Weekend Reading for Financial Planners (October 21-22)

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 October 21st/22nd:

TD Ameritrade Sells Out NextGen Advisor-Client Platform By Replacing 84% Of Its NTF ETF Lineup (Michael Kitces, Nerd's Eye View) - The big news amongst RIAs this week was the announcement on Monday that TD Ameritrade was making major changes to its no-commission ETF Market Center platform, expanding from 100 to 296 available ETFs, including the launch of new ultra-low-cost SPDR Portfolio ETFs (that provide exposure to most "core" asset classes for just 3-7bps, even as its other ETFs remain higher, apparently adopting Blackrock's "pricing for the future" strategy). However, in the process of making the change, TD Ameritrade also eliminated 84% of its current ETF line-up, including all of its Vanguard ETFs and most of its lowest-cost iShares Core ETFs as well, effective November 20th. Which is a substantial problem to existing RIAs using the platform, that must now decide - in barely 30 days - whether to change all of their existing clients from iShares and Vanguard ETFs to the new SPDR Portfolio ETFs (which can have substantial capital gains implications given the multi-year bull market), or to keep the "old" ETFs for existing funds but allocate all new contributions to new clients (which introduces substantial operational challenges, especially for advisors who don't already use iRebal and its "proxy purchase" system of alternative security purchases, and especially given many of the new ETFs in the lineup also have ultra-low-volume that introduces execution risks), or to just keep using the existing Vanguard and iShares Core ETFs and pay the $6.95/trade fee going forward (which is fine for "larger" clients but untenable for younger/smaller clients, especially those making ongoing savings contributions). Which means, ironically, that the change is the most disruptive for the most loyal TD Ameritrade RIAs (that had the most already invested into the platform), and those serving next generation clients (whose modest ongoing purchases necessitate switching to the new NTF ETF lineup). Perhaps the biggest frustration, though, was that TD Ameritrade Institutional completely blind-sided its advisors with the announcement, which is likely driven by the recent Scottrade acquisition and growth potential of the ETF Market Center to those new retail clients, and there doesn't appear to be any advisor- or client-centric reason for the change on the TD Ameritrade Institutional side, beyond that State Street was apparently willing to pay more to get into ETF Market Center than what Vanguard and Blackrock were willing to pay to keep their ETFs there - and that TD Ameritrade simply sold out its existing advisors and clients to the highest asset management bidder. Of course, no one can begrudge TD Ameritrade for trying to get paid for what it does... but the question arises as to why TD Ameritrade Institutional had to let the Retail division take the lead on the change (perhaps not coincidentally just a month after RIA champion Tom Bradley departed), and whether it's time to just let advisors and their clients pay a reasonable asset-based trading fee and have access to 100% of all available ETFs, as RIA custodian disruptor Apex Clearing has been positioning itself to do. Will TD Ameritrade be willing to make right its mistake, after taking the most non-fiduciary action possible for its RIA advisors and clients, especially since it has spent years trying to stand as an advocate for fiduciary RIAs and next generation clients?

E-Trade Enters RIA Custody Business By Purchasing Number Five Player Trust Company Of America (Brooke Southall, RIABiz) - The next blockbuster announcement in the RIA custody news this week is that retail online brokerage giant E-Trade is acquiring the number-5 independent RIA custodian Trust Company of America. The somewhat "niche" RIA custodian was especially known for supporting TAMPs and SMA managers, and reportedly had $17B of assets on its platform amongst about 180 RIAs (though a much, much larger number of IARs thanks to so many broadly-distributed TAMPs on the platform), which provides a strong foundation for E-Trade to make a play for what is known in the brokerage world as the "more stable" revenues of the advisory business over the retail trading business. The head-scratcher, though, was the price, with E-Trade announcing that it will spend a whopping $275M in cash to buy TCA, despite the fact that even at 0.25% of average revenue/assets (e.g., via 12b-1 fees, shareholder servicing fees, sub-TA fees, etc.), TCA would have had "only" $42.5M of revenue, putting the deal at a very frothy 6.5X revenue for what is still a relatively commoditized RIA custody line of business (though on an analyst call, E-Trade indicated that it expects to generate about $80M of additional revenue next year on the deal... but that still puts the purchase at nearly 3.5X revenue!). Nonetheless, the strategic synergy opportunities are clear, for E-Trade to leverage its size and scale into an RIA custody channel that increasingly needs size and scale to compete. Although ironically, in the past one of the primary selling points of TCA was that, unlike the "big 3" of Schwab, Fidelity, and TD Ameritrade, it had no retail side of the business competing against its RIAs... at least not until now that it's being purchased by a larger retail firm!

