Weekend Reading For Financial Planners (Jan 14-15)

How A Federal Ban On Noncompete Clauses Could Affect Advisors

(Mark Schoeff | InvestmentNews)

Noncompete clauses have become increasingly popular features of employment contracts, with the Federal government estimating that 30 million U.S. workers are covered by such provisions (and, according to an informal poll, nearly half of all financial advisors are as well). By restricting employees’ ability to move to a competitor, employers can ensure they get a better return on investment from the dollars they spend training and developing their employees, and prevent the loss of business secrets (or in the case of advisory firms, loss of clients) if an employee moves to a competitor. But for employees, noncompete clauses can restrict their ability to move to a job that offers better opportunities or pay (and can also reduce their leverage in salary negotiations with their current employer, which knows the employee has limited options because of the noncompete clause).

Given the significant implications of noncompete clauses for both employers and employees, these provisions have received significant attention from state governments, with several states either outright banning the practice, or at least restricting it to only certain positions (e.g., limiting them to highly paid workers). And now, the Federal Trade Commission (FTC) has proposed a rule that would ban noncompete agreements nationwide (with an exception for a person who owns 25% or more of an acquired firm). Notably, the rule would not only apply to new employee agreements, but also agreements with current and former employees (which would no longer be valid).

In the advisory firm context, the elimination of noncompete clauses for financial advisors could make firm acquisitions less attractive and/or reduce valuations (given that an acquirer’s greatest fear is that advisors will leave and take clients and revenue with them right after the deal closes, and may not be willing to pay as much if they can’t mitigate that risk), particularly if many of the existing advisors own less than 25% of the firm and therefore would be free to leave for another firm. More broadly, though, banning noncompetes could give advisors more career mobility to move to another firm that offers a better job fit or higher pay (and perhaps expand the talent pool for firms looking to hire, even if it means that their advisors can more easily leave as well). Though notably, it is unclear how the FTC proposal would affect advisor non-solicitation agreements, which restrict advisors from soliciting their previous clients when they move to a new firm and are also common in the advisory industry (and may become even more common as an alternative if the FTC limits noncompetes).

The FTC proposal will now be subject to a public comment period through March 10, which is likely to be highly contentious given the implications for companies and employees alike. But if the proposal is eventually enacted, the competition for advisor talent would likely heat up, creating an incentive for firms to consider ways (from compensation to workplace flexibility) to better retain talent (as employees with noncompete clauses in their contracts would likely have new opportunities at other firms) as well as attract advisors from other firms (who would no longer be bound by noncompete agreements). At the same time, though, advisory firms will also face more pressure to find ways to better establish the client’s relationship to ‘the firm’ and not just the advisor, to further mitigate their risks if the advisor leaves someday. Though ultimately, given the potential benefits of a strong office culture and employee satisfaction to a business’s bottom line, firms could consider how to make themselves a more attractive workplace even in the absence of a formal regulation outlawing noncompete clauses!?

Simplification Is Top Reason That Investors Move Retirement Assets

(Gregg Greenberg | InvestmentNews)

Over the course of a lifetime, investors can build up a large collection of accounts. From 401(k)s at previous employers to IRAs and brokerage accounts, keeping track of these accounts can be challenging. And at some point, these investors might decide to consolidate these accounts, whether through a rollover or a direct transfer.

And according to a study by research firm Hearts & Wallets, simplifying their finances is the top reason (33%) investors roll over or transfer their accounts, followed by a desire to get more involved with their finances themselves (26%) and consolidating for better planning (25%). Though given the amount of time and work it can take to complete a direct transfer or a rollover (with 35% of rollovers of $500,000 or more taking more than 2 years, according to the report), investors must be motivated to follow through with the transaction.

Notably, the report’s results suggest opportunities for advisors to demonstrate their value proposition. First, because many advisors consolidate client accounts that currently sit at a variety of asset management firms into accounts with the advisor’s custodian (subject to regulations, such as PTE 2020-02), working with an advisor tends to create the simplification that many investors seek. Further, advisors can add value to clients by overseeing the transfer or rollover process (with custodians competing to ease the burden of onboarding for both advisors and their clients!).

