Weekend Reading for Financial Planners (Apr 13-14)

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.

(Editor's Note: Want to see what I'm reading through the week that didn't make the cut? Due to popular request, I've started a Tumblr page to highlight a longer list of articles that I scan each week that might be of interest.You can follow the Tumblr page here.)

Weekend reading for April 13th/14th:

How BrightScope Plans To Publicize RIA Advisory Fees Fairly - This RIABiz article discusses the recent BrightScope announcement that they plan to start including RIA advisory fees on their public Advisor Pages later this year, drawing on the data that firms are already required to disclose on their Form ADV, so that consumers can get more perspective on what a firm charges and make more effective comparisons. Of course, the caveat to this is that some firms have a lot of different fees and layers, from AUM and wrap and retainer fees, to bundled fees to separately unbundled financial planning fees, and a range of potential operational/implementational fees from custodians to transactions; as a result, it's not clear how comparable the fee disclosures will really be, and critics suggest that it may just be too complex to really be useful or feasible. And of course, some firms disclose the details of their fee structure much more clearly on the ADV than others - which introduces the risk that firms which obfuscate fees may come out ahead looking cheaper. Nonetheless, BrightScope suggests that just because the matter is confusing and complicated doesn't mean that it shouldn't be addressed; to the contrary, if it's so complex, then shining a light on any of it may help, and even put pressure on the industry regulators to improve the required fee reporting and disclosures further.

Advisers Get More Tactical - This week, Cerulli Associates released their latest research on investment trends for advisors, and found that they have been migrating away from buy-and-hold in droves and adopting more tactical strategies; in fact, the results found that nearly half are employing some form of tactical portfolio management, while tactical strategies didn't even register amongst respondents just four years ago. Notably, the details of how tactical strategies are applied varies significantly; the majority have a strategic baseline allocation with a tactical overlay, while a smaller subset of advisors say they are "strictly tactical." One advisor is using stop orders to limit losses more actively, and is changing his traditional bond allocation to deal with the low-yield environment; he's also managing equity risk by buying higher-yielding dividend stocks. On the other hand, the article notes that with the strong bull market run for the past several years, some institutions that had gone more tactical are already beginning to shift back towards buy and hold, and that in general people tend to turn more tactical after it's already too late (i.e., after the risky events have already happened). Cerulli ultimately notes that the point isn't just that advisors are going tactical, but how they're doing it, and that an asset manager or professional research team might be better suited to apply tactical strategies than just relying on an internal decision-making process.

Chip Roame Imparts Wry Skepticism At Tiburon CEO Summit - This RIABiz article reviews the recent Tiburon CEO Summit in New York City, and in particular industry guru Chip Roame's keynote session to the 200-plus CEOs and executives of a wide range of firms that serve advisors. The core message of his session: "The advisor channel is still the fastest-growing - that's why people are flooding toward it." At the same time, Chip noted several key points, including: the advisor marketplace is still remarkably fragmented, with no firm holding more than 1% market share; ETFs are booming, along with index mutual funds, and managed ETFs are booming as well, but it may still be a decade or more before ETFs surpass mutual funds, if they ever do; independent broker-dealers are on the rise, with a wide range of focus from serving as an alternative to RIA custodians, functioning as TAMPs, or developing proprietary products; do-it-yourself discount brokerage is still growing as well; the breakaway broker trend is overblown, as losing $50 billion of outflows is still trivial compared to their $5 trillion base; and a rising (and more intelligent) focus on women's issues for both female advisors and female clients. On the other hand, Roame was notably negative in several areas, including separately managed accounts, fixed annuities, commingled trust funds, structured notes, limited partnerships, and money market funds. Be certain to read to the end of the article for a great highlights summary of Roame's top 35 key points and trends.

