Weekend Reading for Financial Planners (Mar 10-11)

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 10th/11th:

How A Swath Of Billion-Dollar-Plus RIAs Are Posing A Threat To Indie Advisors - This article by Philip Palaveev on RIABiz discusses the emerging phenomenon of "super ensembles" - firms with approximately $5 billion or more of AUM that are becoming regional dominators, with the size and scale of mega firms (especially with respect to investments in marketing and branding) but the local feel of a close competitor. Examples would included firms like Aspiriant, Ronald Blue, and GenSpring Family Office. Palaveev draws parallels to the accounting world, where there are 350,000 CPA practices in the country, but there are also 4 mega firms that dominate segments of the market (with more than $5 billion in revenue each!) and about 40-50 regionally dominant firms (such as Grant Thornton, BDO Seidman, Moss Adams, etc.). These mid-category firms have been taking lucrative niche markets from the big four, and simultaneously absorbing large numbers of clients from smaller competitors with less size and scale. Palaveev seems the front end of this trend playing out in the coming years amongst a similar emerging group of wealth management firms, growing both organically and by acquisition and by strategic merger, with a similar competitive edge against both firms large and small. Palaveev's recommendation to small firms (that want to survive without merging): find a niche where you can keep your competitive advantage.

Consolidation Quickens - This article by David Lawrence from Financial Advisor magazine focuses on the consolidation happening across the industry, from huge firms (the purchase of Genworth Financial Advisors by the Cetera Group) to small ones (local RIAs trying to reach $100M to register with the SEC instead of individual state(s)). Lawrence notes that advisors who can't get scale on their own are looking to affiliate with larger organizations, but cautions that if advisors look to affiliate with larger firms, pay attention not just to the details of payout structure, but technology integration as well. Overall, Lawrence observes consolidation up and down the advisors scale ladder, be it affiliating with a broker/dealer with an RIA or a larger independent RIA firm or an aggregator like United Capital, or acquiring or merging with a local practice found through services like Advisor XChange or FP Transitions.

Where Are The New Advisors? - This article from the March 2012 issue of Research magazine explores the ongoing industry challenge - there are more advisors aging out and retiring  (industry average age is 50.6 according to Cerulli) than there are new ones coming in to replace them. The article notes that since there aren't enough young people coming into the industry, firms are increasingly recruiting career changers and developing them into advisors. And as firms are finding, there are benefits to hiring career changers, including a wider range of life experiences to relate to clients, and more "hard knocks" experiences that may leave them better prepared for the challenges of starting an advisory practice. Recruiting efforts have focused heavily online, from job sites like CareerBuilder and Monster to social media sites like LinkedIn. Compensation packages have shifted as well, with 'training' programs offering base salaries as long as 5 years, and some trainees earning more than $100,000 while they get up to speed. Although the focus of the article is on wirehouses and big institutional firms, the reality is that that's still where a great deal of total industry hiring is occurring.

Succession Planning 101: How Small Firms Can Recruit the Best Advisors - As a contrast to the preceding article, this one by planner Greg Friedman discusses how small independent firms can identify good young advisor talent. Friedman's key tips: hold lots of interviews for a candidate with several staff members (don't just make a snap decision based on a good resume and one good interview); ask the "right" questions that get at their priorities and passion, not just the general interest and skills; keep in mind generational differences, and that new advisors may have different values, beliefs, and goals, but that doesn't mean that can't be effective in your business; and change venues to shake things up, such as taking the candidate to lunch and seeing how they interact in a somewhat more social environment. Friedman's bottom line: if this is going to be a long-term relationship with your new advisor and your firm, you're looking for chemistry as much as an impressive GPA and certification. 

Wharton Professor Gives Advisory Model Radical Makeover - This article highlights a new advisory firm called Veritat, established by Wharton Professor Kent Smetters, designed to allow advisors a chance to operate an advisory business built on Veritat's technology. What does the firm do? It's intended to provide support to the advisor on planning, allowing clients to enter their own data, with the Veritat software creating a plan in what Smetters calls a "TurboTax approach", which is then transmitted to the advisor to review and approve before the output goes to the client's portal. As Veritat suggests, the advisor focuses on service, while Veritat supports execution, customer support, provides a platform, handles compliance, and supports business operations. The planning philosophy ties to a goals-based investing approach popular in economic circles called Life Cycle Finance (the Veritat board includes active economists in the life cycle finance area, such as Zvi Bodie). Ultimately, the Veritat business is an RIA, and works predominantly on an AUM basis with a 0.7% fee, although clients may also pay a $250 initial planning fee and $25/month (or $40/month for a family) for ongoing access to an advisor. Insurance issues are referred to an outside broker that works with fee-only advisors, and legal issues to Legal Zoom. Veritat expects advisors to add a minimum of 10 clients and $1 million of AUM per year.

