Weekend Reading for Financial Planners (Apr 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.

House Approves $484B Bill To Aid Small Businesses & Hospitals (Andrew Duehren & Siobhan Hughes, The Wall Street Journal) - On Tuesday, the Senate approved legislation to extend the popular Paycheck Protection Program (PPP) with another $310B infusion (after its initial $350B allocation was depleted in less than 2 weeks), as part of what has ultimately shaped up to be another $484B stimulus that also includes another $60B for the Economic Injury Disaster Loan (EIDL) program, $75B for hospitals and health care workers, and $25B to accelerate testing efforts across the country. Notably, though, the final legislation did not include additional aid to hard-hit states and local governments (which may or may not be considered in future legislation). The legislation was then approved by the House on Thursday (in a process that included heavy doses of social distancing, face masks, and handwashing, for the voting itself), and is anticipated to be signed into law by President Trump today (Friday), with hopes that the dollars could be flowing through the PPP again by early next week. However, with substantial pent-up demand in the form of hundreds of thousands of PPP applications already in the pipeline, concerns are already emerging about whether this second tranche of PPP funding will be sufficient, or if it too may be quickly exhausted, even as the Treasury separately released guidance this week to emphasize that the funds were not intended for larger publicly traded firms and pressuring several to return by May 7th the PPP loans they already received so those dollars, too, can be reallocated to other small businesses.

1 In 4 Americans Seek Advisor For First Time As Pandemic Sends Consumers Racing For Financial Advice (Jeff Benjamin, Investment News) - A recent Nationwide Financial survey of more than 2,000 adults conducted in the first week of April found that 24% had recently engaged a financial advisor for the first time ever, as a whopping 80% of respondents indicated that they felt they had lost control of their ability to manage their finances since the pandemic emerged. Accordingly, many financial advisors are reporting that, unlike in the financial crisis, navigating the coronavirus pandemic has been associated with record levels of prospective new clients reaching out, including both do-it-yourselfers that no longer want to be responsible for portfolio decisions amidst the volatility, as well as those of working age being served by non-AUM models (who are most at risk of income and household cash-flow disruptions in the midst of the current economic disruption). In addition, the fact that so many people are 'stuck' at home appears to be giving many individuals some additional time to do their 'financial house cleaning', further supporting the growth of advisory firms that were positioned to attract and service clients virtually.

TD Ameritrade [Still] Sees Schwab Deal Closing In Late 2020 (Janet Levaux, ThinkAdvisor) - In this week's Q2 earnings call for TD Ameritrade, the company noted that it continues to work on the planned merger with Charles Schwab, and that the company saw $45B of net new assets and a positive spike in revenue trades during the March market volatility, even as the company's net income fell 11% from a year ago in the midst of ongoing competitive pressures and the collapse of yields that puts further pressure on its previously lucrative cash sweep program. The comments from TD Ameritrade that the merger is on track mirrored similar comments from Schwab CEO Walt Bettinger, who also remains confident that its acquisition of TD Ameritrade is still on track, notwithstanding an ongoing Department of Justice review of the acquisition. At the same time, though, the decline in the markets - where Schwab had originally offered $26B for TD Ameritrade, which is now trading at a market cap of 'only' about $20B - has raised questions of whether Schwab might prefer to take its $1B breakup fee rather than go through with the deal. Yet given that the proposed transaction is an all-stock deal, where Schwab's stock price (and therefore cost of acquisition) is down as well, and with the potential for an estimated $2B of cost-savings synergies, the long-term economics of the transaction are likely still appealing. Though with trading commissions dropped to zero, along with net interest margins on cash sweeps down (with Schwab slashing its stated rate to 0.01%) amidst the Fed's interest rate cuts, the question remains as to whether Schwab may introduce new custody fees for RIAs after the merger is complete as it seeks to bolster the profitability of serving RIAs with its other major revenue channels down.

