Weekend Reading for Financial Planners (Apr 4-5)

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 April 4th/5th:

Advisor Productivity Is Rising. Here's How. (Charles Paikert, Financial Planning) - According to industry tracker PriceMetrix in their 5th annual "State of Retail Wealth Management" report, advisor productivity (primarily across broker-dealer channels) as measured by assets and revenue continues to improve. The average advisor hit record highs of $97M of client assets and $655,000 in revenue (which appears to include both fee-based and brokerage accounts). Notably, as the industry continues to transition towards assets under management, the overall percentage of fee-based business increased to 35% of the average advisor's book (up from 31% in 2013), and the average AUM fee actually increased to 1.02% last year (up from 0.99% in 2013). In addition, advisors appear to be gaining better client focus as well, as the average number of clients per advisor fell to 150 (down from 156); on the other hand, this appears to be driven in large part by advisors focusing on higher net worth clientele, and letting their smaller clients go, and with advisor headcount declining the total number of clients served by advisors dropped an estimated 10%. Also notable in the data is that advisors continue to serve predominantly older clientele as well, with the average client age now nearly 62, and only 23% of advisor clients under the age of 45.

Liquidity (Howard Marks, Advisor Perspectives) - In his latest Investment Memo, Marks pontificates on the current state of liquidity in investment markets. For instance, the traditional view of "liquidity" is whether something is readily saleable or marketable, such that publicly listed "marketable securities" are liquid and privately traded vehicles like private placements and private partnerships are not. Yet Marks points out that ultimately the real driver of liquidity is not just whether something can be sold, but whether it can be sold without impacting the price and/or at a price equal or close to the last price. Further complicating the matter is that investments that seem (and are) liquid at once point, may turn illiquid at a subsequent point in time; liquidity itself is ephemeral and can come and go, as a security that you want to sell is liquid when others want to buy may become illiquid if everyone else wants to sell it too. Other notable points that Marks makes about liquidity: a liquidity crisis can have unintended side effects (for instance, illiquidity in one asset or market can cause other markets to sell off as investors sell what is liquid because they cannot sell what isn't); illiquidity may not always carry a risk premium, if investors are so willing to count on it that they become risk-intolerant and overbid on the price they're willing to pay; and most important, no investment vehicle should promise greater liquidity than is afforded by its underlying assets, so beware market-traded funds with illiquid underlying holdings, from what happened with senior loan mutual funds last year to a wide range of ETFs that can't arbitrage towards a stable NAV when the underlying securities are illiquid and difficult to arbitrage.

Why Are Interest Rates So Low? (Ben Bernanke, Brookings Institution) - This week, former Federal Reserve chairman Ben Bernanke launched a blog of his own on the Brookings Institution website, and the first topic he tackled is the ongoing discussion of why (global) interest rates remain so low, with 10-year government bond yields at 1.9% in the US, 1.6% in the UK, 0.3% in Japan, 0.2% in Germany, and slightly negative in Switzerland. Yet Bernanke emphasizes that today's low rates are part of a much broader secular trend, with rates declining steadily for almost 35 years now (since a peak in 1981), coinciding at least in part with a steady decline in inflation as well over that time period. Accordingly, Bernanke suggests that despite the common "street" view that rates are low because the Fed is keeping them low, and while that's true in a narrow sense, ultimately the driver for longer term interest rates is the economy's longer-term prospects for growth and the equilibrium real interest rate that can sustain full employment of labor and capital resources. Notably, if the Fed keeps its interest rates below the long-term equilibrium rate, the economy eventually overheats, leading to inflation. Alternatively, if the equilibrium real interest rate really is low, raising rates too soon - e.g., so retirees could enjoy higher interest rates on their retirement assets - would cause a recession that ultimately just makes the situation worse. In the end, Bernanke suggests that given what appears to be a low long-term equilibrium rate - a factor the Fed tries to estimate but which is ultimately outside of the Fed's control - the fact that the Fed has kept short-term interest rates low is simply consistent with that reality, and not a causal fact that is driving rates "artificially low" at all.

