Weekend Reading for Financial Planners (Apr 5-6)

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 5th/6th:

Global Junkets Lavished On Directors Fuel CFP Board High Life - This editorial by Financial Advisor magazine's Evan Simonoff suggests that the CFP Board's growing reach and revenues, despite its consistent ability to periodically inflame licensees, may be fueled in part by lavish compensation it is handing out to its staff and members of its board of directors. Simonoff cites CFP Board CEO Kevin Keller's compensation has climbed 90% in 3 years from $448,000 in 2009 to $888,000 in 2012 as the CFP Board's revenues more-than-doubled from $12.6M in 2009 to $26.4M in 2012, even though the bulk of that increase was a result of the dues increase to fund the CFP Board's public awareness campaign; Simonoff also suggests that board members may be "flying around the world in business class and staying at fancy four-star hotels" as a part of the CFP Board's efforts to support the global adoption of the CFP mark. Although this may be a legitimate goal, Simonoff notes that while the CFP Board has been expanding its agenda with global growth aspirations (not to mention its attempt last year to enter the continuing education business, its recent announcement of a new research institute, and a potential launch into the publishing world with a new Journal), the organization has simultaneously been "dropping the ball" on its essential functions, from revised ethics class requirements that were supposed to go into effect on April 1 (but are delayed), to a proposed revision of the practice standards that has been aborted, to the CFP Board's ongoing debacle regarding the enforcement of its compensation disclosure rules. In addition, overall growth of CFP certificants has been sluggish. Simonoff notes that the board of directors themselves are credible, including widely respected Ray Ferrara and Joe Votava; however, the CFP Board's directors have been respectable for years, and have historically still failed to curb the CFP Board's behavior. The article suggests that the next shoe to drop may be the ongoing Jeff and Kim Camarda lawsuit, which will force a lot more detail about what's been going on behind the scenes at the CFP Board as the discovery process gets underway. On the other hand, it's notable that Simonoff's allegations appear to rely primarily on anonymous sources (or rumors with no indicated sources at all), so it's unclear how much of the allegations about implied irresponsible spending can or will be substantiated.

Why Morningstar's Purchase Of ByAllAccounts Might Be A Bigger Deal Than Its Paltry $28-million Price Tag Shows - The big announcement for M&A activity in the advisory industry this week was not the purchase of an advisory firm, but a major advisory firm vendor, as Morningstar bought out account aggregation tool ByAllAccounts for $28 million. Yet given the potential size and scope of ByAllAccounts, this is viewed by many commentators as a "paltry" sum, and the rumor was that ByAllAccounts was in dire straits and needed a financial savior, with Morningstar winning a bidding war against Envestnet. Notwithstanding its financial woes, ByAllAccounts was unique even amongst account aggregators due to its comprehensive and quality data across custodians (as tech commentator Bill Winterberg points out, ByAllAccounts was the only account aggregator offering "reconciliation-ready" data that portfolio management software tools like PortfolioCenter or Advent could use), and a whopping $730B of assets moves daily through its aggregation engine. The question now is what Morningstar plans to do with the platform, as ByAllAccounts was so integral for many products and services depending on having their (investment/account) data work well together; Morningstar CEO Joe Mansueto suggests that it will continue to be both a supplier of data, and use ByAllAccounts to bolster their advisor workflow tools, perhaps bolting account aggregation onto Morningstar Office especially as such offerings become more and more common, competitive, and integral to advisors. In the meantime, the ByAllAccounts acquisition also raises interesting questions of what Morningstar will do with all the data they can glean as ByAllAccounts gives them a glimpse into what's happening in advisor portfolios across multiple platforms and potential competitors.

The Rise Of The Robo Advisors - In its cover story this month, Financial Advisor magazine writes about the "rise of the robo advisors" with a focus on Bill Harris, the CEO of "robo-advisor" Personal Capital (whose notable business pedigree includes roles as the former leader of both PayPal and Intuit). The basic concept of the robo-advisors is to do to investing what Mint did to personal household accounting and take it a step further, where the robo-advisor firm helps clients to automatically invest in a diversified portfolio using sliders to establish goals and risk tolerance and then invest in an allocation of ETFs chosen based on algorithms that balance the risk/reward profile based on the inputs. While some have suggested this could turn into a cage match between humans and computers about who can make the better portfolios and financial plans, the notable reality is that so far, the robo-advisors have tended to focus primarily on those investors who don't meet the threshold account minimums for most human financial advisors in the first place, and are filling in a void for those still early in their careers. The article also profiles Jon Stein of Betterment and Adam Nash of Wealthfront, whose "robo-advisor" offerings go directly to consumers. The notable difference about Harris' Personal Capital, though, is that it actually does not simply rely on technology; its offering still includes real human financial advisors who are connected to the firm's clients, and its minimums are as "high" as $100,000 (compared to little or no minimum at all at most other robo-advisors). Harris had the insight after having tried to build a do-it-yourself tax planning and financial planning platform several times when at Intuit as a part of the TurboTax and/or Quicken packages, and every time they failed, because there's a difference between what you "must" do (pay taxes and bills) versus what you can "plan" towards (tax or financial planning). While ultimately most of the robo-advisors are still small, at their current pace both Wealthfront and Personal Capital will likely cross $1B of AUM by the end of 2014, and may have several billion in 2015 if the growth sustains; on the other hand, since all of today's robo-advisors have been built since the financial crisis, it remains to be seen how they will fare when the next inevitable bear market comes along.