U.S. Bancorp Venture Uses $2.6 Trillion Running Start In Bid To Become Supermarket-Of-Fund-Supermarkets To Threaten Pershing And Other Clearing Giants (Oisin Breen, RIABiz) - Most investment advisers and broker-dealers pay little attention to the dynamics of the custody and clearing market that underlies their businesses - beyond when companies change models or fund lineups in a way that impacts the advisor directly - but the reality is that the custody and clearing business is struggling greatly as the forces of technology commoditization come to bear, driving a need for substantial scale that is causing consolidation of retail firms (TD Ameritrade buying Scottrade), of RIA custody platforms (E-Trade buying Trust Company of America), and substantial broker-dealer mergers and acquisitions as self-clearing firms bid for assets (e.g., LPL buying NPH). Now, the big news is that U.S. Bancorp, which is not a "household name" amongst the advisory community but is the country's seventh-largest bank (and a player in the private banking market for ultra-high-net-worth clientele), has launched a new service called FundKeeper in partnership with Envision (a recordkeeping and subaccounting software firm). The goal is to provide a centralized clearing system for what is currently a behind-the-scenes spaghetti mess at most independent broker-dealers after decades of building one-to-one connections to mutual fund carriers (from the days when most independent brokers primarily did mutual funds "direct" rather than via the brokerage business). The FundKeeper platform is aimed primarily at the small-to-mid-sized independent broker-dealers that are too small to self-clear, and/or are still doing direct mutual fund business, and want a simpler/"better" alternative to third-party clearing options like Pershing, National Financial Services (NFS), and RBC. The opportunity is significant, not only for US Bank and FundKeeper itself, but because the improved efficiencies could bring down broker-dealer costs and provide a new breath of life for small broker-dealers struggling to find efficiencies with DoL fiduciary compliance obligations.

Advisors & Industry Watchdogs Say FINRA Is Playing Favorites In NPH/LPL Deal (Christopher Robbins, Financial Advisor) - Earlier this summer, FINRA pre-approved a "block transfer" of all brokerage accounts from National Planning Holdings to LPL that would allow the firms to merge and integrate quickly after their announced deal closed by moving all client accounts automatically (without requiring any paperwork short of a negative consent letter information clients it will be happening). However, NPH advisors themselves are complaining that the pre-approval of the block transfer is being used by LPL to hurry through the transition without giving them much time to explore alternatives and whether they even want to make the switch with their clients (and from a practical perspective, brokers can't sue to block it, because waiting to resolve the dispute would shut their businesses down). In addition, some NPH advisors have complained that they had existing employment agreements that would allow them to transfer to firms of their choice, which they now claim aren't being honored (and again, would have to accept the move anyway while challenging it legally). And notably, while block transfers have been permitted since 2002, in the past FINRA has only approved them in situations where a broker-dealer was going out of business or in significant distress – effectively as a consumer protection for brokerage continuity, not as a way for an acquirer to expedite the acquisition and advisor/client retention process. Which has led some to question whether LPL as the acquirer, and Jackson National as the seller, used their size and clout to get approved for a block transfer that hasn't been available to any smaller broker-dealer acquisitions in the past decade. Although alternatively, if the precedent is now set that FINRA will more easily facilitate block transfers with broker-dealer acquisitions, it could just further accelerate the trend of broker-dealer consolidation trend by making it even easier.