A New-And-Improved Shiller CAPE: Solving The Dividend Payout Ratio Problem (Jesse Livermore, Philosophical Economics) - While Professor Robert Shiller's Cyclically-Adjusted Price/Earnings (CAPE) ratio has been increasingly popular, a common criticism is that it fails to account for changes in the amount of earnings being paid out in dividends versus going to reinvestment, which in turn can impact the pace of earnings-per-share (EPS) growth and push up the value of CAPE (all else being equal) making it harder to compare to historical levels. The alternative solution is to build the CAPE ratio built not just around price, but around total return, which can neutralize the impact of varying dividend payout ratios for companies with otherwise similar earnings. Livermore suggests a means of doing this is to use a Total Return EPS Index, which essentially is an index measure that determines what EPS would have been if dividends paid out had instead been used for share buybacks instead (i.e., a dividend payout ratio of 0%, now and at all times in the past). Once a Total Return EPS measure is determined, a Total Return Price index can be recalculated on the basis of this 0%-dividend-payouts structure. Once these adjustments are made, a "new" CAPE measure can be calculated, using the 10-year average of Total Return EPS over the Total Return Price index. The end result of applying such adjustments is that the Shiller CAPE ratio, particularly over the past two decades, would be slightly lower than is conventionally measured. On the other hand, it's notable that even by this measure, the markets would still be "expensive" today; with adjustments, the Shiller CAPE ends out being roughly 25.9 in today's environment, rather than 27.5 (and still very high by historical standards), and overall these adjustments only shift the Shiller CAPE by an average of about 5.7% over the past 100+ years.

Woe Betide The Value Investor (Jason Hsu & Vivek Viswanathan, Research Affiliates) - While investors have historically enjoyed a value premium, which has been well documented over decades of investment research, Hsu and Viswanathan raise the question of whether the value investing approach has/will grow popular enough that eventually the benefits get completely arbitraged away. Tracking value funds since 1991, the researchers find that while buy-and-hold value funds did manage to outperform the S&P 500 by a modest 39bps, the dollar-weighted return of those value funds reveals that the average value investor is underperforming the S&P 500 by 92bps (and the buy-and-hold value investor by 131bps). The phenomenon appears to be exacerbated by the fact that the value premium is erratic and mean-reverting, going through long periods of outperformance and underperformance, which may just further encourage investors to (badly) try to time value funds (and ironically - or perhaps not - the authors note that with growth funds, the investor performance-chasing and dollar-weighted returns are even worse, with a 194bps annualized return shortfall over time). On the one hand, these results suggest that the average value investor isn't actually enjoying a return premium for value at all; on the other hand, though, the fact that even value investors can't fully capture the value premium due to their own trading suggests that there's still ample room for the value premium to persist without being arbitraged away!

The Evolving Idea Of Retirement (Michael Finke, Research Magazine) - The conventional view of retirement is that it's something you sacrifice for with work and saving in your middle years to "enjoy" life and stop working in your later years. Yet Finke notes, based on the research of UCLA economist Dora Costa, that this form of retirement is entirely a 20th century idea, a combination of some people starting to retire because they could afford it (even though many other could not) and wanted to pursue that new lifestyle of fun and relaxation, and often simply because they were too old to get hired for anything anyway. Yet for many in today's world, it's increasingly feasible to work later and later in life, a result of both medical advances that make us healthier for longer, and also the fact that less of today's work is the kind of hard manual labor that simply becomes physically impossible at some point. In fact, the reference point of retiring at age 65 itself seems to be a remarkably arbitrary point, driven by early retirement developments like the first pensions for Union soldiers in the late 19th century (granted at age 65) and the first social insurance program in Germany (setting the retirement age at 65 in 1916, and later adopted by Social Security here in the US in the 1930s as well) - and that age was chosen both due to the physical (and sometimes mental) decline that occurs around that age, but also because it was so old that relatively few pensions were expected to actually have to be paid. Given the arbitrary nature of retiring at age 65, Finke suggests this raises the question of why "work in middle age and retire in old age" is the right paradigm at all; for instance, why not take time off in your 40s "when you can enjoy it" and simply commit to working longer in your 60s instead, just trading leisure in one time period for another? Is it time to rethink the framing of retirement altogether?

Deciphering Misleading Financial Aid Letters (Lynn O'Shaughnessy, The College Solution) - In this season of college financial aid letters, students (and their parents!) are often overwhelmed by the information and details contained therein, and unfortunately a lot of colleges don't seem to make it easy to evaluate the situation and make comparisons. Ideally, every financial aid letter should include information about the full cost of attendance (broken down into expenses including tuition, room and board, textbooks, etc.), any grants and scholarships, any assumed loans (including the types, amounts, and interest rate), the net amount the student will have to pay after financial aid is deducted, and a notation of the parent and student's Expected Family Contribution (EFC) that was used for the calculations and represents the minimum amount the family really will be expected to pay. Yet O'Shaughnessy includes several examples of incomplete aid letters; for instance, one included the estimated tuition and fees and room and board, but not the almost $5,000 of additional expenses that go into the full cost of attendance, and when the total cost was compared to the EFC it turns out that the financial aid had still come up short. In addition, some schools will include loans in their listing of aid, even if the loans are simply direct unsubsidized (formerly "Stafford") or PLUS loans for the student and their parents - which they could have used to borrow and qualify for regardless of any "aid" being offered! Once you back out the "questionable" aid numbers like loans (and work-study) that shouldn't really be included, it's possible to compare the results to the typical financial aid the school awards by looking up their numbers with the College Board, and see whether it's realistically possible to go back to the school and try to get more (or not) based on the percentage of need provided (the total amount of aid properly calculated, compared to the total expected cost of attendance minus the EFC) and the proportion of assistance that was provided in the form of loans.