Ultimately, the key point is that while portfolio management is a part of the value proposition for many financial advisors, this value is not just in recommending an asset allocation and selecting investments, but, also in helping clients organize and simplify their disparate accounts in the first place!

FINRA Expands Enforcement Priorities For 2023

(AdvisorHub)

The Financial Industry Regulatory Authority (FINRA) is a self-regulatory body overseeing about 3,400 broker-dealers and their registered representatives (who total more than 600,000!). Each year, FINRA issues a report on its examination and risk monitoring program to provide firms and their representatives with its priority issues for the coming year, covering a range of issues from firm operations to market integrity.

In its recently released report for 2023, FINRA highlights a range of compliance-related issues for broker-dealers and their representatives to consider. Such topics include manipulative trading, with FINRA specifically citing firms for inadequate written supervisory procedures, non-specific surveillance thresholds, and surveillance deficiencies that can allow such behavior to go undetected. Another new addition is a focus on fixed-income pricing problems, based on incorrect determinations of prevailing market prices, outdated mark-up/mark-down grids, failure to consider the impact of mark-up on yield to maturity, and unreasonable supervision. The regulator also plans to focus on trading in fractional shares, highlighting the importance for firms of maintaining adequate supervisory systems and procedures to ensure that fractional share orders and trades are reported in a timely manner.

In addition to the new topics, the FINRA report also cites a range of ongoing concerns. These include cybersecurity, with FINRA expecting firms to develop and maintain sufficient programs and controls based on their risk profile, business model, and scale of operations. Enforcement of Regulation Best Interest (Reg BI) also remains an area of focus, with FINRA including a series of questions that broker-dealers should be asking about a variety of client transactions and whether they meet the standards of Reg BI, particularly in the areas of reasonable diligence in investment recommendations to clients, heightened scrutiny for high-risk or complex products, recommendations of new accounts for clients, and rollovers.

In the end, while FINRA oversees broker-dealers and their registered representatives, many of the highlighted issues will be relevant to RIAs as well, whether it is in maintaining proper cybersecurity procedures or taking care when conducting fixed-income transactions (which could become more prevalent in a higher-yield environment)!

RMD Quirks That IRA Beneficiaries Face In 2023

(Ed Slott | InvestmentNews)

One of the many ways advisors add value for their clients is by helping them navigate the various rules surrounding Required Minimum Distributions (RMDs) from retirement accounts. This is particularly true for clients who inherit retirement accounts, as the 2019 SECURE Act changed the rules regarding required distributions from these accounts significantly, and some of the provisions remain in flux. With this in mind, advisors can support clients by being aware of the latest rules surrounding inherited retirement account required distributions.

For “Designated Beneficiaries” (i.e., where an individual human being, as opposed to the estate or a charity, was named on a beneficiary form), the key question is whether the decedent who left the account to the beneficiary died before or after 2020. If the decedent died before 2020, the beneficiary can use the pre-SECURE Act ‘stretch’ rules (taking RMDs over the course of the beneficiary’s lifetime), though notably these individuals had to reset their ‘stretch’ RMD schedule in 2022 to the current IRS Single Life Table (which resulted in slightly lower RMDs) and will take their 2023 RMD accordingly (determining their life expectancy by subtracting one year from the life expectancy used in 2022).

However, Designated Beneficiaries who inherited retirement accounts from decedents that died after 2019 (after the SECURE Act took effect) and who do not qualify for “Eligible Designated Beneficiary” status (which applies to spouses and other specified types of beneficiaries) are subject to a different slate of rules. Under IRS proposed regulations released in early 2022, if the decedent in these situations died before their Required Beginning Date (RBD) when their own lifetime RMDs would have begun, Non-Eligible Designated Beneficiaries would be required to empty the account by the end of the 10^th year after death, though they do not have to take RMDs in the interim. However, if the decedent died after their RBD, then the proposed regulations stipulate that Non-Eligible Designated Beneficiaries must take RMDs for years 1 through 9 of the 10-year term, and the account must be emptied by the end of the 10^th year after death (i.e., whatever wasn’t already withdrawn from earlier RMDs and voluntarily withdrawals must be liquidated by the end of that 10^th year after death). And while there is no penalty for those who didn’t take these RMDs for 2021 and 2022 (as the result of an IRS notice eliminating the penalty for missed RMDs in these cases), that relief does not impact the calculation of the 2023 RMD, where Non-Eligible Designated Beneficiaries of those who inherited from a decedent who died after their RBD must take ongoing RMDs (though the IRS could issue final rules or clarifications before the end of the year).

