition that is expected to shorten their life expectancy), but another line of thinking (for those individuals who have sufficient resources to cover their spending needs without relying on Social Security) suggests that individuals could claim benefits as early as possible in order to leave more of their assets invested in the market (i.e., because of the Social Security benefits received, they will have to withdraw less from their investment accounts to support their retirement spending needs).

Using historical return data, Pfau and Parrish explore whether claiming benefits at age 62 leads to greater wealth at death compared to delaying Social Security benefits until age 67 or 70. Using selected assumptions (e.g., an individual’s life expectancy, current wealth, and spending needs), the researchers found that delaying Social Security typically led to higher amounts of wealth at death than claiming it at age 62, refuting the idea that it’s a good idea to start Social Security benefits early just to keep more dollars invested in the market. The percentage of cases where the legacy amount is greater when claiming at 67 or 70 compared to 62 ranged from about 60% to almost 97% depending on the assumed allocation to stocks (the early claiming strategy tended to fare better when higher stock allocations, and when stock market returns were strong in the years between when the individual turned 62 and 70). In essence, the internal rate of return on delaying Social Security is actually a very favorable real return (and separate research has shown that those who delay claiming until age 70 and reach age 90 can generate the equivalent of a 5% real rate of return on what is essentially a government-backed bond)! Further, delaying Social Security benefits also tended to reduce the chances that an individual would end up with a ‘negative legacy’ (i.e., run out of money before death), providing an additional benefit to this strategy.

Ultimately, the key point is that the ‘guaranteed’ return provided by delaying Social Security is actually a compelling benefit for those who have the means to delay claiming – effectively competing with the returns of (all but the most aggressive) investment portfolios. And as Pfau and Parrish’s data show, waiting to claim benefits can not only reduce the chances that an individual will run out of money during their lifetimes, but also make it more likely that they will be able to leave more assets to their heirs!

Monte Carlo Failures Aren't Plane Crashes

(David Blanchett | ThinkAdvisor)

Planning for retirement entails a great deal of uncertainty, from an individual’s longevity to the market returns they will experience in retirement. This is what leads many pre-retirees to approach financial advisors to help them figure out when they ‘can’ retire and what a sustainable retirement lifestyle might look like given their individual circumstances. And while advisors cannot eliminate the uncertainty surrounding retirement, they have a range of tools and strategies to help better understand this risk.

One of these tools is Monte Carlo simulation, which distills hundreds of pieces of information into a single number that purports to show the percentage chance that a portfolio will not be depleted over the course of a client’s life. Importantly, though, the results of a Monte Carlo simulation require nuance to interpret. For instance, while a simulation can show the percentage chance that a client will not deplete their assets in retirement (e.g., a 90% ‘success’ rate), this number does not show the magnitude of the shortfall (e.g., while falling $50,000 short of needed income at age 75 and $1 short at age 95 are both considered ‘failures’ in Monte Carlo simulations, the former situation would likely require more draconian changes by the client). Therefore, having a Monte Carlo success rate of less than 100% does not necessarily mean that a client is leaving themselves open to financial disaster, but rather it signals that adjustments to the plan (e.g., reduced spending) might need to be made in the future (particularly if portfolio returns are weak).

Ultimately, the key point is that unlike a flight (where the plane either lands or crashes), a retired client has the opportunity to change course along the way to ensure that they will not run out of money in retirement, even if it means a (possibly temporarily) reduced lifestyle. Therefore, advisors can add significant value to clients not only by running Monte Carlo simulations for clients, but also by putting the results in the appropriate context for the client’s income in retirement and suggesting changes when necessary!

It's More About Market Domination, Not Diversification, In The Shifting RIA Space

(Ali Hibbs | Wealth Management)

Financial advisors often preach the value of diversification to their clients. Whether it is holding a diversified portfolio of investment assets or having multiple streams of income in retirement, diversification can help prevent against catastrophic losses resulting from a single point of failure. And while some firm owners might look to diversify when it comes to growing their business (e.g., serving the broadest possible range of client types), taking a more focused approach could be a more successful strategy in the years ahead, according to one industry expert.

