Weekend Reading for Financial Planners (July 25-26)

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 July 25th/26th:

The Countdown For DOL To Advance Its Fiduciary Rule Ticks Loudly (Mark Schoeff, Investment News) - This past week was the deadline for comment letters to the Department of Labor on its proposed fiduciary rule, and the DOL received a whopping 775 comment letters from both individuals and organizations. Now, the DOL needs to take all the feedback in, prepare for three days of upcoming public hearings in August (the next stage after the public comment period), and begin to make adjustments (as secretary Thomas Perez has said, the goal is to implement an enforceable best-interests standard, but the DOL is open to making adjustments to the final rule). And making adjustments itself is challenging, as if the adjustments are "too" significant, it will require another public comment period for feedback, which just delays the process of implementation further. And all of this must be done with the clock ticking over the next 18 months until the end of President Obama's term, which many industry commentators believe is a crucial deadline for the DOL to meet, or risk being derailed by the next administration. Nonetheless, with significant White House backing, the DOL does appear intent on trying to implement the rule, suggesting that the dynamic has shifted from "whether" the rule will be implemented, to just the details of "how" at this point, especially on key points like disclosure requirements, data retention, and when exactly (i.e., in what circumstances)  the "best interest contract" must be signed by clients. Still, even as the Financial Planning Coalition supports the rule, along with pro-consumer groups like the Consumer Federation Of America, critics abound as well, from the Investment Program Association that represents non-traded REITs (and suggests the rules should be expanded to allow them), to the Investment Company Institute that cautions the DOL rule could extend fiduciary duty 'too far' to mere websites and call centers, to NAIFA and the Insured Retirement Institute that complain the rules would limit variable annuity sales. And some question lingers as to whether industry groups like SIFMA might even challenge the rule in the courts as a last resort to keep it from being implemented.

MLPs Yield Headaches For Advisers Who Bought Them For Income (Trevor Hunnicutt, Investment News) - Energy-infrastructure investments structured as Master Limited Partnerships (MLPs) have been popular for yield-starved clients in recent years... even though the decline in energy prices is leading to a bear market for MLPs this year, where yields often exceed 6% but the whole energy limited partnership category is down over 15% year-to-date. In fact, the average oil-and-gas midstream company is actually experiencing negative free cash flow over the past 12 months, an ominous signal for what is classically an income-cash-flow-paying investment. And the declining cash flows of MLP entities is not only a risk to their ability to keep paying income, but their ability to sustain as business at all, as there are some indications that the high-yield bond market may be pricing in a risk of outright defaults in parts of the energy sector, which could ripple through to MLPs. In addition, there are concerns the whole industry has become 'overinvested', with a whopping $10.5B of new flows coming into MLP-related mutual funds and ETFs in just the past year, leading some companies to use the 'cheap' capital to invest into projects that may not be fruitful. On the other hand, MLP advocates suggest that if/when/as interest rates rise, and access to other capital gets more difficult, the investments that MLPs have been making will pay off, and that relative to other asset classes that may be even more overvalued, MLPs still have at least cheap relative valuation. And from a broader perspective, the increasing dominance of the U.S. in producing natural gas and oil may mean long, continued demand for energy distribution infrastructure for a long time to come.

Longevity Credits: The Time To Act Is Now (Tom Hegna, LifeHealthPro) - As Baby Boomers continue the en masse transition into retirement, the annuity industry is seeing record sales of immediate annuity income products, with sales spiking 17% in 2014 (to $9.7B of purchases). However, last October the Society of Actuaries released a report recommending that it's time to implement the new RP-2014 mortality tables, which will replace much older mortality from the year 2000. The difference between the two is that life expectancy of 65-year-olds has increased almost two full years over that time period given medical advances, which in turn may result in a significant haircut to annuity payout rates starting next year. Hegna also notes that more broadly, as boomers age and an increasing number buy lifetime annuity solutions while fewer and fewer keep their life insurance (where the latter helps to hedge the former for insurance companies), payout rates may be further adversely impacted in the coming years. Of course, a potential for interest rate increases in the future could help to boost future payouts as well, but for the time being interest rate increases remain uncertain, while the new RP-2014 mortality tables (and the reduced payments associated with them) do appear to be coming next year.