For “Non-Designated Beneficiaries” (e.g., an estate or charity), the RMD rules are again based on whether the death occurred before the decedent’s own RBD; if the death occurred before the RBD, then the beneficiary must withdraw all of the inherited funds by the end of the fifth year after the owner’s death (not counting 2020, as the CARES Act waived RMDs for that year). If the death occurred after the RBD, then the beneficiary is required to take RMDs based on the decedent’s remaining single life expectancy had he or she lived.

Ultimately, the key point is that given the patchwork of beneficiary types and the range of RMD rules that apply to them, advisors can play an important role in making sure clients take the appropriate distributions (and avoiding penalties in the process) based on their unique situation (and analyzing potential distribution strategies when possible), by determining whether the decedent died before or after their RBD and whether the beneficiary is an Eligible Designated Beneficiary (generally still able to stretch), a Non-Eligible Designated Beneficiary (subject to the SECURE Act’s 10-year rule), or a Non-Designated Beneficiary (generally subject to the 5-year rule). Though given the ongoing series of changes to the rules for RMDs for inherited retirement accounts, advisors can also add value to their clients by staying abreast of the potentially changing requirements as they continue to evolve with more guidance from the IRS!

The Dangers Of Monte Carlo Simulations

(Massimo Young and Wade Pfau | Advisor Perspectives)

Monte Carlo simulations have become the dominant method for conducting financial planning analyses for clients and are a feature of most comprehensive financial planning software programs. By distilling 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, advisors often use this data point as the centerpiece when they present a financial plan. However, a Monte Carlo simulation entails major statistical and philosophical nuances that advisors can consider when producing the analysis and presenting it to clients.

One of these considerations is the capital market assumptions underlying the simulation. For instance, the probability of success (i.e., not running out of money) for a client with a given portfolio value can vary significantly depending on the assumptions the advisor uses for returns, volatility, asset class correlations, and the shape of the return distribution (i.e., the specific shape of the bell curve). Looking at investment returns, a 2022 survey of 40 investment firms found that the 20-year return assumptions for stocks ranged from 5.15% to 10.63% and were 2.42% to 5.82% for bonds. For a hypothetical client with a $1 million portfolio, 30-year retirement, a portfolio consisting of 60% stocks and 40% bonds, and withdrawals based on the ‘4% rule’, the probability of success would range from over 95% (using the most bullish return assumptions) down to 62% using pessimistic return expectations. Notably, this range is derived from different assumptions for a single input; changes to volatility and other assumptions could change the probability of success as well.

Given the importance of the underlying assumptions to the results of Monte Carlo simulations, advisors can consider taking measures to fine-tune their use of this tool. One option is to take advantage of the “wisdom of the crowd” by using an average of different firms’ assumptions for returns and other factors (instead of only relying on the advisor’s own projections). Further, an advisor could ‘stress test’ their analysis by using lower returns, higher volatilities, more positive correlations, higher safety thresholds, and/or longer life expectancies than the baseline assumptions. Advisors also can consider whether the Monte Carlo simulation is being conducted for a client making a one-time election for their annual portfolio withdrawals in retirement (making the accuracy of the assumptions even more important) or whether it will be revisited for clients on an annual basis (and whether the client is willing to make changes to their spending), which provides significantly more flexibility.

Altogether, advisors can improve the accuracy of Monte Carlo simulations by regularly examining the inputs that go into the analysis and running multiple simulations with a range of assumptions in order to give clients a better picture of the range of possible outcomes (in addition, given the nuances involved in Monte Carlo simulations, advisors might consider relaying the results to clients in dollar terms rather than as a probability of ‘success’!).

