Weekend Reading for Financial Planners (Oct 16-17)

Authors:

Ben Henry-Moreland

Team Kitces

Ben Henry-Moreland is a Senior Financial Planning Nerd at Kitces.com, where he specializes in writing and speaking on financial planning topics including tax, practice management, and technology. He also co-authors the monthly Kitces #AdvisorTech column. Drawing from his experience as a financial planner and a solo advisory firm owner, Ben is passionate about fulfilling the site’s mission of making financial advicers better and more successful.

Read more of Ben’s articles here.

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Adam Van Deusen, CFP

Team Kitces

Adam is a Financial Planning Nerd at Kitces.com. He previously worked at a financial planning firm in Bethesda, Maryland, and as a journalist covering the banking and insurance industries. Outside of work, he serves as a volunteer financial planner and class instructor for local and national non-profits.

Read more of Adam’s articles here.

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Schwab Advisor Services Informs Its 13,000 RIAs They Must Buy E&O Insurance (Lisa Shidler, RIABiz) - Errors and Omissions (E&O) insurance is often considered an essential component for owning an RIA business. Because clients often stake large amounts of money on the advice that advisors give, the result of that advice leading to negative or unforeseen outcomes – even when the advice was given with good intentions – can be a liability judgment against the advisor that could range in the millions of dollars. Consequently, RIAs purchase E&O insurance in order to protect their own assets, while remaining accountable for the quality of advice they give to their clients. But though it is best practice (and relatively inexpensive) to own E&O insurance, it is not mandated for RIAs registered with the SEC or in most states (with the exceptions of Oregon and Oklahoma). Which means that Charles Schwab’s announcement of a new policy requiring all 13,000 users of its Schwab Advisory Services platform (including firms migrating from TD Ameritrade as a result of the Schwab-TD merger) to obtain at least $1 million of E&O coverage might be the single most impactful E&O mandate in the industry to date. Ironically, Schwab’s reasons for mandating E&O coverage for its advisors may be more related to managing its own risk… because, for example, if an advisor moves money out of a client account after receiving instructions from a hacker pretending to be the client, both the advisor and custodian of the client account could be held liable for the client’s loss. Schwab’s mandate, therefore, is about preventing loss to itself due to cybersecurity threats and money movement errors (where the advisor may have been unwittingly complicit) rather than trying to protect the advisor’s losses on account of their own advice. Though because many E&O policies cover both types of losses, advisors who decide to buy coverage as a result of Schwab’s mandate would at least be covered on both fronts. Notably, Schwab is so far the only major custodian to require E&O coverage for its advisors, other firms – like Fidelity, who recently began offering the Armorblox anti-phishing tool to its advisors for free to similarly help them protect themselves from email hackers trying to impersonate clients to commit wire fraud – are clearly thinking about the cybersecurity risks that the RIAs on their platforms pose to them, and may take notice of Schwab’s more ‘proactive’ approach.

Labor Department To Reverse Trump-Era Rules That Curb ESG In Retirement Plans (Andrew Welsch, Barron’s) - In October 2020, the Department of Labor (DOL) under then-President Trump released a regulation requiring retirement plan fiduciaries to select investments and strategies based “solely on financial considerations” rather than “non-pecuniary” goals. While not naming them outright, the regulation was aimed at prohibiting fiduciaries from considering Environmental, Social, and Governance (ESG) factors in selecting investments, and reducing the use of ESG funds in 401(k) and other retirement plans covered by ERISA. But after President Biden took office, he pledged to reverse the Trump-era rule, and so on October 13, the DOL formally announced a new proposed rule expressly allowing plan fiduciaries to consider ESG factors in their investment selection process once more. The change comes at a time when ESG’s popularity is booming among investors and fund providers, and the new rule will almost certainly lead to even more growth in what was once a niche sector of the industry. In particular, fund companies like BlackRock and Nataxis that have developed ESG-focused target-date funds could soon have the green light for those funds to be built into retirement plan investment lineups, and possibly even used as Qualified Default Investment Alternatives (QDIAs) – a retirement plan participant’s automatic investment election that they get by default, unless they opt to change it – which could truly bring ESG investing to the mainstream. Notably, the rule states that plan fiduciaries still must determine that ESG investments “equally serve the financial interests of the plan” compared to other options, meaning that ESG factors would at best serve as a tiebreaker after expected performance and risk are factored in. Still, the rule is a potentially large step toward achieving the goals of ESG advocates like BlackRock CEO Larry Fink, who profess that large-scale ESG investment will help move the needle towards reducing the global risks of climate change, political instability, and social upheaval.