Retirement Income: Smart Tax Strategies (Ed Slott, Financial Planning) - Tax planning in retirement often revolves around two key issues: the taxation of IRAs (especially at Required Minimum Distributions begin at age 70 1/2), and the taxability of Social Security benefits as income increases. The interplay between the two can be especially challenging - for lower-income individuals in particular, it's actually the income triggered by RMDs that causes the Social Security benefits to rise above the provisional income thresholds that trigger taxation of those benefits. Accordingly, some advisors might actually look to begin tapping IRA dollars in modest amounts earlier in retirement, to reduce the size of the 'forced' distributions later, especially if this is done while Social Security benefits themselves are being delayed; of course, the caveat to this strategy is that if the client doesn't live long enough, delaying Social Security and then only getting a few payments will result in a financial loss for the client, taxes notwithstanding. For those who are younger, the alternative workaround is to begin doing partial Roth conversions earlier on, utilizing low tax brackets in any years they are available to whittle down the size of the IRA, which can reduce the tax consequences of IRA distributions (or RMDs) in retirement but without being forced to delay Social Security in a manner that may be undesirable for those with poor health.

RIA Profits, Revenues Hit Record Highs (Charles Paikert, Financial Planning) - The latest Schwab RIA Benchmarking study is out for 2015, and the results are very positive. Nearly half of the 1,000 firms participating in the study have doubled revenue since 2009, and profitability has increased as well, with the median firm enjoying a 27% operating margin. In addition, the study found RIAs have been increasingly successful at higher net worth levels in particular; the average RIA's account size is now a whopping $1.9M, with the top-performing firms averaging $3.9M; notwithstanding the growth, though, the opportunity for RIAs to grow further is still significant, with RIAs controlling only an estimated 7% of the market for high-net-worth assets. In addition to serving larger households, an increasing number of RIAs are also adopting formal client segmentation strategies to profitably serve multiple tiers of clients as well. In the meantime, though, the slow-motion demographics challenge of the industry is taking its toll on RIAs, and a whopping 1-in-4 RIAs now report that recruiting is a leading priority in 2015, with firms most commonly hiring either client relationship managers or investment professionals to help continue driving growth; as firms grow larger, 10% are also looking to add dedicated management to focus on running business operations (and a Chief Operating Officer is now employer at nearly half of all firms with more than $1B of AUM). Notwithstanding the strength of the RIA marketplace, though, Schwab warns that the greatest risk for RIAs may be complacency about how good it is right now, noting that RIA growth has been fueled in part by the strong bull market of the past 6 years, and that continued reinvestment into technology (e.g., "robo-advisor-for-advisors" solutions) will be critical for RIAs to maintain their competitiveness in the future.

Breaking Away—When the Wirehouse Wants You to Stay (Jane Wollman Rusoff, Research Magazine) - As the trend of "breakaway brokers" going independent increases, and the market share of wirehouses continues its fall from 47% in 2007 to 42% in 2013, wirehouses are stepping up their efforts to retain advisors. The pain for wirehouses started in the global financial crisis, when for many advisors the wirehouse brand become a liability instead of an asset, and existing deferred compensation plans laden with employer stock become less valuable as the financial sector tumbled; in response, wirehouses offered extensive multi-year retention bonuses at the time to keep brokers from jumping ship, but now those agreements are expiring. In fact, the expiring bonuses is viewed as the primary reason that the major wirehouses have been increasing the amount of advisor compensation that is paid as deferred compensation and/or subjecting advisors to tougher production requirements to get at it - to make it more 'expensive' for today's brokers to consider walking away as their other retention bonuses wind down. Notably, though, the focus from the wirehouses has generally been on the biggest producer teams, while the smaller ones are getting little or nothing in the way of bonuses or retention offers. At the same time, though, the largest teams also tend to be the most sophisticated, and appear to be the ones most resenting the increasing wirehouse shift towards mandatory-deferred compensation packages. Other incentives that wirehouses are offering to keep advisors include beefed-up succession planning programs (giving nice 'retirement' payouts to those advisors, but only those who leave the industry, not just the firm), expanded team-based approaches (which are popular in independent channels to serve clients more comprehensively, but are also being encouraged by wirehouse management because it's harder for an entire advisor team to leave and take clients than just an individual, and the team can retain clients if one individual breaks away from the team), and even legal threats (although complying with the Broker Protocol provides a path out for brokers who follow it to the letter). On the other hand, it's worth noting that relative to the overall size of the wirehouse channel, the breakaway broker 'trend' is still more of a trickle than a waterfall, and many wirehouses are actually boasting record-low attrition rates in today's environment.

