Weekend Reading for Financial Planners (Feb 29 – Mar 1)

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.

Massachusetts Promulgates Final 'Fiduciary' Rule... With Some Key Parts Removed (Mark Schoeff Jr., Investment News) - Last week, Massachusetts finalized its proposed state fiduciary rule, becoming the first state to fully implement an increase in advice standards on brokers doing business and making investment recommendations to customers in the state (New Jersey and Nevada are also working on rules, but have not issued them in final form). At its core, the new Massachusetts fiduciary rule for brokers will require them to make recommendations "without regard to their own financial interests", which Massachusetts states is a higher standard than the more limited protections provided to consumers under the SEC's Regulation Best Interest. However, the Massachusetts rule in final form did ultimately make several concessions to the financial products manufacturing and distribution companies, including that it will not apply to insurance (nor annuity, even variable annuity) product sales, it won't impose an ongoing fiduciary duty on brokers unless account monitoring is part of the customer contract, and it doesn't include any adviser title restrictions (it also doesn't apply to Registered Investment Advisers doing business in Massachusetts, but only because they are already subject to a more stringent fiduciary duty). Ironically, though, the endpoint of Massachusetts' compromise has left both sides unhappy, with the industry already raising the possibility that it may sue Massachusetts regulators to block the rule, while investor advocates from the Consumer Federation of America suggested that Massachusetts backed down too far to provide truly meaningful fiduciary advice protection for consumers in the state and that the rule ended out being too aligned and only a modest improvement over Reg BI's lesser standard anyway.  Nonetheless, as it stands, the finalized rule will go into effect on March 6th, with broker-dealers receiving approximately 6 months (until September 1st) to make adjustments to their models before enforcement will begin.

Supreme Court Rules On ERISA Fiduciary Obligations For Ensuring Disclosures Are Read (C.J. Marwitz, ThinkAdvisor) - This week, the Supreme Court handed down a unanimous decision against the fiduciaries of Intel's defined contribution plans, ruling that when plan documents and disclosures are delivered electronically in a manner that employees may not see or read, the statute of limitations for those employees to challenge the plan's fiduciaries doesn't kick in until the plan participant actually reads the plan documents and related disclosures. Consequently, even though the Intel employee involved had received the plan documents and disclosures in 2015, the fact that he never read the disclosures until years later (upon discovering what he viewed as questionable alternative investments being offered in the plan), meant he had 3 years from when the disclosures were read (not just when they were delivered) to sue the Intel defined contribution plan fiduciaries responsible for selecting and including those investment options. From the perspective of plan sponsors, though, the concern was that the Intel employee was confirmed as having received and even accessed the documents; still, though, the fact that he couldn't recall reading the documents, and stated he was otherwise unaware his savings were invested in alternative assets, meant he didn't have "actual knowledge" (and thus hadn't yet triggered the 3-year statute of limitations measured from the point of having 'actual knowledge'). Ultimately, the real impact of the case is that it means providing electronic disclosures alone, and receiving a confirmation receipt that the document has been delivered, still doesn't ensure the participant has actual knowledge of what's in it, creating a potentially-open-ended fiduciary liability exposure for plan sponsors. On the other hand, it's even less feasible for plan sponsors to verify that a paper disclosure document that was physically mailed to a participant's home or business was read... and as a result, the Supreme Court decision is anticipated to accelerate the push towards electronic disclosures in the future (albeit with 'check-the-box' requirements along the way for participants to affirm they didn't just receive but actually read the document).

Contact Your Clients About The Market Now; Here's What To Say (Steve Wershing, Client Driven Practice) - With market indices down about 10% in the span of just a week, even clients who normally don't pay much attention to markets may be noticing... which means it's time for clients to hear from you as their financial advisor. In fact, at a recent meeting with a financial advisor's Advisory Board, Wershing found that even beyond sending out regular email or social media communications to clients (e.g., ongoing market commentary), that one of the things that clients valued most was the "out-of-cycle" email they received when markets were especially turbulent or there was "significant news" impacting the market. The key in such communication, though, is to recognize that clients have often delegated investment decisions (or outright discretion) to the advisor, so the key is that clients don't literally need to understand how their portfolios are being managed in the turmoil, or hear that they should "stay the course"... instead, the real issue is that clients are experiencing fear, need to feel understood, and want to know that you as the advisor are watching out for them and that they can trust you are managing their portfolio (even if the management decision happens to be to Stay The Course and do nothing). Accordingly, key talking points to convey trust that the advisor is "on top of the situation" include: What IS the advisor watching (of all the possible statistics and data, which indicators really matter that the advisor is actively monitoring?); What is the advisor's Strategy (i.e., what will you do if the situation does deteriorate and get worse and does necessitate some action beyond just staying the course?); and What will Trigger the action (i.e., if the right decision is to sit tight, at least for now, knowing the threshold for making a change can help to make the waiting and monitoring more bearable). The key, though, is simply to recognize that it's not enough to just show clients that you care but also to demonstrate how you are actively taking care of them, too.