A New Approach To Hedging Concentrated Stock Holdings Without Diversifying (Sean Allocca, Financial Planning) - One of the major challenges when working with high-net-worth executives is that they tend to have a substantial concentration of their wealth in their company stock, from which they may not want to or be able to sell and diversify (either for tax reasons, or due to restrictions on liquidations as an executive). Enter the Stock Protection Fund, where a group of 20 executives from different industries collectively hedge their exposure by contributing cash equal to a certain percentage of the value of their stock (e.g., 5% or 10%), which in turn is invested into 5-year Treasuries... and at the end of 5 years, any investors whose original stock positions are down are compensated for their losses from the pool (and if there's more than enough available because most investors are "up", the excess is simply divided evenly amongst all the investors). In essence, the strategy is a kind of small-group mutual insurance arrangement, but the diversification of participants holding stocks across different industries is meant to help reduce the risk that most/all investors need to file a "claim" at the same time. In other words, with "diversified" exposure, the odds are good that many/most of the stocks will be up (and those investors just "lose" their 5%-10% contribution, which amounts to only 1%-2%/year for 5 years, in addition to a one-time upfront placement fee of 2% and some foregone interest used to cover operational costs), while those who have losses are made whole (and if almost everyone is up, and there are few or no claims, the "insurance premium" contributions are simply returned with growth). In fact, a 2006 trial of the Stock Protection Fund that started in 2006, with 10% cash contributions protecting 20 stock positions, still ended up returning 31% of the original contribution to investors (with the other 69% making whole the few stocks that were still down by the end of 2011), although one study suggests there's still a 30% chance that the bonds in the SPF won't cover all the losses of all the investors. Technically, the investment is treated as a private placement security – first created by StockShield, although now several SPF offerings are available through Intelligent Edge Advisors – but since most executives easily qualify as accredited investors, the private placement treatment shouldn't be a blocking point for those that might want to use it. And again, the virtue is that the original stock itself remains held by the original owner, avoiding adverse tax consequences for any sales, and leaving the stock available for future bequest (to a charity or heirs).

How To Sell A Business Tax Efficiently Via Structured Installment Sales (Adam Tkaczuk, Alpha Architect) - For those who spend a lifetime building a business, the sale of that business may cost them as much as 1/3rd of their entire net worth in taxes, and easily becomes the single largest tax payment the owner will ever make. Fortunately, the "installment sale" tax rules allow owners to spread out the tax consequences of a sale by receiving payments over time – except the risk of an installment sale is that, if the buyer themselves fails and defaults while payments are still ongoing, the seller could lose some or all the value of the remaining payments. The alternative? A so-called "Structured Installment Sale", where instead of selling directly to the buyer for an installment sale, an M&A Reseller buys the business instead, makes installment note payments to the seller, and then re-sells the business itself to a buyer in a controlled auction (ostensibly using the M&A Reseller's deeper business-selling resources to create a proper pitch deck and doing the legwork to solicit interest from potential buyers), sometimes after first providing consulting services to help better systematize the business (and better enhance its value in the first place). However, because the M&A Reseller now executes the sale, the proceeds can be held with and further reinvested by the reseller, allowing both the ongoing payments of installment note principal and interest, plus growth of the M&A Reseller's account, to be paid on a tax-deferred basis over time (where taxes are only due as payments are received by the original seller). Of course, it's possible all along for the seller to stretch out the tax consequences of sale with an installment transaction in the first place; the key to the M&A Reseller strategy, though, is that the buyer actually makes a single-lump-sum payment to the M&A Reseller, which then has the cash available to secure the payments to the buyer, drastically reducing the risk of installment sale default. (And because the M&A Reseller provides consulting services to enhance the value of the business, and has an economic incentive to maximize the value of the business as its "new" owner until ultimately sold, it has a bona fide economic purpose to avoid being characterized as "just" a tax shelter.)