The 4% Rule Did Not Become A Whole Lot Easier

(James Shambo | Advisor Perspectives)

During the past decade of relatively low interest rates, it was challenging to find sources of yield for clients without taking on significant market risk (particularly for advisors looking to optimize their clients’ safe withdrawal rates). But the rapid increase in government bond yields this year presents an opportunity for advisors and their clients to get higher yields on their fixed-income investments. At the same time, because the current elevated inflation level can eat away at nominal bond yields, Treasury Inflation-Protected Securities (TIPS), which include both a fixed real yield plus an adjustment of principle based on inflation rates, have emerged as a potentially attractive opportunity for advisors and their clients.

As an example of the potential usefulness of TIPS in the current environment, one advisor was able to construct a nominal TIPS ladder that would provide for a 4.36% real annual withdrawal rate throughout a 30-year retirement. However, Shambo raises several potential concerns with such a strategy, particularly if this bond ladder made up a significant portion of a client’s portfolio. For instance, a given retiree’s spending is unlikely to match the CPI-U, the inflation measure used to adjust the principal of TIPS, as their personal spending preferences are not likely to exactly match the basket of goods and services used in the inflation calculation and because seniors have certain spending profiles (e.g., greater spending on healthcare than is represented in broader inflation measures), among other differences. Another concern is the potential for deflation, as bonds purchased on the secondary market could lose substantial principal in the event of prolonged deflation. Further, a bond ladder can be rigid, and, if spending needs increase, ‘breaking’ the ladder could prove costly, particularly if the bonds have to be sold at a discount.

Ultimately, the key point is that while TIPS can serve a useful role within a client’s portfolio, a heavy reliance on them to generate sufficient income to meet retirement income needs could be risky!

What Is The Optimal Rebalancing Frequency?

(Zhang, Ahluwalia, Ying, Rabinovich, and Geysen | Vanguard)

Rebalancing plays a crucial role in ongoing portfolio management, both to ensure that the overall risk of the portfolio doesn’t drift higher (as risky investments can out-compound the conservative ones in the long run) and to potentially take advantage of sell-high, buy-low opportunities. However, advisors have a range of choices when it comes to rebalancing client portfolios, such as frequency (e.g., rebalancing monthly, quarterly, or annually) or threshold (i.e., rebalancing when the portfolio drifts from the target allocation by a selected percentage) for rebalancing.

With this in mind, researchers at Vanguard created a model that, among other features, uses a range of possible asset returns, volatilities, and correlations to help determine the optimal rebalancing frequency and/or threshold. In addition, the analysis also accounts for transaction costs, which are modeled as a function of bid-ask spreads (which tend to widen during periods of market volatility, increasing transaction costs). The researchers sought to find a rebalancing strategy that would maximize the expected utility of an investor’s after-transaction-cost wealth at the end of a given investment period (though it is worth noting that the analysis does not account for tax-loss harvesting strategies, which typically would lead to more-frequent rebalancing to take advantage of market declines in a timely manner).

Altogether, the researchers found that for calendar-based rebalancing methods, annual rebalancing is the optimal choice. In general, rebalancing more often than annually resulted in larger tax implications for taxable accounts and higher transaction costs, while a less-frequent rebalancing period caused the portfolio to drift too far from the target asset allocation over time, leading to a disconnect with the investor’s risk tolerance. Further, while a strategy of annual rebalancing can stand on its own, for advisors who also want to incorporate a threshold-based rebalance (perhaps because they are required to maintain a low tracking error with a given asset allocation), a 1% threshold was found to be optimal.

In the end, rebalancing can play an important role in optimizing risk-adjusted returns for clients. And while advisors might be tempted to demonstrate value by rebalancing more frequently, Vanguard research suggests that annual rebalancing is sufficient!

How Do Stocks & Bonds Perform Following Big Down Years?