Speaking in September, former Pershing Advisor Solutions CEO Mark Tibergien suggested that the most successful RIAs of the future are likely to be those that are dominant by a certain demographic (e.g., client type or geography) rather than being large for their own sake. For instance, while RIA M&A has been at a fever pitch during the past few years, not all buyers have had a strategy for how to successfully integrate the acquired firm and its talent (potentially leading to a situation where the firm has significant assets under management but becomes unwieldy to operate). Tibergien recommended that firms first identify their primary motivator, optimal client, and differentiated specialties to establish themselves as a marketplace leader, and then consider acquisition targets based on how they could enhance the firm’s impact in these areas.

In the end, Tibergien’s warning about ‘overdiversifying’ holds potential lessons for firms looking to grow organically (by offering specialized services to a target client) and/or through acquisitions (by first considering their specific place in the market before seeking deal targets). Which suggests that the most successful firms in the years ahead might be those that emphasize depth rather than breadth!

4 Ways To Add Next-Gen Advisors To Your Practice

(Todd Rebich | ThinkAdvisor)

Amid an aging advisor workforce, the hunt for next-generation talent has been a common theme in the financial planning industry for the past several years. And amid a broader tight labor market, many firms are looking to step up their game in order to attract and retain top talent.

Advisory firm owners looking to hire next-gen talent can first consider the compensation packages they provide to employees. For instance, because burnout and attrition are common among young advisors (particularly in sales positions where much of their compensation is derived from commissions), paying new employees a salary can help keep them ‘in the game’ for the long haul. Further, comprehensive benefits packages are increasingly seen as table stakes for next-gen employees, so having a robust offering that goes beyond medical insurance (e.g., by offering student loan assistance) could attract more candidates. In addition, firms can consider ways to reward strong performances, perhaps through bonus pools or perhaps the opportunity to purchase equity in the firm.

Firms can also make themselves more attractive to next-gen talent by creating an attractive work environment. Whether it is through flexible work locations, casual dress requirements, open communication, or team social events, there is a range of ways for owners to thoughtfully demonstrate that they are prioritizing the preferences of their employees. In addition, by offering sufficient training to employees, firm owners can demonstrate that they are invested in their employees’ professional development.

Notably, the ability to be flexible and act quickly is an advantage for owners of smaller practices compared to larger firms when it comes to attracting and retaining talent. And given the current challenging environment for bringing on next-gen employees, those firms that are most thoughtful and nimble could be those that are most successful in attracting talent in the years ahead!

Practice Made Perfect: How Advisors Can Solve The Capacity Problem

(Sheryl Rowling | Morningstar)

When a firm first opens its doors, the owner is often the only employee, charged with handling all aspects of building their practice. But over time, as the firm grows, the owner is likely to hit a capacity ‘wall’ where they can no longer handle all of the responsibilities on their own. This could mean adding staff, upgrading the firm’s tech stack, or outsourcing certain tasks to create more capacity for the owner to focus on their most important duties.

But as the firm grows further, it can continue to hit capacity walls where its current staffing and resources are straining under the weight of providing high-quality service to its client base. At this point, firms can consider several tactics to ameliorate the situation. One option is to think about “prehiring” by adding additional staff before reaching the next capacity wall. Because it takes time to hire and train new staff members, hiring in advance of a need can ensure that the new employee is ready to go by the time the firm nears its breaking point. In addition, while a firm owner will have delegated many of their responsibilities at this point, they can look for further opportunities to ensure that the firm can operate without them (or any other single employee) if needed. This delegation can either be done internally (through reassigning work or bringing on new staff) or externally (by outsourcing responsibilities like compliance or marketing).

Growing firms can also ensure they are remaining profitable by regularly assessing their client base, perhaps by categorizing their clients based on the fees they bring in and the effort required to serve them. Firms can then either increase their fees (to reflect the work being performed on the client’s behalf) or consider ‘graduating’ clients who require a significant effort but do not pay commensurate fees by referring them to another advisor who could serve them profitably.