When Is Securities-Based Lending (SBL) Right For Clients? (Zohar Swaine, Wealth Management) - Securities-Based Lending, or "SBL" for short, is a loan obtained directly from a brokerage firm that is collateralized by the underlying assets in the borrower's (non-retirement) brokerage account. Loan-to-value borrowing power varies from 50% of the portfolio value (for highly volatile assets) to as much as 90% of the account balance (for low-volatility holdings). A securities-based loan is especially appealing for short-term or bridge loan needs – for instance, making a downpayment on a house, paying estimated taxes, or other similar situations. In essence, the SBL is a form of margin loan, although it is specifically required to not be used to pay off existing margin-loan balances or to purchase additional securities (which helps the lender affirm that the investment risk isn't being amplified further). From the client's perspective, SBLs are appealing because they typically have little-to-no underwriting, provide a way to generate (at least short-term) liquidity for a portfolio without triggering capital gains, and are a relatively inexpensive way to borrow (as the loans are typically based on LIBOR, not Prime rates that usually apply to Margin and other types of consumer loans). Minimum loan balances range from $100,000 to $250,000 (varying by institution), and while they have been historically available at major wirehouses (e.g., Merrill Lynch, Morgan Stanley, and UBS), they are increasingly coming to broker-dealers and some RIA custodians as well. Of course, it's important to remember that as long as the portfolio remains as collateral, there is a risk that a decrease in value could trigger the institution to call in the loan – requiring the borrower to repay immediately, or to liquidate the portfolio to cover the loan (which may be an ill-timed sale), so it's important to monitor the value of pledged assets and be wary of borrowing up to the maximum available LTV ratio. Nonetheless, when used prudently, the SBL may be very appealing as a short-term borrowing/liquidity option for those with substantial non-qualified brokerage accounts.

Three Questions To Help You Master Your First Appointment (Stewart Bell, Audere Consulting) - One of the keys to really learning new skills is that you have to actually implement and practice them, as reading a book summary doesn't constitute mastery of the topic, and buying weights doesn't mean you're going to exercise and get healthy. And in the context of meeting with prospects and approach talks, Bell laments that many advisors who have "learned" that it's important to build rapport have glossed over the real lessons – for instance, understanding how fact-finding questions are really about trying to find the prospect's emotional payoff points and figure out how to define the value of financial planning in terms that will be measurable to them, how outlining an agenda isn't just about explaining what you'll cover but getting permission to have the conversations, and that it's crucial to make prospects feel involved in what's happening as though the solutions are their idea (which makes them really own it and want to proceed). Accordingly, Bell advocates trying a series of three questions to help really go deeper: 1) "If we were having a conversation 10 years from now, and you've achieved all you set out to achieve in life, financially and otherwise, tell me the things you're likely to have nailed?" (And then keep asking "What Else" at least five times until the answers run out); 2) Then ask a more "Quant" question about 2-3 of the just-stated goals to help pinpoint the real objective (e.g., "So, if we're talking about your goal of achieving financial freedom, how much money do you need specifically?" or "If the goal is to send the kids to private school, which school and how much do you need?" (Where the point is to get past just the list, and into the measurable outcomes it will take); and 3) Then circle back to connect the emotion of the outcome, because that's what really makes them act: "So, if you were able to achieve sending the kids to that particular private school and cover the cost of doing so comfortable, what would be the best part of that for you?" or "If you could pay off the home in ten years and accumulate an investment holding of $300k in that time, how would that change things for you?" It may be easy to skip over the last part in particular, and conclude that a "good" first appointment is about getting the right list of questions, and showing your technical knowledge to solve them... but as Bell notes, the real key is about connecting with and managing the client's emotional state, so they feel connected to the opportunity of working with you.