The Dos and (Compliance) Don'ts of Client Events (Elizabeth McCourt, Financial Planning) - Client appreciation events are a popular strategy for advisors, operating under the basic idea that if the experience is exceptional, clients will become so bonded to the firm that it's easily worth the investment to conduct the event. For some advisors, client events are not only an opportunity to more deeply engage with clients, but can be a chance to create a connection with an otherwise-less-engaged spouse as well. Notably, events are not only a means to deepen relationships with existing clients, but can still be an opportunity to reach new clients as well, though in a world where direct-mail seminar dinners are grossly overdone, advisors marketing in this manner are often focusing on smaller, higher-end, more intimate prospecting events. However, be cognizant that compliance issues can significantly complicate client events, especially for registered representatives of broker-dealers, thanks to FINRA Rule 3220, which limits noncash compensation in excess of $100/year to any person related to the broker where the payment relates to the business being conducted; as a result, some brokers are compelled to charge clients for the event (to bring the net cost down under $100/person/year), which greatly diminishes participation (not to mention changing the perception of the event for the client). On the other hand, there are exceptions under FINRA Rule 3220 for "an occasional meal... ticket to an event... or comparable entertainment that is not so frequent nor extensive as to raise any question of propriety" and as a result the compliance 'hassles' of an event may vary by the interpretation the compliance department takes regarding the rule.

Cybersecurity: Hitting A Moving Target (Bill Winterberg, Journal of Financial Planning) - In April, the SEC issued its IM Guidance Update No. 2015-02 on cybsecurity for investment advisers, a three-page brief urging RIA firms to periodically assess their cybersecurity risks, identify how attacks will be detected and responded to, and implement a strategy with written policies and procedures and staff training to combat the issue. However, Winterberg critiques that the SEC's guidance is too broad, and falls short of the day-to-day realities that advisors face, offering his own tips and strategies for what advisors should consider when it comes to cybersecurity. Key issues include: because our worlds revolve around passwords, and weak passwords are the lowest hanging fruit for attackers trying to gain access to sensitive client data, use an enterprise password manager like LastPass, 1Password, or Meldium, and activate two-factor authentication (where you must log in using a password and a code that is sent to you via text message) on any/every site you use where it is available; send client documents using a secure vault, and not just via email as a password-protected PDF (they're not really that secure, and a simple tool from Elcomsoft for $49 can hack most of them easily), and certainly be cautious not to send any sensitive client information in the body of an email to the client; be cautious to check whether the sites you're visiting are secure (the website address at the top of your browser should start with HTTPS:// instead of just HTTP://) for any sites that request secure information; and beware of "social engineering" strategies, where hackers try to get sensitive client information not by "hacking" into your computers, but simply by trying to fool your staff with a realistic-sounding-but-urgent "client" request that won't be discovered until it's already too late (an especially popular technique for thieves trying to commit wire fraud against your clients). Winterberg also suggests engaging third-party vendors to conduct cybersecurity assessments (and even training for your team).

SS&C's First Big Act As Advent Software's New Owner Is To Put RIAs Using Axys And APX Under Black Diamond (Brooke Southall, RIABiz) - After years of 2,000+ Advent Axys users continuing to run the 'legacy' system even as Advent had acquired RIA-centric Black Diamond portfolio performance reporting software in 2011, the company is finally beginning a process of transitioning RIAs using Axys over to Black Diamond's BlueSky solution, in an initiative instigated by Advent's new owner SS&C and which will be run by the popular RIA-friendly Black Diamond executive Dave Welling. Notwithstanding the announced initiative, though, Black Diamond has yet to actually communicate what the path from Axys to Black Diamond will be and how burdensome it will or won't be to implement, an issue that has challenged the company and limited migrations from Advent to Black Diamond for years. Still, industry experts widely acknowledge that Black Diamond has superior client reporting capabilities, and its web-based infrastructure trumps the third-party integration capabilities of the existing Axys server-based systems. And the presumption is that if Black Diamond can make the Axys migration path reasonable, it will still be the easiest place for existing Axys users to go, allowing the company to retain those RIAs against competitors like Orion Advisor Services and Tamarac. From the broader industry perspective, though, the most notable thing about SS&C's decision to drive the migration of Axys users to Black Diamond is simply that the company is willing and interested in reinvesting into the RIA and wealth management environment, and not just focusing on its existing focus on solutions for hedge funds.