Advisors Want CFP Continuing Education To Count Towards State Requirements (Mark Schoeff Jr., Investment News) - In February, the North American Securities Administrators Association (NASAA) released a model rule proposal that would mandate 12 hours per year of continuing education for Investment Adviser Representatives (IARs) of RIAs, with a public comment period open through April 13th for feedback. From NASAA's perspective, the proposed CE rule is intended to close the gap that exists between IARs of RIAs (that historically had no CE requirement) and the registered representatives of broker-dealers who do have an ongoing CE obligation under FINRA. However, with advisors increasingly likely to hold multiple licenses and/or designations, each of which have their own CE requirements, comment letters in response to NASAA urged that if the initiative is rolled out, the states accept other types of CE (e.g., for CFP certificants, or FINRA CE) in satisfaction of the IAR CE requirement as well. Fortunately, there is already precedent for states to recognize other designations - for instance, the Series 65 requirement is already waived for those who have CFP certification - which increases the likelihood that NASAA will accept cross-credits with other programs (and effectively focus the 'new' IAR CE requirement on advisors who have no other designations or licenses). Ultimately, if NASAA decides to move forward, the rule would likely be voted upon at its August annual meeting, though state legislators would still have to subsequently evaluate and decide whether to actually adopt the rule into law in their individual state.

FINRA Proposes One-Stop Shopping For Background Checks On Advisers (Mark Schoeff Jr., Investment News) - This week, FINRA submitted a rule proposal that would allow FINRA's BrokerCheck to share information with the SEC's Investment Adviser Public Disclosure (IAPD) website, making it feasible for consumers to see information about brokers who are dually registered as investment advisers all in a single location (and matching a similar change that IAPD made in February to bring BrokerCheck information into its own website). Ultimately, the goal and intention of the proposal, based on a 2015 recommendation from the SEC's Investor Advisory Committee, is simply to make it feasible for consumers to see all relevant background information about a prospective dual-registrant in a single location on BrokerCheck, rather than forcing them to also go to the IAPD website to gain a complete picture of the advisor's background (including any disciplinary actions). Though notably, the proposal would still "only" capture FINRA BrokerCheck and the SEC's IAPD information, and not be integrated with state registrations of insurance licenses, which have in recent years become an increasingly popular domain for 'problem brokers' who drop their securities licenses (and associated disciplinary history) and continue to sell high-commission fixed annuity products to consumers instead.

How Coronavirus Volatility Piqued Interest In Block Trading (Jessica Mathews, Financial Planning) - As independent RIAs get larger and larger with more and more clients, there is an increasing risk that either it takes so long to enter trades for each client that not all clients get consistent pricing at execution, or that the aggregate amount of trading for an advisory firm's clients can actually move the market and the price of a stock, bond, or ETF itself. And in times of heightened volatility, when bid/ask spreads are even wider, the risk of getting poor or inconsistent trade execution from one client to the next is even more problematic. To fill the void, RIA custodians have been increasingly building out and expanding their "block trade" desks - centralized trading teams that can aggregate together the trades of all of an advisor's clients, and obtain better trade execution (particularly when it comes to liquidating a larger block of trades all at once). In the past year alone, TD Ameritrade's block trade desk team executed trades of nearly 2 billion shares, facilitating an estimated $45M in savings on trade execution pricing. Notably, advisory firms that still use mutual funds won't necessarily need to avail themselves of the service - as mutual funds already all trade at set end-of-day closing NAV prices - but with the ongoing shift towards stocks and especially ETFs, block trading (especially for more esoteric ETFs with less liquidity and trading volume) has become increasingly relevant as a support service for RIAs, where on a sizable trade across the entire client base even 'just' a basis point or two in efficient trading execution is a material cost savings for clients.

Advisor Portfolio Models Underperformed When Markets Tanked (Bernice Napach, ThinkAdvisor) - According to a new report from Blackrock's latest Advisors Insight Guide, the stock sleeves of most advisors' moderate growth portfolios were off just 0.4% from their benchmarks, but their bond sleeves underperformed by a whopping 5%(!) during the selloff from late February to mid-March. The key driver appears to have been the tendency for advisors to buy either short-duration bonds (i.e., underweighting duration/interest rate risk) or higher-yielding corporate bonds (i.e., overweighting credit risk), and thus facing a double-whammy when the pandemic both caused risk spreads to blow out (resulting in underperformance of credit risk) and the Fed to aggressively cut rates (for which advisors received little benefit if they had already cut their duration short). In other words, despite holding a mixture of "stocks and bonds", advisory firms in practice appear to have tilted their bond exposure to perform best in the same positive-economic-growth scenario (overweight credit risk, underweight interest-rate risk) as their stock allocations, such that advisors were actually 'underdiversified' into government bonds when the recession emerged and the market fell, where their bonds may have been an absolute buffer (falling less than stocks) but actually ended out being a worse relative underperformer against benchmarks. In turn, Blackrock's study also notes that the more conservative the client portfolio (and the more weighting towards bonds), the more advisor portfolios tended to underperform their benchmarks. Other notable tips and guidance from the Blackrock study included: advisors were better served by rebalancing on the basis of how far allocations had drifted from their targets (rather than simply on a calendar basis of monthly, quarterly, or annually); tax-loss harvesting, not surprisingly, continues to be an appealing strategy; and simply taking a hard look at both whether the client's current portfolio still aligns with their goals in the current environment, and also whether the market and economic shifts have changed the advisor's outlook on what is best to hold in client portfolios in the first place.