Another Yield-Curve Inversion: Symptom Of A Recession Or Covid-19? (Leon LaBrecque, Forbes) - With the markets pulling back into "correction" territory (down more than 10% from their highs) in barely over a week, one of the biggest questions that loom is whether "that's it", or if there's still more turmoil to come. Especially since not only are markets themselves down, with concerns rising about whether the coronavirus could trigger a recession but also that this week the 10/1 yield curve inverted (again, for the second time in recent months)... an adverse signal that has preceded 11 out of the last 11 recessions (albeit also with two false-signal 'soft landings' as well in the past 70 years). Notably, though, recessions don't typically follow a yield curve inversion for 12-18 months, suggesting that a recession still may not necessarily be 'imminent'. And with the very direct market fears of the coronavirus (Covid-19), it's not entirely clear whether markets are actually signaling a recession, or whether the (still slight) yield curve inversion is simply a short-term visceral reaction to fears of the virus itself. Either way, though, with more warning signals flashing, LaBrecque suggests that investors need to be prepared for escalating recession risks (which suggests that the downturn may not be finished yet?).

CDC Guide On What You Need To Know About Coronavirus [Covid-19] (Centers For Disease Control) - With the rising number of coronavirus cases around the world stoking talks of a potential 'global pandemic' that is already routing markets, it's important to recognize and understand what the coronavirus itself really is (and how dangerous it is, or isn't). The coronavirus is believed to have emerged from an animal source originally but is now spreading from person to person. Notably, though, the coronavirus is not as communicable as many other diseases, with estimates that the pathogen can travel through the air (in tiny respiratory droplets expelled when we breath, talk, cough, or sneeze), but only carrying for a few feet (unlike measles, chickenpox, and tuberculosis, which can travel 100 feet, but more communicable than HIV or hepatitis transferred only via direct contact with bodily fluids); consequently, the infection rate is estimated at 'just' 2-4 people (i.e., each person who contracts the virus tends to infect 2-4 others if there are no other containment measures), which is only slightly higher than the seasonal flu or the common cold. In turn, the fatality rate for the coronavirus is estimated at below 3% (i.e., the virus only kills 3 out of every 100 people it infects), which is also only slightly higher than the fatality rate of the seasonal flu (and drastically lower than SARS that had a 10% fatality rate, or Ebola that had a nearly 50% fatality rate). Because of its similarities to the flu, prevention mechanisms are similar - staying home when sick, covering coughs and sneezing into tissues, and cleaning/disinfecting hands regularly - though ultimately the biggest preventative mechanism is simply not traveling to where the virus is currently concentrated (in mainland China, which still has more than 90% of all reported cases)... which may help to prevent a global pandemic, but unfortunately causes potentially significant economic repercussions if business-related international travel grinds to a halt.

Study: Smaller Firms Must Specialize If They Want To Grow (Bernice Napach, ThinkAdvisor) - Solo and "small" advisory firms (defined in this context as those with <$500M of AUM) are increasingly being squeezed by mega-RIAs growing scaled firms with regionally-dominant or nationally known brands, and the ever-expanding presence of digital/virtual advisors on the other, making it harder and harder for the typical firm to differentiate itself. In this increasingly competitive environment, a new study from SEI and the Financial Planning Association, aptly dubbed "Growth by Specialization", suggests that for small firms to compete in the 2020s they will have to take on a specialty as a means to create a more personalized experience (and therefore a differentiated solution) for their clients. Notably, though, the nature of specialization and choosing various types of niches goes beyond just 'traditional' niches like a particular profession (e.g., doctors or architects), as one firm specializes in ultra-high-net-worth families focusing on life planning and investing with purpose (i.e., ESG investing), while another exclusively targets Generation Y (Millennial) clients, another specializes in working with widows, and another is an expert in equity compensation and employee stock options (particularly in the technology industry where such compensation is common). Notably, the study also finds that for advisors more niche-focused, leveraging social media to market themselves is becoming increasingly common as a means to both demonstrate their specialized niche expertise to the broader marketplace, and then attract prospective clients into the firm (which in turn is necessitating the use of new/different/non-traditional digital marketing tools not currently available in the advisor community), with several of the specialist firms profiled reporting the majority of their new growth is coming from SEO, Google searches, and social media.