(Ben Carlson | A Wealth Of Common Sense)

2022 will be remembered as one of the worst years in history for investors, with the large-cap S&P 500 falling by 18.1% (its 7^th-worst loss since the 1920s) and the Bloomberg Aggregate Bond Market Index experiencing a total return of -13%, by far the worst year for the index, which dates back to 1976. But as a new year begins, many advisors and their clients might be wondering how markets tend to act in the years following large downturns.

Considering the 10 worst years for the S&P 500 since 1928, the following year saw an average annual return of 2.7% (ranging from -43.8% to 37%), while average three-year total returns were 32.5% (ranging from -23% to 77.4%) and five-year returns averaged 78.9% (ranging from 11.6% to 162.1%). These figures suggest that while 2023 might not see an immediate bounce back in returns, the outlook for a few years down the line could be rosier.

For 10-year treasuries, annual returns in the year following the 10 worst years for these bonds since 1928 ranged from -17.8% to 23.5%, with an average annual return of 9.5%. The average return three years out was 30.8% (ranging from 12.9% to 48.3%) and the average five-year return was 46.7% (ranging from 16.1% to 112.0%), suggesting that bond returns could be strong in the years ahead as well.

Ultimately, the key point is that while 2022 was a challenging year for client portfolios (and the bottom lines of many advisory firms), historical data suggest that time could be on the side of investors who are able to ride out the bumpiness along the way (though, as they say, past performance is not indicative of future results!). Which means that advisors can potentially add value to their clients during this period by listening to their concerns and encouraging them to stay the course!

How Much Growth Can You Expect?

(Nick Maggulli | Of Dollars And Data)

Working-age clients might have significant incomes but limited portfolio balances (perhaps they just finished paying off student loan debt), and therefore might have a hard time imagining the growth of their (currently small) portfolio. But by explaining the benefits of regular contributions combined with investment performance, advisors can give them a better picture of how their wealth might increase in the years ahead.

For example, using inflation-adjusted returns for rolling 10-year periods from 1970-2022 (rebalancing annually), an individual who invests $10,000 per year into a portfolio made up of U.S. stocks and bonds would have seen median growth of 50%, for a final portfolio value of $150,000 (notably, an investor in a portfolio of 80% global stocks and 20% U.S. bonds would have a median portfolio balance of $135,000). Extending the time period, over 20 years the same investor would have ended with a median portfolio balance of $424,000 ($356,000 for the global portfolio). Importantly, there were no 20-year periods where either of these portfolios ended up with a negative return.

In summary, an investor who engages in consistent dollar-cost averaging in a portfolio with a heavy (though not exclusively) equity allocation can expect to see significant returns over time, approximately doubling the inflation-adjusted value of their contributions over 20 years (at least based on returns from the past 50 years). And while this might be cold comfort after a rough year in the markets, historical returns suggest that clients who can maintain a long-term outlook (and keep their contributions going) will likely be rewarded!

Understanding The 4 Types Of Attention

(Stephanie Vozza | Fast Company)

In the modern world, it can be hard for a worker to maintain a high level of focus throughout the day. From having numerous tasks on your plate to the innumerable potential sources of distraction in the working world (everything from the latest email that arrives in the inbox to the lure of social media), paying attention to the task at hand can be a challenge. But by recognizing periods when your attention is waning (and taking breaks when necessary!), you can better align your periods of high attention to your most important tasks.

According to psychologist Dr. Gloria Mark, author of the book Attention Span: A Groundbreaking Way To Restore Balance, Happiness, And Productivity, attention can be understood along two dimensions: how challenged you are in what you’re doing and your level of engagement. These combine to create four ‘attention quadrants’. For instance, ‘focused attention’ occurs when you are highly engaged and challenged, and is correlated with motivation, activation, concentration, creativity, and satisfaction. At the same time, this state can cost a significant amount of cognitive resources to maintain, so it can be hard to stay in this state for long periods. Many individuals experience a focused attention peak in the late morning and again in the mid-afternoon.