Challenging Previous Research On Bucket Strategies (Joe Tomlinson, Advisor Perspectives) - So-called "bucket strategies" have long been a popular approach for advisors managing volatility for retired clients, where several years' worth of cash is held in a side "bucket" to provide both a liquid reserve to tap for spending (without needing to withdraw from portfolios while they're down) and a psychological buffer against the volatility. However, despite their ongoing popularity, Tomlinson notes that the actual academic research for bucketing strategies is not so positive. In fact, studies have long suggested that bucketing strategies don't actually enhance the performance of portfolios in the aggregate during a bear market, and can actually result in less retirement spending simply due to the long-term drag of the cash itself. A recent such study by Javier Estrada similarly found that bucket strategies didn't necessarily help mitigate retirement plan failures (especially for those whose spending rates were reasonable in the first place), and instead was more damaging due to the drag of cash returns instead. In a follow-up analysis by Tomlinson himself, another version of rules-based bucket strategies (where withdrawals are taken from cash if stock returns are negative, and from stocks if their returns are positive, using excess returns if available to replenish the cash bucket) was tested looking in particular at the historically-challenging 1966 retiree and again found that bucket strategies performed worse than simple static balanced portfolios. Notably, in wider tests of the data - both internationally using Estrada's data, and on a Monte Carlo basis with Tomlinson's analysis - bucket strategies often at least performed 'similarly' to static allocations of balanced portfolios. Still, the results suggest that at best, bucket strategies produce 'similar' returns to simply holding balanced portfolios and that their value is only psychological (in the client comfort of having the cash reserves available), but that in practice bucket strategies may represent a scenario where clients are accepting the psychological benefits at a cost of what will actually be lower long-term retirement spending.

How Financial Plans Must Adapt To Market Crashes (Michael Finke, Advisor Perspectives) - When markets decline, it's common for financial advisors to suggest 'updating the projections' to show clients whether the market decline has actually had a material impact on their ability to achieve their goals. The good news is that often, what seems like a dramatic market decline does not in fact materially derail a long-term retirement goal... unless, in some cases, it does, and the updated Monte Carlo projections do in fact show a material reduction in the probability of success that may necessitate a portfolio change. Of course, even a reduction in the probability of success does not itself mean that a retirement plan is doomed to failure; in practice, it generally only means the client has at least taken some step down the less-than-ideal path (but still has time for the portfolio to recover). Still, though, retirees must ultimately accept the current reality they're faced with, and Finke notes that if in practice today the client's withdrawal rate is 'dangerously' high, some adjustment may be necessary... just as if Google Maps shows that there's only a 63% chance of arriving at the wedding ceremony by 2PM instead of a 94% chance, you will likely make some change to your behavior (e.g., leave at least a little bit earlier!). Accordingly, Finke advocates the use of 'guardrail' strategies that don't just update or track the client's Monte Carlo probability of success, but monitor their current withdrawal rate on an ongoing basis, and encourage at least some spending adjustment when their spending in real time exceeds a dangerous percentage of the then-current portfolio withdrawal.