A Huge Opportunity - This article by Bill Bachrach in Financial Advisor magazine suggests that flat fees are about to go mainstream in financial planning firms (which Bachrach suggests are better accomplished via a flat annual rate, instead of an hourly billing approach). Bachrach starts by emphasizing that change can and does happen, and can sometimes be quite rapid - from Schwab decimating the traditional broker commission model, to advisors insisting that no one would live in a 1% (of AUM) world and give up an 8% commission... until they did. Bachrach notes that the whole industry is shifting away from commissions to at least ongoing fee models like AUM, and that flat fees are simply the next step; in addition, some other countries like Australia are mandating a fee-for-advice model. In Bachrach's "new normal" flat fee world, advisors will create a business model and determine how much revenue per client is necessary, and simply set their fee accordingly. Although some may debate a few of Bachrach's points or whether the trend will go as far as he suggests, it does present an interesting possible view of the future.

Capital Gains, Ordinary Income and Shades of Gray - This article by economist Gregory Mankiw in the New York Times provides a remarkably simple and straightforward explanation of the carried interest debate, by drawing an analogy to people who either buy a house and resell it, buy a house and fix it up as a carpenter and sell it, or simply work as a carpenter to fix up a house that someone else has bought to resell. While the first scenario is clearly a capital gain and the last is clearly employment income, the middle scenario is murky - both when it's a carpenter who puts sweat equity into a real estate purchase, and when it's an investment manager putting "sweat equity" into a private equity partnership. The bottom line is that the situation overall is difficult to evaluate and has troubles people setting tax policy for years; carried interest is only an example of a broader difficulty in creating effective and appropriate tax policy.

Western Civilisation - Decline--Or Fall? (free registration req'd but worth it!) - This article by Niall Ferguson in John Mauldin's "Outside the Box" weekly reading draws on Ferguson's newest book, "Civilization: The West and the Rest" which looks at how powerful civilizations tend to rise and decline - or as Ferguson notes, collapse, as historically most civilizations that may rise for hundreds of years often fall apart in less than a generation. Ferguson suggests that western civilization is at risk for being on the cusp of such a collapse, as much of the rest of the world is suddenly catching up or passing the US and western Europe in areas that have been the sole domain of the west for centuries. Yet Ferguson suggests there is still time to recover, especially in the United States where "the country has the right software. [We] just cannot understand why it is running so damn slowly." Overall, I suspect many will find Ferguson's ideas and suggestions controversial in questioning the hegemony of US and the west, but it contains important points that shouldn't be ignored.

An End To The 60/40 Asset Allocation - This article by Bradley Jones on Pensions & Investments magazine, a summary of his longer research report "Rethinking Portfolio Construction and Risk Management: A Third Generation in Asset Allocation" takes a hard look at how the 60/40 portfolio has really performed across time, both in the US and abroad, on a real return basis. The results are quite striking. Jones notes that the 60/40 portfolio barely kept pace with inflation in 7 of the past 11 decades; the other decades did most of the heavy lifting, and also were associated with "unrepeatable or rare events" such as the post-World-War recoveries of the 1920s and 1950s, and the secular decline in inflation and interest rates in the 1980s and 1990s. Abroad, the results can be even more dismal; on a real basis, the domestic 60/40 portfolio in Japan isn't any higher now than it was in 1987; in Ireland, since 1993. In addition, Jones notes that 95% of portfolio volatility is attributable to the 60% equity portion, and stocks have a positive correlation to bonds in many environments, suggesting 40% in bonds itself is a poor portfolio hedge. The "second generation" investor response has been to shift into "leverage-sensitive" alternative assets, such as hedge funds, real estate, private equity, etc. But these still share many common risk factors to equities, as 2008 revealed. Jones' conclusion: diversification by risk factors, instead of conventional asset classes; a more forward-looking approach than historical correlations; regime-based capital market assumptions; and a blurring of the line between strategic and tactical asset allocation.

I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!