Merrill Bulks Up Training - This Research Magazine article highlights how Merrill Lynch has been completely revamping its training program to develop new financial advisors - creating an environment that looks entirely different than the wirehouse training programs of old, an an effort to create "the Ivy League of financial advisor training." So what's changed? Years ago, Merrill trainees went through a 6-week development program at the national headquarters, followed by two years of salaried training at a branch, for which there was a high degree of variability in success and outcomes; by contrast, the program is now 43 months long, and has executives for each of 11 geographic markets driving training consistency. And Merrill is no longer placing an emphasis on hiring people with sales experience, but instead is simply focusing on finding high achievers who can cope with rejection, have a strong work ethic, and an appetite to take risks of trying to build an advisory business, and putting them through training to become a financial planner - in fact, the CFP certification is now a requirement of the curriculum. Although the program is still being developed, last year an unprecedented 68% of advisor trainees hit their production goals; in fact, Merrill is trying to avoid the traditional "throw new hires against the wall and see what sticks" approach and instead is focused on hiring people who can succeed and giving them the tools and training to do so, with training adapted accordingly (e.g., someone with advisory experience has a different training focus than someone with no investment experience at all). There's even a focus on personal health as a part of the curriculum. The article wraps up with profiles of 3 Merrill trainees who have been finding success in the program, but the real point of the article is that if Merrill Lynch is figuring out how to produce thousands of new advisors with a high-quality advisor training program, clear career path, and large firm resources, it could significantly impact the advisor landscape in the coming years.

Ready For Takeoff - In Financial Advisor magazine, technology consultant Joel Bruckenstein reviews TradePMR, a custodian that serves independent and hybrid RIAs, and is rapidly growing - from 300 advisors in 2009 to 563 in 2010 to over 1,350 today. What's notable about TradePMR is its use of technology, including their upcoming release of Fusion later this year, which Bruckenstein notes is "the most impressive custodial interface [he's] ever seen" that was built from the ground up for use on both Windows 8 touchscreen PCs and all touchscreen mobile devices (although it performs fine on "normal" non-touch Windows operating systems, too). The software itself is accessed via a web browser or a Windows application to connect to TradePMR's technology cloud. Notably, Fusion was also built with a software API that should make it significantly faster and easier for the platform to be integrated with other advisor applications, such as creating a prospect record in RedtailCRM and having it turn seamlessly into a client in the Fusion software as well. The TradePMR platform is also built with other efficiencies that may be helpful, such as the ability to view all clients within the practice (across multiple advisors) and then share the model portfolios across multiple advisors (which can then be executed, rebalanced to, or traded efficiently with baskets), or evaluate portfolio analytics across the practice (or for specific advisors or clients) from asset allocation to trading activity to fees and more; notably, this is all available within the custodian's software itself, not merely for data download into third party portfolio reporting software. Another benefit of Fusion is that workflows between the advisor and custodian are built right into the software system; for instance, address changes and check requests are assigned directly in the system, and receive a unique tracking number that can be monitored through every step of the process and notified (within Fusion, by email, or even via text message!) when it's completed. More creative tools within Fusion include a download of client social networking activity into the software's basic CRM so the advisor can see "What's New" (and get a notification of important events, like a client who goes through a job change on LinkedIn) and flexible customization of the Fusion interface itself to make the most commonly used sections easily accessible (with the rest hidden but just a click or swipe away). The bottom line - when Fusion comes out later this year, it may set a new benchmark for custodian platform technology and usability.

Choosing An Actively Managed Fund: What Works And What Doesn't - On Advisor Perspectives, Joe Tomlinson provides a great overview of the research regarding how to identify a "good" active manager, or at least avoid a bad one, especially given that all else being equal the average fund manager is expected to underperform indices by the amount of their fees. Nonetheless, Tomlinson acknowledges that skill can/may still exist, as long as it's sought out using a fund selection process that properly adjusts returns for risk, and can produce results that are statistically significant to differentiate skill from mere luck. The discussion begins with an overall of a 2011 study by Jones and Wermers, which itself surveyed a wide swath of literature on the value of active management, finding that: while past performance seems to have at least some predictive value of relatively short time periods, the overall evidence is mixed; macroeconomically-driven strategies show potential, but may require higher turnover; key fund manager characteristics include whether they're smart, well-networked and well-educated, but also whether they have some of their own skin in the game, and they should have relatively few artificial constraints (e.g., be "go anywhere" funds); and that superior managers tend to maintain stable risk profiles, not locking in gains to protect performance, nor doubling down on risk when they're behind. Tomlinson also discusses research by Harlow and Brown, which found some support for the idea that past risk-adjusted performance (alpha over the past 3 years) actually can identify funds that will at least be more likely (albeit far from perfect) to produce superior performance going forward (over the next 1-12 months), and can also identify especially bad funds likely to underperform (which therefore should be avoided). Tomlinson also notes the Cremers and Petajisto research on active share, finding that fund managers who are NOT closet indexers tend to significantly outperform their benchmarks, although there are some vocal critics of the research. Perhaps the key takeaway of the article, though, is the point that while there may be some indicators to identify active managers, that process itself requires significant data, analysis, time, and attention, and while it may be possible to deliver value in this area, it must still be acknowledged there's no "sure thing" approach.