The 5 Must-Have Client Meetings (John Bowen, Financial Planning) - The most successful advisors are the ones that spend the most time connecting with their clients, which inevitably means an ongoing series of relationship-building meetings. Bowen delves into the 5 more common types of meetings, and the key aspects for executing each one well, including: 1) Discovery Meeting, where it's not about showing off the advisor's specialized expertise, but uncovering the clients' key financial and personal needs, which means conducting a "total profile" interview that goes beyond just their assets and financial information; 2) Investment Plan Meeting, where if you're going to propose to manage the client's portfolio, you need to actually show a detailed plan that affirms the prospect's long-term needs and objectives (and values, time horizon, risk tolerance, etc), show exactly what you will do/change to help them, and then ask them if they feel positive about going forward with the relationship; 3) Mutual Commitment Meeting, which follows the Investment Plan Meeting, where you actually ask the client for their business and the opportunity to work together to execute the plan (but first ask if they have any questions about the prior meeting, and respond to concerns!); 45-Day Follow-Up Meeting, which many advisors overlook, but is crucial to help them "Get Organized" and ensure that clients aren't feeling overwhelming by the volume of financial paperwork that often hits in the initial weeks of implementation (and in general, helps to affirm to the client they made the "right" decision); and 5) Regular Progress Meetings (where you don't just check in regarding investment results, but ask about major life changes, and review other planning opportunities... not to mention remembering to ask them for additional business opportunities now that you're working well together!).

Creating (Next Generation) Client Events That Aren't A Waste Of Time (Cam Marston, Investment Advisor) - Event planning is a challenge for most financial advisors, as they require a lot of planning and effort to pull off (and time and money), and it's often difficult to get a good turnout (and in many cases, a "bad" turnout is worse than none at all, as sparse guests awkwardly look around and wonder how long they have to stay until they can leave without looking rude). Marston suggests that one of the best ways to ensure that clients (or prospects) attend an event is to tie it to relevant life changes that the target audience may be facing – because those kinds of changes are often more emotional and pressing, and will drive people to take action. For instance, one non-profit in his area did an event to connect with parents of children entering their teenage years, and got a huge turnout – as any parent facing the "tweens" has a lot of common concerns about how to handle challenging situations! In the context of financial advisors working with clients (or prospects, or children of clients), relevant life-stage-transition events could include: "Five steps for helping your adult child become independent", or "Top 3 mistakes parents make when teaching children about money", or "Changing careers: four ideas to get you started on your next chapter", or "Five biggest mistakes empty-nesters make". The key point: people feel vulnerable to the unknown when they transition to/through new life stages, and those are opportunities to engage them – and don't underestimate the value of a relatively "simple" event or topic, when it's well targeted to a relevant life transition issue!

Betterment's Evidence-Based Approach To Improving Investor Behavior (Dan Egan, Betterment) - While most financial advisors talk about the value of a (human) advisor to help clients make behavioral improvements, a big caveat is that there's relatively little research that actually shows advisors what to do and how they can improve investor behavior, and most individual advisors have too few clients for a robust experimental test, beyond trying something different on the next client and seeing if there's an anecdotally-better outcome. Betterment, on the other hand, has more than 150,000 clients, and therefore has the ability to try out handling different clients in different ways (randomly assigned), and seeing which approaches actually lead to better client outcomes. For instance, in one version of an A/B test, Betterment wanted to see if the conventional wisdom that advisors should proactively contact clients during a market decline is actually effective... as it's also possible that the clients didn't even see the news, and contacting them will just remind them that they should worry. And so when the S&P 500 fell 6.05% from May 21st to June 24th of 2013, Betterment sent a carefully crafted outbound email talking about what was happening in markets and why clients should remain invested (and compared to a control group of clients who didn't receive the email), and found that while a subset of clients who already actively engaged with the platform (e.g., regularly checking accounts) were helped by the email, others were blissfully ignorant and were more worried by the email (suggesting that universal blast emails to clients during times of market stress may not be the best approach!). Another test in August of 2015 and January of 2016 (when markets had significant corrections) used in-app notifications (from Betterment's app), ranging from positive forward-looking notifications (e.g., "Don't worry, stay the course") to a more explanatory one (e.g,. "Why am I losing money?"), and found that the in-app notifications had impact, but actually led to decreased rates of ad hoc deposits, and the only positive one was a "What Should I Do When My Returns Are Decreasing?" notification that reminded clients that market declines are a buying opportunity. Following up on this, a third test found that when clients may be tempted to sell, an ad-hoc "Tax Impact Preview" that shows them the tax consequences of a sale were materially less likely to follow through on it. The key point: Not all points of "conventional wisdom" about how to best serve clients are necessarily correct... or at least, there are times where the exact nuance of the message actually matters, far more than most advisors might realize!