SEC To Assess When 'Psychological Nudges' Become Recommendations (Mark Schoeff, InvestmentNews) - In a speech on October 12, SEC Chair Gary Gensler made perhaps his most detailed comments to date on the risks he believes are posed by the Digital Engagement Practices (DEPs) used by ‘digital finance platforms’ (i.e., tech-savvy online brokerage platforms) like Robinhood. While it has long been clear that the SEC plans to look into the use of behavioral nudges like the ‘gamification’ of trading – the SEC also just wrapped up a request-for-comment period on regulatory concerns for DEPs – Gensler’s comments elaborated further on what he sees as the most important potential issues as digital platforms use their ‘machine learning’ power to increase their ability to predict and more importantly influence investor behavior. Most notably, he touched on the potential conflicts of interest inherent when a digital platform develops its algorithms to optimize its own revenue when suggesting trades to an investor, rather than the investor’s returns. Because, though the SEC has yet to formally decide on the line at which digital platforms’ behavioral nudges turn into formal recommendations (rather than simply executing unsolicited self-directed trades), or in the extreme full-on ‘investment advice’, that determination could potentially subject investment recommendations from platforms like Robinhood to the SEC’s Regulation Best Interest rule (which requires broker-dealers to make recommendations in the client’s best interest), or even an RIA’s fiduciary duty if the nudges are deemed ‘advice’. And, as Gensler suggested in his comments, even if DEPs do not ultimately meet the definition of recommendations for soliciting trades or outright investment advice, the SEC could consider additional regulation specifically targeted at brokerage apps to address the potential conflicts that they pose. Meanwhile, as the SEC hints that digital investment platforms could be subject to additional regulation, Robinhood hinted in a letter of its own that such regulation would be challenged in court (presumably by Robinhood), setting up the stakes in what could be a drawn-out battle between the fast-moving technology company and the regulator that is still trying to get a handle on how to address a rapidly changing industry.

Fee-Only RIAs Are Crushing It When It Comes To Growth (Kenneth Corbin, Barron’s) - Despite being dominated by the uncertainty of the pandemic, 2020 saw double-digit percentage increases in both the number of fee-only investment advisory firms (15%) and the assets managed by those firms (22%). And while some of the AUM increase can be explained by the year’s strong stock market performance, the increase in the number of fee-only firms (especially compared to ‘hybrid’ firms with other compensation models, which increased by only 8%) indicates that new firm owners saw it as an especially good time to enter the industry with (or transition from an existing broker-dealer to) a fee-only RIA model. What’s also notable from the research is that the fee-only firms were also able to add more high-net-worth clients than the hybrid firms, and did so despite the larger increase in new firms competing for those clients… revealing that especially high-net-worth consumers are increasingly showing a preference for the fee-only RIA model versus those who are dually registered to offer advisory accounts but also still do brokerage business as well. Which is happening despite the competitiveness of the financial services industry, as RIAs are still managing to successfully move farther “upmarket” towards even wealthier clients, drawing even more new advisors and existing brokers into the RIA channel. However, the trend of HNW clients increasingly working with RIAs also raises questions about whether the RIA channel is too focused on working with HNW clients… or if the reality is simply that there aren’t enough RIAs to serve the investor demand, such that the most affluent clients are ‘outbidding’ the rest and existing RIAs are simply limited in their capacity to serve a broader marketplace?

Flat Fee Models Can Keep Clients Around Longer (Sam Del Rowe, Financial Advisor IQ) - For over two decades the AUM model has been the standard model for fee-only advisory firms, often promoted as an alternative to the previously dominant commission model as a fee structure that was more aligned with the client’s interest (because the advisor ‘wins’ and can earn higher fees by growing the client’s wealth, either through higher savings and/or investment returns). However, as many advisory firms have increased their focus on financial planning while outsourcing the investment management process to technology, the AUM fee has itself come under criticism in recent years for being misaligned with the value that the advisor is actually providing, which is driven more and more by financial planning advice and is often largely unrelated to the size of the client’s portfolio. Consequently, some firms now use a flat-fee model, such as a monthly retainer, to differentiate themselves and focus their value proposition around financial planning. Among the benefits to clients of flat fees are predictability, transparency, and accessibility for individuals who cannot meet the investment minimums typically imposed by AUM-based firms. For advisors, on the other hand, the flat fee allows for a clearer explanation of the advisor’s value, and avoids having to justify changes in their fees based on market movements. And even though strong market growth over the past decade has incentivized many firms to stick with the AUM model, the increase in awareness and popularity of flat fees among consumers means that other firms may see the flat fee model as an opportunity to attract a new generation of clients, who, like the generation before them, demand a new alternative to the established model that is more aligned with their interests.