Portfolio Optimization Theory Versus Practice - In the Journal of Financial Planning, Roy Ballentine takes an interesting look at the theory of portfolio optimization versus its practice, highlighting gaps between what modern portfolio theory suggests should be done and how the real world works, and how to reconcile the two with a better portfolio construction process going forward. The starting challenge is that the theory assumes the characteristics of asset classes are well defined and stable, although in reality we often disagree about what even constitutes an asset class, and the compositions seem to shift over time (for instance, are hedge funds even an asset class, or what constitutes "emerging markets" and at what point is China no longer one?); there's also not always agreement about what index or benchmark effectively represents an asset class. Classic modern portfolio theory also assumes that expected return and risk parameters are all that matter, but not taxes, liquidity, cash flow, and other real-world concerns that planners routinely take into account. In addition, it's difficult to determine appropriate investment expectations, especially since optimization tools are highly sensitive to inputs; in turn, this means investors may not even prefer the "most efficient" portfolios, if they were produced with an unconstrained optimization process that may be overly reliant or sensitive to a few key assumptions. The list of criticisms goes on and on, and at the end Ballentine suggests an alternative approach that is less reliant on the science of MPT, and instead wraps portfolios deeper around client needs and goals. For instance: adapt the portfolio to whatever risks the client is concerned about (which may or may not be standard deviation); what kinds of worst-case risks would the client have witnessed historically and can they afford those risks; what is the broad investment outlook for major asset classes, and which ones still belong in the portfolio; what alternative, unexpected scenarios could occur, and how does the portfolio fare if it is "stress tested" through that; and what other issues will/could/should drive investment selection for a particular client, from taxes to liquidity to other concerns? The ultimate point to all of this: clients and advisors may be relying too much on the mathematics and science of optimization techniques, and not enough to the art - in the form of experience, judgment, skill, and even luck - of how to best apply it.

How Final Is A College’s Financial Aid Offer? - This NY Times article is written for consumers, but shares some valuable guidance for planners as well, about types of financial aid and things to consider when a client and their child receive a financial aid offer letter. Most colleges will offer a financial aid information package that includes details about grants and scholarships available from the college, Federal and state aid programs, student loans, and student employment opportunities. In terms of the offer letter itself, though, the key points to focus on are how much will the child/parent ultimately need to pay, what are other costs to be aware of beyond just tuition itself, how much will need to be repaid in the future (e.g., loans, versus grants or tuition discounts that don't have to be repair); and are there any factors from the institution that could cause available aid to change after the first year (which also means being careful not to focus too much on the first year's cost and too little on the anticipated overall cost for degree completion). The student's aid offer letter will likely include details about most available loan options, but if there's a creditworthy co-signer available, it may be looking around at some other student loan options. To maximize aid itself, be certain to fill out the forms properly and follow the directions, and don't be afraid (or shy or embarrassed) to include a letter that explains unusual circumstances that may help receive additional concessions, such as unusually high medical expenses for the family or a parent's recent job loss. While asking for more aid generally doesn't help, the article does note that contacting the financial aid office to follow up, and having them review your aid application with you, may reveal factors that were either misreported or misinterpreted initially that could improve the situation.

Obamacare's Small Business Health Insurance - Is Delay Another Tactic To Remove Employers From The Market? - This article by physician and financial planner Carolyn McClanahan discusses the recent announcement by President Obama that the Small Business Health Options Program (SHOP) will delay full implementation. The basic idea of SHOP was to establish small business insurance exchanges, where employers would choose the level of coverage they wanted to offer (including legislatively-defined bronze, silver, gold, or platinum plans, which differ only in copay obligations from 40% down to 10%) and how much of the coverage they'll pay for, and then employees can buy that level of coverage from whatever company they want through the exchange (the employer makes its contribution to the exchange, which splits the premiums to the various insurers on its behalf); in addition, there would be no health underwriting for the group, and coverage cost would be based only upon age, geography, number of family members, and tobacco use. This was hoped to be a significant improvement over the current marketplace, where group plans are health-underwritten, employees are stuck with the plan the employer chooses, the choices themselves are complex, and companies face an annual decision to change the entire plan if/when/as premiums change. However, due to delays in implementation, when SHOP opens in 2014, the 33 states for which the Federal government runs the exchange will only offer one insurance choice, and if the state runs the program they'll have the choice to delay it entirely until 2015. McClanahan suggests that this may just be another step in the process of separating employers from offering coverage altogether - as the individual insurance exchanges will be open in 2014 with their full diversity, regardless of the availability of SHOP for small businesses. While that may be nice for employee flexibility, McClanahan notes that it is a less desirable income tax result, as employer-paid coverage is pre-tax, while most individuals will be buying coverage with after-tax dollars due to deductibility limits on insurance.