Facts Don't Change People's Minds... Here's What Does (Ozan Varol, Heleo) - The classic view about how to change someone's mind is to treat it like an intellectual debate, where you rely on objective facts and statistics to develop a strong case for your side, back it up with data, and win over with your point of view. The reason is in part the so-called "confirmation bias" – that we tend to undervalue evidence that contradicts our beliefs and overvalue evidence that confirms them, which means we effectively filter out inconvenient truths, and can even convince ourselves to support "alternative facts" that fit our pre-existing beliefs. Just think of your own behavior when doing a Google Search – when you enter a question and see the results, do you meticulously read each link, or just click the one with a headline that matches what you expected/believed already? The problem is compounding by the fact that we simply don't like to acknowledge and admit that we're wrong, which can undermine our own self-confidence. Accordingly, Varol suggests that the key is tricking your mind by giving it an excuse – an "out" – such as recognizing that your prior belief was right given what you knew, but that it's OK to change your mind now that the underlying facts have changed. Which is important, because most people go the opposite direction – instead of giving the other side an out, we belittle the other side (e.g., "I told you so" or "basket of deplorables" or "He's an idiot"), which just makes people dig in their heels even deeper. In other words, if you want to convince someone, don't just show them whether/how they're wrong – help them comfortably make the transition, such as pointing out "Well, of course you were in a position to make that prior decision, because no one knew about X at the time... but now you do, so what will you do going forward with this new information?" Of keys for being able to more effectively change your mind: beware entwining your beliefs with your identity, as that makes it harder to let go of them without letting go of yourself (e.g., as an academic, Varol began to say "In this paper, I argue..." so that if it's wrong, he is not wrong, the paper is wrong); build up your empathy muscle (as people won't change their mind to agree with you if they're being blocked by an underlying concern, such as trying to convince Detroit auto workers about global warming and not recognizing that they may fear environmental policies will threaten their jobs); and get out of your echo chamber by trying to connect with (or stay connected to) people you know will disagree with you, because as uncomfortable as that might be, it helps you keep better perspective.

Good Advice Vs. Effective Advice (Ben Carlson, A Wealth Of Common Sense) - One of the hardest parts of giving financial advice is that "good advice" alone is often not enough. After all, there's really no lack of good advice out there already; the problem is that most people ignore it most of the time. In other words, it may be good advice, but it's not effective advice, because knowledge and a bit of willpower are often not enough to help people actually do what they already know they should do. So how do you create effective advice, beyond just giving good advice? The key is to incorporate the good advice into a behavioral strategy that will make it easier for people to implement. For instance, good advice is preaching to clients to stay the course, but effective advice is to build more durable portfolios that are easier to stick with. Good advice is to buy low and sell high, but effective advice is to create a rules-based system that forces you to sell a little bit of what has worked and buy a little bit of what hasn't (e.g., rebalancing). Good advice is giving people tactics they can use, but effective advice building systems and policies for clients that they can apply over and over again to different situations. Good advice is telling people to save more, but effective advice is helping people to automate their saving. Or stated more simply, good advice is universal, but effective advice is personal, and while good advice tells you how to succeed, effective advice shows you how to do it. Is your advice good, or actually effective? And what could you change to make it even more effective?

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.