Advisors Should Charge More For Retirement Spending Advice (Ginger Szala, ThinkAdvisor) - Financial planners often divide the lifetime of an individual into two phases: accumulation (during which the individual earns income from working and saves money toward retirement) and decumulation (when they stop working and live partially or entirely off of withdrawals from their portfolio). These two phases often have their own distinct concerns, complexities, and risks, but most planners charge the same (AUM) fees for their advice no matter which phase their clients fall into. Two recent developments, however, have caused a dislocation in the value of advice for individuals who find themselves in the accumulation or decumulation phases. First, the commodification of building and managing well-diversified investment portfolios (including the rise of automated ‘robo-advisor’ platforms) has made planning for the accumulation phase simpler, as individuals can now set up a semi-customized investment portfolio and automatic contributions to their accounts with a few clicks of a mouse. Conversely, the decumulation phase has gotten more complicated, as individuals work longer into their ‘retirement’ years, manage withdrawals from multiple account types (e.g., Roth and traditional IRAs), and face key decisions such as when to claim Social Security. As a result, advisors may need to more fully consider the value they are providing to clients in each phase, and reconsider how that value aligns with the fees they charge. Because, while many younger individuals might be content with using a robo-advisor to manage their retirement savings, retirees starting their decumulation phase face more complex decisions than a robo-advisor can manage, where the cost of a mistake could make a significant difference to their chances of a successful retirement… a fact that may be comforting to advisors who worry about the rise of robo-advisors leading to ‘compression’ of their advisory fees and profitability (as it suggests that the additional complexity of retirement decumulation means advisory fees could rise in the future!)!

Media Coverage Of Social Security Could Affect Claiming Age (Emile Hallez, InvestmentNews) - The annual release of the Social Security Board of Trustees’ report outlining the current state of Social Security and projections for its future solvency generally leads to a flood of headlines regarding the potential depletion of the Old Age and Survivors Insurance (OASI) Trust Fund (used to pay out Social Security benefits for seniors). Media coverage of the Board’s 2021 report fits this pattern, emphasizing that the OASI Trust Fund is now projected to be depleted in 2033. With this reaction in mind, researchers at the Center for Retirement Research at Boston College tested whether headlines regarding Social Security’s solvency could impact individuals' decisions on when to claim Social Security benefits. The researchers ran an experiment where workers were shown the same article describing the Board of Trustees’ report, but with different headlines describing the projections for the OASI Trust Fund. The study found that those who were given a headline that mentioned the year the Trust Fund would be depleted said they would elect to receive benefits a year earlier than those shown a headline without a date for the shortfall. In addition, those shown a headline with both the projected date of the Trust Fund’s depletion and the amount of benefits Social Security would be able to pay at that time based on ongoing revenues (currently projected to be 78% of payouts in 2033 absent any policy changes) had a more accurate view of the reduced level of benefits they would be projected to receive than those who were given less detailed headlines. Ultimately, the experiment demonstrates the importance for financial advisors of accurately framing potential changes to Social Security benefits (including why possible benefit reductions discussed in the media might be overstated!) to help clients understand the news they read and make better claiming decisions.

Should You Include Social Security In Your Financial Plan? (Tolerisk Blog) - Social Security benefits are a significant source of retirement income for many Americans, and an important part of financial planning projections in retirement. The projected depletion of the Old Age and Survivors Insurance (OASI) Trust Fund in 2033 might lead some clients (particularly those who have many years until retirement) to consider whether they will receive the full amount of their projected Social Security benefits (or wonder about the risk that they will even receive any benefits at all). Yet, there are many potential actions the government can take to help shore up the Social Security system, only some of which would reduce benefits for current (or near-current) retirees. Potential actions include increasing the retirement age for younger workers, increasing the cap on wages on which Social Security is taxed, increasing the percentage taxed on wages to pay for Social Security, decreasing current or future planned benefits, and further means-testing benefits. And while these actions have not yet been implemented, financial advisors can include them in financial planning scenarios for clients to demonstrate how they would affect their individual situation. For example, an advisor working with a younger client could extend their Full Retirement Age (FRA) past the current FRA (67 for those born in 1960 and later) to age 68, 69, or 70. Also, advisors working with clients who are projected to have significant taxable income in retirement (from investment income, Required Minimum Distributions (RMDs), or other sources) could exclude Social Security benefits from the projection to model potential Social Security means-testing. While future changes to Social Security benefits are unclear, advisors can add significant value for clients by educating them on the current status of the Social Security program, including what changes it would – and wouldn’t – take to keep Social Security on track, which clients can then plan for.