It's Time To Build (Marc Andreessen) - Notwithstanding the political finger-pointing, Andreessen notes that in the aggregate, the entire world was so unprepared for the coronavirus pandemic that all institutions must bear some of the blame, for both a failure of execution and simply a failure of 'imagination' of what might happen.... and resulting in the recent recognition of and desperate grab for the things we urgently need but don't have (from coronavirus tests, to even common test materials like cotton swabs, along with ventilators and ICU beds, and of course vaccines as well as the facilities necessary to mass produce them for the population). And of course, there's also the ironic challenge that the government has built ample systems to collect tax dollars from its citizens, but didn't have the sufficient systems to distribute any money back out to its citizens when they need it most. And in practice, most of these systems aren't actually hard to build (aside, perhaps, from the vaccines!); instead, we simply hadn't chosen to build them. Similarly, American educational systems have changed remarkably little since the 1960s (despite ongoing education research), difficulties in building housing capacity (where it's needed) is resulting in skyrocketing real estate prices in parts of the country, and despite the promise of the Jetsons we still don't have flying cars. Accordingly, Andreessen suggests that now it's "time to build", in the same ways we did in the more distant past that powered the growth of the country (from roads and trains to farms and factories, then the computer and the microchip and the smartphone), but now focusing on the things that have been recently escalating dangerously in cost - from housing to schools to hospitals - and trying to leverage American innovation to drive down those costs as we have in other areas (e.g., computers). Leading Andreessen to ask (everyone) the question: what are you building?

How To Build If... It's Time To Build? (Bilal Zuberi, Medium) - In response to Andreessen's essay that it's "Time To Build", the venture capital industry has been abuzz with not only the call to build itself, but also Andreessen's recognition that we must want to build these things. Which is a non-trivial challenge, given that when it comes to venture capital investors in particular - who power much of the funding towards innovation - the obsession in recent years has been largely on software and technology companies, that can enjoy 70%+ gross margins and quickly take over the world (a la Uber and Airbnb, and ironically Andreessen's own popular essay from nearly a decade ago that "Software is Eating the World"), rather than the "hardware", infrastructure, and physical businesses that are less exciting and harder to grow and scale but ultimately represent the raw "building" of things we actually need. So what would it take for venture firms to shift away from software companies and (back) towards more "deeptech" and infrastructure startups that actually build things? Zuberi notes first and foremost that investors of capital will need to both adjust to lower margins (than the eye-popping software businesses), longer sales cycles (than impulse-buy software on a smartphone), more complex supply chains, and the real-world regulatory hurdles that crop up when businesses try to "build" things. Not to mention that such businesses can be more capital intensive, and have fewer potential acquirers at exit. Still, though, if "building" is ultimately what the world needs and really wants, it's ultimately what will most likely be rewarded in the marketplace... raising the question of whether investors of capital itself will begin to shift and start to support our efforts to build?

Shoes To Masks: Corporate Innovation Flourishes In Coronavirus Fight (Greg Ip, The Wall Street Journal) - When paint producer True Value heard from its 4,500 affiliated hardware stores that they were all running out of hand sanitizer on the shelves (a shortage both for customers and for the stores' own employees), the company took two weeks with its engineers to retool some of its paint-filling lines to produce jugs of FDA-approved hand sanitizer, which this week has begun to ship free to its stores for their use. The changeover is just one of many recent stories emerging of how businesses are quickly adapting, from breweries also pivoting to hand sanitizer production with beer sales down at pubs, General Motors teaming up to make ventilators, and even individuals with 3D printers churning out N95 masks. Not to mention a bevy of companies all scrambling to produce a coronavirus vaccine itself, just months after the virus' genome was sequenced, and a dramatic ramp-up in ever-faster-turnaround coronavirus testing capabilities. In turn, both Google and Apple are developing software to alert users if they may have come in contact with someone infected with the virus (based on smartphone locations), and businesses of all types are restructuring to accommodate social distancing. Notably, history is, in fact, replete with situations where national crises (from wars to pandemics) spawn a wave of entrepreneurial innovation that leaves a positive mark on economies for a long time thereafter, and with the modern reach of the internet and automated supply chains, industry seems to be adapting even more rapidly than in past crises and doing so with less government involvement than in prior 'wartime' retooling of private industry (though the government has stepped up its involvement more recently), aided in part by the fact that while past wartime efforts struggle to adapt in part because productive workers are sent off to war, in this environment shutdowns and social distancing may actually be creating more economic capacity to adapt. Still, though, the sheer amount of economic activity in this pandemic is far less than wartime government spending. But nonetheless, it is creating lessons on how economies can adapt (or be made to be more adaptive) that may help build more capacity to handle the next crisis even better, whenever it may come.

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.