5 Smart Tech Tools for Advisors (Dave Grant, Financial Planning) - As a technology-centric financial advisor, Grant provides a list of some recent advisor technology tools he's been checking out that may be of interest. Potential solutions include: Advizr, a financial planning software that is trying to differentiate from larger competitors like MoneyGuidePro, eMoney Advisor, and MoneyTree by focusing on simpler planning situations, and offering tools where clients can input data themselves, aggregate accounts, and even view a preliminary plan, making the plan delivery process for advisors more efficient (though so far, Grant is waiting for Advizr to add more third-party integrations with other providers before making a leap); Schwab's Institutional Intelligent Portfolios (also known as "Schwab Blue"), the advisor version of its direct-to-consumer Schwab Intelligent Portfolios "robo-advisor" platform that amassed $2.5B in AUM in just the first few months; MyPlanMap, a tool that aims to automate the process of working with clients after the initial planning meeting, with tools to help create custom client agendas, to-do lists for the client (and advisor), built around a timeline that shows clients what needs to be done by when (and what's been done); Twenty Over Ten, a new advisor website design company that focuses on creating advisor websites that are mobile responsive (i.e., easily viewed on mobile devices) and more visually appealing than many of the 'traditional' templated advisor website solutions; and ClickDesk, an on-website chat program that gives visitors to the site an opportunity to contact the advisor directly, on the spot, to begin a conversation as a prospective client (which is then archived in an email after the fact for compliance purposes) while limiting the amount of time the advisor has to invest into the discussion if it turns out the prospect isn't qualified.

Why SigFig Is Shifting Its Focus To Using Banks As Middlemen Despite Having Captive Consumer Audience With $350 billion (Kelly O'Mara, RIABiz) - The "robo-advisor" SigFig has built a platform that is analyzing a whopping 2 million users with over $350B of assets loaded into the analytics platform, yet its Wealth Management division has only managed to generate fees from 0.05% of those assets, or about $69M of actual AUM. Sha claims the challenge is that actually the company has tested a more direct outreach to users to see if they would convert assets to management, and that the interest was so overwhelming, the company has slowed its asset management to find a more scalable path to implementation. Whether due to limited willingness of consumers to convert assets, or the company's efforts to "slow the growth", founder Mike Sha is now looking to pivot his company's solution to work with existing financial services firms, as the growing interest in "robo" technology has led to "skyrocketing" interest from big banks looking to partner and who can more readily implement the asset management opportunities SigFig claims it can deliver. Nonetheless, some industry analysts are skeptical that SigFig can really deliver, noting that there's still a huge difference between a free analytics app (which for SigFig is often embedded on reputable existing platforms like Yahoo and CNN), and actually getting people to transfer money and pay for advice or management. And ultimately, it remains to be seen whether partnering with a large bank or other institutional partner will really allow the robo-platform to monetize more effectively in the B2B channel, give its lackluster AUM thus far in the world of B2C.

Wealth And Personality: Can Personality Traits Make Your Client Rich? (George Nabeshima & Martin Seay, Journal of Financial Planning) - Using data from the 2010 Health and Retirement Study (from the Survey Research Center at the University of Michigan), the researchers tested for relationships between personality traits and net worth. The results found that, in addition to 'typical' demographic results found in other studies (married couples tend to have higher net worth than single individuals, net worth tends to increase with age and education, and racial minorities are correlated with lower levels of net worth), personality traits have a small but material impact on net worth as well. In particular, extroversion and conscientiousness were positively associated with higher levels of net worth, while agreeableness was actually associated with lower levels of net worth. The extroversion result is consistent with other studies that have also found higher levels of extroversion tend to be associated with greater income (and notably, extroverts also tend to have higher levels of risk tolerance and may therefore compound greater wealth over time). The relationship between conscientiousness and wealth is also logical, as the trait includes tendencies like being organized, responsible, hardworking, self-disciplined, and thrifty). The finding that agreeableness was negatively associated with net worth was somewhat more surprising, though it may be because high levels of agreeableness tend to spend more (and/or give more money away). Ultimately, as noted earlier, the effect sizes of these personality traits (i.e., the magnitude of the net worth impact of having these traits) was statistically significant but not 'huge', implying that they are not solely determinative of future wealth, but their measureable impact is arguably notable nonetheless.

How To Make Managing Your Money Less Scary: Do It Over Eggs And Bacon (Natalie Kitroeff, Bloomberg) - This article is a profile of Pamela Capalad, a 29-year-old financial planner who runs an advisory firm called "Brunch & Budget", which as the name implies is a business where Capalad starts working with clients on their budgeting issues over brunch. The idea is to make the process of financial planning less intimidating and more comfortable for clients, by getting started in an environment that is more casual and relaxed than a traditional advisory firm office, sitting across a conference room table. For the initial meeting, clients pay a modest upfront fee ($50 is the minimum), plus covering the cost of brunch (for the client and the advisor). While the setting is casual, though, Capalad still engages in a focused financial planning process, including familiar life-planning-style questions (e.g., "What's important about money to you?"), and using account aggregation information (viewed on an iPad at the table) to look over the client's budget and do some planning and advice delivery on the spot. In just over 3 years since launching the service, Capalad has picked up 95 clients, and notably a whopping 79 of them are of the 'elusive' Millennial generation, who seem to respond especially well to the service.

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!

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.