Fewer Retirees Are Claiming Social Security At 62 (Mary Beth Franklin, InvestmentNews) - An individual’s decision on when to begin claiming Social Security retirement benefits can be based on a variety of factors, including their desire (and ability) to keep working, savings, life expectancy, and a spouse’s Social Security benefits. For those who can, delaying Social Security benefits can be a lucrative strategy, and now recent research has shown that more workers are taking advantage. The percentage of individuals claiming Social Security at age 62 (the earliest possible age) has been generally declining for decades (even as the raw number of people claiming at age 62 has increased due to those in the Baby Boomer generation reaching retirement age) to the point that in 2019, out of all individuals who claimed Social Security retirement benefits that year, only 34% of women and 31% of men were age 62. Researchers from the Center for Retirement Research at Boston College found that this effect is even more pronounced when considering the percentage of individuals born in a given year who claim benefits at age 62, with only about 25% of eligible individuals who turned 62 in 2019 claiming benefits in that year. The researchers also found significant declines in the percentage of 62-year-olds claiming benefits from 1997 to 2019, with only a brief and slight increase during the 2008 Financial Crisis/Great Recession, and do not expect the 2020 pandemic-induced recession to have a major impact on the downward trend. In fact, financial advisors might find some clients taking advantage of newly expanded remote work opportunities to further delay claiming Social Security and reap the rewards of increased future benefits!

The Curse Of Off-Hours Email (Laura Giurge and Vanessa Bohns, The Wall Street Journal) - Smartphones have made it easier to stay connected to work outside the office and beyond normal business hours. However, this convenience can come at a cost of increased stress and potential burnout, particularly for those who think they must act on emails received after hours. One stressor for these individuals is deciding which emails require an immediate response, and which can be put off until the next workday. And in practice, research by Giurge and Bohns has found there is a mismatch between the perceived need for an immediate response by the sender and the extent to which the recipient thinks they need to respond quickly to an off-hours email. Specifically, the researchers discovered that those sending emails often assumed that those receiving the emails would recognize that a response was not urgent, while those receiving the emails thought an immediate response was more necessary than it was in reality. And while many individuals are used to applying an “urgent” label to emails that require an immediate response, Giurge and Bohns found that explicitly mentioning in the email that a response was not required until the next business day eliminated the urgency bias the recipients felt. For financial advisors emailing with colleagues or clients, whether during office hours or otherwise, being clear on the urgency of a response can clear up confusion and create a healthier office culture. Advisory firm owners can also consider whether making themselves “accessible” rather than “available” at all hours would improve their (and their employees’) productivity and well-being!

Email Is Making Us Miserable (Cal Newport, The New Yorker) - Email has become a part of everyday life and can take up a significant portion of a given workday. Yet the convenience of email can come at a cost, and research demonstrates that an individual’s stress increases the longer they spend on email during a given hour during the day. Email can even ruin vacations, regardless of whether a worker is expected to check email during their time off, because the mere awareness that there are messages waiting somewhere can trigger anxiety. And while there are a number of ‘hacks’ that can be used to better manage email, Newport advocates for methods that can reduce the need for email in the first place. One way to reduce reliance on email is to use shared project management systems (e.g., Asana, Trello, and Flow) that show the status of projects and who is working on them. Another potential method to reduce email use is to set periodic “office hours” where a technical expert answers questions all at once for clients, rather than receiving sporadic emails throughout the week or month. Advisory firms could also consider creating email accounts for certain tasks or clients, that are monitored by a range of employees, to reduce the anxiety created for an individual who is solely responsible for responding to an email (e.g., a standard “[email protected]” email address for top clients to use). The key point is simply that advisory firm owners who adopt these tactics for their firms might find that they reduce stress and improve productivity for both themselves and for their employees not by being more email efficient, but less email reliant in the first place!

How To Spend Way Less Time On Email Every Day (Matt Plummer, Harvard Business Review) - With the average American worker receiving 120 email messages and spending more than 2.5 hours per day dealing with them, creating efficiencies in reading and processing email can result in significant time savings. Individuals can turn off email notifications and check email hourly to reduce the number of interruptions when new emails come in. Another tactic is to move every email out of the inbox and into folders the first time it is read, to avoid the temptation of reading the email again the next time the inbox is checked. Plummer also suggests setting up just two folders to archive emails (one for emails that require action, and another for items to read later), and using the email program’s search functionality to be able to find old emails rather than taking the time to search through multiple folders to find them. Finally, individuals can use automatic filters and spam blockers to avoid the time needed to process irrelevant or less important emails. Plummer and his team found that by implementing these tactics, time spent on email can be cut by more than half. For advisors facing a flood of emails, creating more efficient email processing can allow them to spend less time on email, and more time on tasks that require cognitive focus and concentration or even free time with friends and family!

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 Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.