Does Money Really Affect Motivation? A Review Of The Research - This Harvard Business Review article looks at some of the research on the connections between how much people are paid, and their motivation to work; does getting paid more make us feel happier about our jobs and enjoy them more, or can higher salaries actually be demotivating? A meta-analysis of over a century of research on the first question found that there is an association between salary and job satisfaction, but it is very weak, with a mere 0.14 correlation; notably, even the relationship between salary and pay satisfaction wasn't much stronger, at a 0.22 correlation, suggesting that the driving factors for what makes people satisfied with their salary is mostly independent of their actual salary! And the results held up around the world and across different cultures, and were similar amongst those with higher incomes and lower incomes. However, it's one thing to say that money doesn't help engagement much; it's another to suggest it actually demotivates, as some have suggested, noting that extrinsic money motivators can actually crowd out or depress intrinsic motivators like enjoyment, sheer curiosity, learning, or personal challenge. And the research does suggest there's some concern for this, at least - or perhaps especially - in the context of tasks that were otherwise interesting and enjoyable before the introduction of heavy extrinsic financial motivators; on the other hand, money does seem to help motivator for tasks that are otherwise boring and meaningless. Overall, though, the research suggests that intrinsically motivated employees tend to be more engaged (whether extrinsically motivated people can be taught to be more intrinsically motivated, though, is still subject to some debate), and that intrinsically motivated employees tend to have better job performance as well. Ultimately, the author does note that our relationships to money tend to be highly idiosyncratic and vary significantly from one person to the next; nonetheless, the results still have significant implications, not only for how we compensate employees (in financial planning firms and elsewhere), but also in how we communicate about money, satisfaction, and job performance issues to our clients as well.

The Destructive Influence of Imaginary Peers - This article from behavioral finance blog Farnam Street takes an interesting look at how to help people with their problem behaviors, noting that "typical" strategies like labeling the problem a widespread crisis (e.g., the "retirement crisis") may actually be harmful, not helpful; it shows people that the problem behavior is actually the social norm, and it's very difficult to tell people to change their behavior when it would be against the norm (even if it's otherwise good for them). Instead, the better solution is to show people how others are doing things right, not nag them about what they're doing wrong. If people find the norm to be credible, and realize they're behind - for instance, the average person saves 10% of their income, but you're only saving 3% - they may be inspired to step up. However, this can also cause good behavior to boomerang, as those who realize they're "above average" may actually feel encouraged to slack off and fall back to the norm. Fortunately, this latter problem can be solved with rewards; in other words, an ongoing reward system for good behavior can help people ahead of the norm to stay ahead, even while the norm itself inspires those who are behind. Given financial planning's history of telling people to change their own behavior, but not necessarily comparing it to others - as we like to say each person is unique! - the implications of using social norms represent a potentially dramatic change to how financial planning is done!

Where Are Your Assets? - This article from marketing guru Seth Godin is not about assets from the perspective of financial planning and investment management, but about how you build your own personal asset value. Godin suggests that the three core assets we can all build are: our brand, which isn't just a logo, but represents a promise and an expectation; permission, to communicate with people and deliver them relevant information, who would miss you if you were gone; and expertise, which is the knowledge they can't take away even if you lost your job or business. These personal assets become the difference between the trusted, experienced entrepreneur or business owner, and the business newbie who might have a great idea, product, or service, but it's difficult to trust them. Of course, this doesn't undermine the value of companies building assets, from processes to machinery to talented employees; but each of us can pay attention to these aspects of our individual asset value, especially as the economy increasingly shifts to being about people and connections. As Godin wisely remind us, "Do work and get paid once. Build an asset and get paid for as long as it lasts."

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!