‘Rote attention’ occurs when you are highly engaged but not mentally challenged. While these types of tasks (e.g., playing solitaire online) might seem like time-wasters, they can potentially be beneficial if they are used to replenish your mental resources while being lightly engaged. On the other hand, ‘boredom’ occurs when you are neither engaged nor challenged. While a feeling of boredom is not mentally taxing, it can leave you most prone to distraction. Finally, the most uncomfortable stage is ‘frustration’, which occurs when you are challenged but not engaged. This can occur when we are faced with a difficult activity but are not making progress. Often, individuals seek to exit this stage quickly by putting the task aside (perhaps until they are in a better attention space later on).

Ultimately, the key point is that your ability to pay attention to the task at hand is not fixed throughout the day, and by making a change – perhaps by giving yourself a short break to help restore a state of focused attention or finding meaningful work to take on when you start to feel bored – you can better avoid distractions and boost productivity over the course of the day!

How To Process All Of Your Inboxes In Under 25 Minutes

(Marian Knopp | RadReads)

When you hear the word ‘inbox’, your email account (or several of them!) probably comes to mind. But there are likely other inbox-like programs in your work life that you check on a regular basis (and can be just as distracting as email), such as company messaging platforms (e.g., Slack) or social media. So even if you are able to get to “inbox zero” with your email account, you might still spend a significant amount of time checking other platforms.

With this in mind, Knopp proposes a “Reaching Inbox Zero Everywhere” (RIZE) approach to reduce the time spent reviewing the range of ‘inboxes’ in our lives. The first step is to make a list of every ‘inbox’, not only including your email inbox(es), workplace messaging platform(s), and social media accounts, but also websites you check regularly (e.g., blogs or news sites). The next step is to assign a frequency to each of these ‘inboxes’: ASAP, daily, weekly, monthly, or spontaneously (for those ‘inboxes’ that do not actually need to be checked). After each ‘inbox’ is assigned, you can compile these websites or platforms into a single list (in a task manager or calendar) so that all of the inboxes on each list can be checked quickly and in succession. And because the RIZE process can create more time for ‘focus work’, the next step is to schedule times during the day to check the ‘inboxes’ according to their frequency. For example, you could block out time from 10 am-11 am each day to check the ‘daily’ RIZE inboxes or set a Monday morning time block to read your favorite weekly blog posts (cough, cough). The final step is to create a strategy for actually processing all of the ‘inboxes’; Knopp suggests sending quick replies to emails and instant messages if possible and setting tasks in your task manager (and setting up time blocks to address them) for items that require a longer response (so you can make it through all of the scheduled ‘inboxes’ in the allotted time).

In the end, email is not the only distraction we face in our work lives. But by grouping the wide range of ‘inboxes’ we check on a regular basis and processing them in an organized manner, you can prevent these distractions from interfering with your ability to take on more thought-intensive tasks!

How To Focus Like It's 1990

(Dana Smith | The New York Times)

Technology is a double-edged sword, in that it can help boost productivity and efficiency while also serving as a distraction. And today, there is no shortage of ways to be distracted, from the buzz of an incoming text message to the lure of the latest Tweets. And while it might seem like the best way to rid yourself of these distractions is to quit ‘cold turkey’, taking a more measured approach can lead to better productivity and more sustainable habits.

Smith suggests the first step is to understand what is distracting you. Notifications are ubiquitous today, from those on the computer (e.g., new email alerts or the sound of an incoming instant message) to regular cell phone vibrations, and turning them off is a good way to reduce distractions. But unfortunately, doing so will not completely solve the problem, as these external distractions have been found to account for only half of the interruptions in focus. This means that the other half of distractions are internal and occur when we ‘self-distract’ from stress or boredom.

The key, then, is to incorporate breaks during the day to not only scratch the itch of checking notifications, but to give your brain a break from the intensity of focused work. For instance, you can start with 15 minutes of focused work, followed by 1-to-2 minutes of checking your phone, email, or other favorite distractions. The goal, though, is to gradually increase the time between these ‘tech breaks’ so that you eventually have 45-minute or longer stretches of focused work without having to scratch the itch of checking your tech tools.

Ultimately, the key point is that while distraction is nearly inevitable in today’s tech environment, separating the need to scratch the itch of checking notifications and favorite apps from time dedicated to focused work (or even leisure activities like reading) can lead to a more productive balance of activities!

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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.