Estate Planning Tips: Before & After Client's Death (Martin Shenkman, Financial Planning) - With rising estate tax exemption amounts, estate planning in recent years has been shifting from strategies to minimize estate taxes (except for the very wealthiest of clients) and focusing instead on the income tax planning opportunities at death. For instance, clients who have irrevocable trusts often have "swap powers" to exchange assets inside the trust with others outside the trust, which may be appealing if there's a chance to exchange high-basis assets (or even cash funded via a short-term loan) for low-basis assets that have been growing in the trust outside the estate but can now be swapped in to obtain the step-up in basis at death. Similarly, with trusts that allow for discretionary principal distributions, it may be appealing to shift high-basis assets out of the trust and back into someone's estate, especially if the exemption has risen enough they no longer face any estate tax, and/or to decant the trust into another sitused in a state with better state income tax treatment. Other strategies for those with no estate tax exposure include amending family limited partnerships to not produce a discount valuation in order to have a higher value for a step-up in basis, and doing charitable gifting while still alive to get the income tax deduction (since there's no benefit to a charitable estate tax deduction if there's no estate tax!). After death, some additional strategies to consider include: re-evaluate whether it's worthwhile to claim executor commissions (deductible to the estate but taxable to the recipient, which may not be helpful if the estate isn't facing any estate tax exposure anymore); beware funding bequests with any appreciated assets; be cognizant that it's still necessary to honor estate planning documents, including funding trusts (e.g., bypass trusts) that the Will states must be funded even if they may no longer be needed (if that's not desirable, the documents must be changed before death!); and be cognizant that it often is possible to distribute different types of assets to beneficiaries to accomplish family goals (e.g., to give the vacation home to one child and the investment account of equal to another, if that's what they wish to inherit).

How do Deferred-Income Annuities Stack Up Against Rival Products? (Joe Tomlinson, Advisor Perspectives) - The Deferred Income Annuity (also sometimes known as the longevity annuity, advanced-life deferred annuity [ALDA], or the qualified longevity annuity contract [QLAC] in retirement accounts) is one where the buyer exchanges an upfront premium payment for an ongoing series of (usually monthly) payments that will continue for life - but unlike an immediate annuity, where those lifetime payments start immediately, with the deferred income annuity (or "DIA") the payments don't begin until a more distant point in the future (e.g., buying at age 65 with payments beginning at age 85). Although DIAs have actually been around for many years, the contracts have gained far more visibility in the past year with the Treasury Department's issuance of the QLAC regulations, allowing DIAs to be purchased inside retirement accounts without running afoul of the Required Minimum Distribution (RMD) rules with follow-up guidance also allowing them into target-date funds. When comparing DIAs (plus TIPS portfolios to cover the early years) to just buying a single premium immediate annuity (SPIA) or just a full portfolio of TIPS, Tomlinson finds that DIA-plus-TIPS portfolios provide income comparable or higher than TIPS-only portfolios (especially for those who fear living to age 100) and only slightly lower than using a SPIA; the difference, though, is that a combination of DIAs and TIPS can produce income close to a SPIA yet while maintaining liquidity for 83% of the assets (with a buy-at-65-payments-starting-age-85 scenario). For those who don't want to risk the losses in an early death with a SPIA contract, a SPIA-with-cash-refund provides payments slightly lower than a DIA/TIPS combination, even as the latter also allows for greater liquidity along the way. In analyzing the use of a DIA in earlier years (for instance, buying at age 55 to start retirement income at age 65), the strategy again is superior to just using TIPS, but is more mixed against diversified portfolios, winning in some cases but losing in others.