The key point is that by being proactive when it comes to staffing, technology, and the client roster, firms can maintain a sustainable operational tempo even as they approach capacity walls. Which can not only benefit the firm’s long-run profitability, but also ensure that the owner has more time to focus on growing their business and perhaps even take a few more vacation days?

A Timeless New Year

(Lawrence Yeo | More To That)

For some people, New Year’s Day is one of the most important times of the year. The stroke of midnight represents a new beginning (and perhaps an opportunity to drink copious amounts of champagne). To others, January 1 is just another day, and the dawn of the new year is just an arbitrary flip of the calendar page. Either way, the new year can represent an opportunity to take stock of where you have been in the previous year and where you want to go in the future.

Some people view the new year as an opportunity for a fresh start and make resolutions to achieve certain goals or start a new habit. But as many previous resolution-makers have recognized, these goals often fail. Yeo suggests this is because resolution-setters are tying their habits to time (the new year) rather than an internal motivation to complete their goal. Instead, he suggests that the biggest changes often occur when they are in sync with how individuals view themselves. For example, Yeo’s decision to quit his cigarette smoking habit came over time, as he realized he no longer wanted to smell like smoke and did not want to identify with being a smoker. And so, while the start of the year can be a natural time to reflect on your values and ambitions, checking in throughout the year can be a good practice (as goals can change over time!) to identify the changes you want to make in your life.

So whether you have a ‘big’ goal for the new year or want to check in on your current goals, reflecting on why you are pursuing these aims in the first place can help you realize whether your self-identity and these goals are aligned, and, ultimately, make it more likely that you will achieve them!

Time Is Slippery. Don't Waste Yours.

(Joy Lere | Finding Joy)

Somewhere in the back of our minds, humans recognize that we are mortal. But as any financial advisor trying to get a client to complete their estate documents knows, we don’t always like to face it head-on. But without a sense of finiteness, we can sometimes put off the goals we want to accomplish.

With the new year arriving, many individuals will set fresh goals, one of which could be to avoid squandering the limited time you have each day (and in a lifetime). By doing a ruthless audit of your time, you can identify the time-wasters in your life, whether it is social media, television, or something else, and then create a plan to reduce time spent on these items (perhaps by deleting social media apps from your phone or by cutting down the number of streaming subscriptions from five to one?). Notably, a ‘time audit’ of your professional life can also be helpful. Perhaps you can identify tasks in your day that could be performed by a staff member or could be outsourced. Or maybe your goal for the year is to devote the time to starting your own firm in order to gain more control of your time (even if the path is likely to be challenging at first!).

Ultimately, the key point is that our lives are finite whether we like it or not. And because we do not get to choose (or know) how many more years we have, trying to make the most of the time you do have could be the best resolution you make this year!

How To Build Healthy Habits

(Tara Parker-Pope | The New York Times)

The new year often serves as a reminder to review our habits, both the good and the bad. At the same time, it can be challenging to remember how we started a certain habit. For example, taking a walk at lunch might come automatically to you now, but it had to start somewhere. So for those looking to start a new positive habit (or break a bad one), research suggests a few practices to help it stick.

Research suggests that a good way to form a new habit is to tie it to an existing one. For example, if you want to start a meditation practice, you could link it to your morning cup of coffee by doing a one-minute meditation while it’s brewing. Another key is to start small. If your goal this year is to be able to do 50 push-ups, but it’s been a while since you exercised, trying to ‘go big’ right away could lead to frustration (and injury!). Instead, you could consider starting with one push up after breakfast and dinner, building up to your goal as the year progresses. In addition, making your new habit a daily exercise can help it stick, as building a habit is not a one-week endeavor. For example, one study found that the amount of time it took for a habit to become ‘automatic’ among participants ranged from 18 to 254 days, with a median of 66 days.

In the end, building any new habit is challenging. But starting small, tying it to a current practice, and practicing it on a daily basis can increase your chances of success!

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

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.