McKinsey's 'Two Winning Models' For Wealth Management (Michael Thrasher, RIA Intel) - A recent McKinsey consulting report on wealth management finds that the sheer breadth of consumer demands means that few advisory firms will be able to achieve enough size and economies of scale to truly be one-stop-shops that provide "everything" to the client... requiring, according to McKinsey, literally millions of clients to do so cost-effectively, such that even digital 'robo-advisor' leaders like Betterment and Wealthfront (at $16.4B and $13.6B of AUM respectively, and fewer than 1M accounts between them) may be nowhere near large enough to succeed in the new competitive environment. Yet with nearly half (49%) of wealthy clients saying they'd prefer a single financial institution to serve most/all their needs, continued consolidation efforts are anticipated (for firms trying to buy their way to economies of scale). Though McKinsey remains skeptical that many mid-market firms will 'crack' the HNW segment, and that traditional HNW firms (e.g., Morgan Stanley buying E*Trade, Goldman Sachs launching Marcus) may struggle more than they anticipate to move 'downmarket' (and instead may be better remaining focused on their ultra-HNW premium bespoke models). However, even with these challenges, McKinsey suggests that the rest of the advisor marketplace won't necessarily wither away - in fact, independent wealth managers have been siphoning off some of the most affluent clientele from wirehouses and private banks for years (now up to 13% market share, from 11% just 5 years ago). However, for 'the rest' to survive, they will have to stay more specialized and 'boutique' focusing on a small subset of more affluent clientele (which continues to be a lucrative business opportunity, as the relatively few ultra-high-net-worth clients by numbers still control nearly 60% of the industry's revenue opportunity).

Five Trends Reshaping The Advice Business (Angie Herbers, ThinkAdvisor) - The 'good' news about trends in the financial advisor industry is that, despite all the buzz of "disruption", change doesn't happen overnight (as clients don't change advisory firms often enough for change to happen quickly!). Which means that while the industry may be substantially reshaped in the coming decade, firms do have time to begin to adjust and adapt to that future reality. Key trends that Herbers suggests advisory firms should be preparing for include: Millennials are becoming a real force, as the generation is now aged 25 to 40 years old, which means they're at the age where their earnings start to rise, they start to take their finances more seriously... and they start to hit the radar screen of traditional financial advisors to provide advice services to them; the rise of Transparency is not only impacting how fees are discussed and presented to clients, but are creating "Operational Experience" expectations for clients as well, who want to be able to see the current status of everything that's being done on their behalf by the advisor firm (when trades are placed, the status of their financial plan being produced, their account being transferred, etc.); holistic advice is really, finally on the rise (with the caveat that it doesn't just mean getting 'broader' in terms of topics, but instead is also taking on more of a coaching/counseling aspect to the relationship that requires new and different skills); hybrid fee models are taking hold, where advisors begin to unbundle fees and allow clients to choose what they want to purchase (with the opportunity to generate more in total fees and protect against fee compression when clients actually want to buy 'everything' the advisor offers); and solo advisory firms are increasingly valuable as technology makes it more and more feasible to run a solo firm profitably.

The Future Is In The Long Tail (JD Gardner, Backcourt Report) - The big buzz in the advisory industry is all about reaching economies of scale, and that the firms achieving scale will reduce their costs and cause fee compression... but in practice, the biggest constraint for an advisor themselves is not scaling the costs of the business but the advisor's time (and the value of the time) itself. In this context, the Pareto principle often holds - that for an advisor, the top 20% of their clients often generate 80% of the profits. Which is important, because it means that the real opportunity isn't necessarily about trying to be "huge" and achieve scale, but instead to survive and thrive in the "Long Tail" (per the Chris Anderson book of the same name), finding a small subset of profitable clientele where the advisor can differentiate and drive success. In that context, the key to future success for an advisory firm may be about not going after the traditional million-dollar household aged 50-75 (approaching or in retirement) where the rest of the industry is, but finding 'long tail' opportunities, such as younger clientele with more specialized needs (who will ultimately be the future lifeblood of the industry anyway). In fact, the sheer number of households outside of the industry's core demographic is far larger than the small subset that has significant investable assets to transfer to an advisor today. Which in part helps to explain the rise of robo-advisors and industry consolidation (as a small base of assets times a lot of households is still a huge business opportunity). But ironically, the consumer tail is so long that the biggest problem may not be the shortage of clients to attract and work with, but that there aren't actually enough financial advisors to serve a truly broader consumer marketplace? (Which, to say the least, is an incredible opportunity for advisors who are in the marketplace today and willing to expand and serve new types of clientele!)