Why Zenefits Isn’t Anti-Broker (Elizabeth Galentine, Employee Benefit Adviser) - While there has been much debate about the potential impact of "robo-advisors" and technology on financial advisors and investment advice, one of the hot stories and fastest growth software-as-a-service companies in Silicon Valley right now is Zenefits, a web-based employee benefits and HR company that does everything from benefits to payroll to on- and off-boarding employees and more, and may be in the process of disrupting the world of brokers who offer employee benefits. Yet in this parallel story of technology-vs-humans, even Zenefits notes that they're not necessarily in direct competition with the value proposition of brokers; instead, they note that actually the typical broker today spends about 90% of their time dealing with administrative burdens, and that's something that Zenefits has been able to automate. Accordingly, Zenefits is actually hiring brokers to help service their clients, and one employee benefits broker who went there notes that now he's actually able to be more client-centric, as Zenefits has taken away the administrative burden. In turn, Zenefits notes that while it is making humans available to support their clients, the efficiency of the technology means that their human advisors simply aren't needed as often in the first place. When humans are needed, service is provided through a combination of telephone, online interaction, and video chats. The bottom line for Zenefits - and increasingly a parallel for financial advisors as well - is that strong technology tools and automation helps get the administrative burdens out of the way, and actually lets employee benefits brokers (or advisors) spend more time doing the human interaction they do best. And Zenefits is hiring a lot, with its humans-augmented-by-technology service reaching what are now over 10,000 client firms and more than 100,000 employees across 47 states (despite being around for only 2 years!), mostly small-group employers with under 50 employees that other (traditional human) brokers had been pulling away from as being "unprofitable" anyway! Notably, the Zenefits boom has also spawned growth for over technology-for-employee-benefits-brokers platforms, who are feeling the pressure to step up on their own technology offerings for clients to match.

Funds Run By Robots Now Account For $400 Billion (Anthony Effinger & Eric Balchunas, Bloomberg) - The "smart beta" investment approach has witnessed explosive growth in recent years, but one of the most notable caveats to the strategies is that because they are rules-based, they can be almost entirely automated with technology - one the algorithms are created, the only need for the manager at all is to occasional "press the button" for the algorithm to execute, and perhaps review/monitor its activity to be certain everything remains in good order. This technology efficiency, combined with interest in smart beta, has led to an explosion in smart beta ETFs in particular, with almost 400 such funds now available accounting for about $40B of AUM (or 20% of all domestic ETF assets!). Notably, the smart beta category itself is somewhat inconsistent, and the lines have gotten even more blurred with the rapid growth of assets that has attracted new companies and imitators; there are smart beta strategies ranging from Fundamental Indexing to equal-weighted indexing to algorithmic strategies pursuing everything from betting on ECB actions by going long euro zone exporters while hedging the Euro to using leverage to buy a wide range of companies meeting various formulaic targets. On the one hand, the upshot of "robotic" formula-based algorithms is that it can remove the human emotions that may make it hard to execute a strategy during times of stress; on the other hand, it also raises significant questions about the quality and credibility of some algorithms in the first place. Either way, though, while "smart beta" itself remains controversial as an investment strategy, perhaps the most notable aspect of the movement remains that it is being implemented so heavily through robo-technology, that it represents another means by which robo-advisor platforms could ultimately disrupt traditional financial services investment products.

If You Want To Nail An Email Introduction To A Busy Person, Here's How (Bruce Upbin, Forbes) - Introductions can be a powerful social currency, and in today's world introductions are increasingly done via email, whether connecting two people to each other, or trying to introduce yourself to a relative stranger. The caveat, though, is that e-mail is a difficult medium by which to connect, as many of us are overwhelmed by our email and/or see it as a chore. Accordingly, it's crucial to make the email as efficient and effective as possible. Accordingly, Upbin suggests that the starting point for an introduction email is to establish the higher purpose - why is the introduction being made and what is it intended to accomplish - along with establishing the credibility of the person/people being introduced. From there, you have to decide how to make the connection - email each person separately to confirm they want to be introduced, or Upbin's recommendation to contact one person, make the introduction and invite them to forward it on to the other party if they're interested (which empowers that person to control whether they want to see follow-through on the introduction). The email should close with a clear call-to-action - if the person is interested, what, exactly, should they do next (forward the message? Call you? Check out a website?)? Notably, a good introduction message can be further enhanced with a little text formatting to highlight certain areas; for instance, bold text for the "ask" at the end of the email, use clean embedded hyperlinks instead of raw (ugly-looking) URLs, and a clean signature section at the end (without images, that tend to be rather unfriendly when viewed on a mobile device). And if you have no response to the initial email, one follow-up is fine just to nudge the issue back to the top of their Inbox, but recognize that after two non-responses the answer is probably "no" and it's time to move on.

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. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!