Sir William Osler's Advice To Students: Practice Concentrating On Hard Things (Cal Newport) - Sir William Osler was one of the founding figures of modern medicine nearly 100 years ago, and published a book entitled "Aequanimitas: With Other Addresses To Medical Students, Nurses, and Practitioners of Medicine" about how to handle the emerging burden of thriving in an increasingly-intellectually-demanding medical field. Of particular note, in dealing with the demands of learning complex information as a professional, Osler suggested to "Let each hour of the day have its allotted duty, and cultivate that power of concentration which grows with its exercise, so that the attention neither flags nor wavers, but settles with bull-dog tenacity on the subject before you. Constant repetition makes a good habit fit easily in your mind, and by the end of the session you may have gained that most precious of all knowledge—the power of work." The key point is that Osler wasn't just teaching about medicine itself, but how to be a good student to learn complex medical (or other professional) knowledge, in a world that increasingly focuses on educational content over the learning skills themselves. Per Newport's own book, "Deep Work", understanding what it actually takes to create deep focus to learn complex information is a lost art, one challenged even more in the always-on age of smartphones and social media. Though ultimately, as Osler's work shows, the challenge of being distracted from studies long predates the emergence of smartphones and social media, and the remedy is the same: allocating dedicated time blocks on a regular basis to learn in a focused manner, and exercising that learning 'muscle' until using it becomes a learning habit.

Why Are We All Working So Hard? (Milo Benningfield, Benningfield Financial Advisors) - Early on years ago in his career as a lawyer, Benningfield once had a law firm partner say to him in a hushed tone "I'd accept a 20% pay cut to work even half a day less around here"... only to express a look of preposterousness when Benningfield simply asked why she didn't go ahead and do that. And in practice, the phenomenon seems to be becoming more common, with more and more individuals in professional services working for decades to the pinnacle of their careers... and then abruptly quitting, in recognition that professionally they may have "had it all", but personally it wasn't fulfilling. Yet that divergence illustrates a stark contrast itself - "you're either on the bus or off [entirely], as far as work is concerned", in the 25-40-25 model of learning, work, and retirement. Which is surprising, as nearly 100 years ago, the famous economist John Maynard Keynes predicted, observing the ongoing improvements in technology (of the time) and productivity in his famous "grandchildren essay" that by now we'd have an 8-fold increase in productivity that would drop work to just 3 hours per day or about 15 hours per week (such that we'd no longer be 'grappling with the means of life' and instead would have more time to focus on the 'art of life' instead). So how did we succeed in Keynes' prediction of productivity, but so fail in the prediction of the 3-hour workday, particularly for those who don't either "have to" to make ends meet (at the lower end of the spectrum) or just happen to be so passionate about their work they'd do it for free anyway? Some suggest it's the "hedonic effect" (we always want more new things as the novelty of the old ones wears off), others the "Keeping up with the Joneses" phenomenon (when we all compare ourselves to each other, none of us can stop), and some that it's "network effects" that keep us bound to the system (not wanting to skip the latest thing for fear of missing out). Yet emerging research is starting to find that fewer work hours are associated with greater happiness, and can even boost productivity. Raising the question of whether Keynes was wrong about the future of our productivity, or if we just haven't had the mindset shift to recognize the positives that can come from working less?

Becoming Elite Comes From Being Just 1% Better (Tony Vidler) - Some sports champions succeed from their own personal endeavors, but most sports - and virtually all businesses - succeed on the strength of a team, which means not only having the right people on the team, but keeping them focused on the right things, and then having them do those things better than the competition. For instance, one famous world champion rugby team explained their unanticipated success as "we won because everyone on the team had the same individual goal: be 1% better at everything we have to do..." In other words, it wasn't about trying to practice and run plays to perfection, or superhuman training, or relying on good fortune, or setting massive (and potentially unrealistic) goals. Instead, they simply tried to be 1% better at everything, recognizing that it only takes 1 point or 1 goal more than the other team to 'win'. Accordingly, for instance, the team didn't train to jump 2 meters high... just 2 centimeters higher than the competition. In the context of an advisory firm, this means that firms can excel simply by getting through paperwork 1% faster, returning phone calls and emails 1% quicker, being 1% more comprehensive, etc... and setting expectations accordingly to the team (not for perfection, but continuous 1% incremental improvements). Which in turn means focusing on what it really takes to get and deliver a quality service in the first place - to ensure the firm is trying to be 1% better at the right things. Because as in sports, advisory firms don't have to be perfect to succeed in business; they just have to be 1% better than any other advisory firm at whoever they serve best to become known as "the best" at whatever they do!

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.