Why I Find The Term 'Robo-Advisor' Objectionable And Unhelpful - On RIABiz, editor Brooke Southall sounds off regarding the growing use of the term "robo-advisor" to characterize the series of web-based start-ups serving investors and the "thinly veiled contempt" the "robo-" label implies (evoking images of rote, mindless actions and the dreaded robo-call). As Southall notes, the truth is that many robo-advisors don't even offer financial advice but rather the cheaper delivery of asset management; however, it's also not clear what a good alternative term might be anyway (as "online advisors" packs less of a punch and comes close to sounding like "online brokers"). On the other hand, the reality is that some owners of online start-ups have shown "shown a penchant for disrespect" towards RIAs as well, talking about "disrupting" the market with the implied condescension towards the "dinosaur" that is being disrupted, so the robo-advisor response may be a simple case of "tit for tat" as well. Yet Southall ultimately suggests that these two roads will converge, and that the distinction of "robo" vs advisor may be more about where the firm started (as a startup website or a traditional RIA) than where it ends out, which will be a blend of human and technology.

Getting More Mileage From Your Lead Advisor - The FA Insight People and Pay study shows that most advisory firms continue to struggle to find experienced advisors to bring on board and have little structure to internally progress junior advisors to lead roles; this is resulting in lead advisors becoming an increasingly scarce, which in turn is forcing advisory firms to figure out how to use them more efficiently by offloading more and more of the lead advisors' time to other team members. Overall, the problem may get worse before it gets better, as there are still only 3 support or associate advisors employed in the industry for every 5 lead advisors; the ratio is worse than it was just a few years ago in 2009, which FA Insight attributes to a combination of firms promoting associate advisors to lead advisors (possibly even before they're ready), and a struggle for firms to even find good entry level talent to fill into the support/associate advisor roles (which is also leading to a significant rise in compensation for support and associate advisors). In fact, some of the standout growth firms are actually hiring outside of financial services altogether - either career changers, or new students just entering the profession - rather than the "traditional" hiring grounds of advisors at other firms, and are also more active in using non-advisors to support advisors in a wide range of positions from operations to professional firm management. These trends are by far more noticeable in firms with $500k to $1.5M of revenue, and especially those at $1.5M to $4M of revenue that are trying to accelerate their growth.

When to Fire a Toxic Client - This article by practice management consultant Christine Gaze looks at the phenomenon of "firing a client", something that many advisors have never done, but those who have state that (if done for the right reasons) the decision can be liberating. When firing clients who are abusive to staff, the decision to fire the client - and stand up for the staff member - can also be pivotal for the culture of the firm, strongly communicating to employees that their dignity and integrity is more important than any client. Of course, advisors shouldn't necessarily just fire every client who has a rude moment, but Gaze does suggest that at a minimum ,advisors should give an opportunity for staff to vent about serious client problems and frustrations, establish a system for staff to raise more significant grievances regarding clients, or even create a system for the firm to identify and focus on its most problematic clients (either to fire them, or at least to address the issue with them). The bottom line: losing a client and the revenue they pay may be tough, but standing up for your staff may have the better long-term return anyway, as the cost of staff turnover will usually far exceed the revenue and profits of any one problematic client.

Rob Arnott and the Rise of Smart Beta - From Investment Advisor magazine, this article looks at the rise of fundamental indexing, where an index is built weighted based not on market capitalization but instead on the underlying fundamentals of the stocks. The distinction is that cap-weighted indexing will be definition overweight stocks that are overvalued and underweight those that are undervalued; the results may look like the stock market, but they will not necessarily be representative of the underlying macroeconomic footprint, and the "father" of fundamental indexing Rob Arnott has research showing that over time this will lead to stronger results for fundamental indexing (some studies suggest a difference of almost 200 basis points of additional returns over time). More broadly, the approach towards alternative ways to build an index has been dubbed "smart beta", which now defines any number of "transparent, rules-based investment strategies that are designed to provide exposure to market segments, factors, or concepts", a blend that is partially passive and partially active (Arnott is often credited with creating the smart beta label, though he states he did not). The caveat, however, is that because "smart beta" is such a loose term, it captures many types of strategies, and not all will necessarily perform well (and many seem to do little more than replicate the value of a simple equal-stock-weighting strategy). Notwithstanding the debate of the terms, "smart beta" has been popular, with research suggesting as much as $180B invested in such strategies ($45B added in 2013 alone), with the bulk invested in Arnott's Research Affiliates Fundamental Indexes (RAFI).

High-Frequency Hyperbole - Last weekend, 60 Minutes aired a segment with Michael Lewis on his new book "Flash Boys" (currently available for deep discount on Amazon!) which in turn discusses the recent innovation of High-Frequency Trading (HFT); Lewis has suggested that HFT is leading Wall Street to be "rigged" against retail investors. In response, AQR Capital Management founder Cliff Asness states in this WSJ article that the stock market is not rigged and suggests that Lewis may have been doing little more than "talking his book" as many investment managers have been known to do as well (though in this case, Lewis was doing it literally!). In fact, Asness claims the reality is that HFT really is supporting a market-maker role and is leading to a reduction in investment costs; Asness notes that his firm intimately studies their transaction and trading costs, and their conclusion has been that HFT really is reducing their costs, in part because computers can make markets faster and easier and cheaper. In fact, Asness notes that why there's a lot of focus on the speed-of-light trading focus of HFTs, the reality is that that kind of speed really only matters for HFTs beating each other (not consumers), and that this intra-HFT competition may actually be helping to further push down trading costs! Furthermore, Asness points out that many of the largest criticisms of HFTs can actually be traced back to traditional Wall Street institutions, that are profiting less on the backs of consumers as they are undercut by HFTs, but in the end that's still driving lower costs.  All that being said, Asness does acknowledge that some HFTs may be negotiating unfair advantages that are bad for markets, and that more transparency would be good; nonetheless, Asness suggests that the bottom line we should really be worrying about is the sheer complexity of how modern markets operate, and that it's the market structure that enables HFTs (and provides us with their benefits) that may be the real risk (which, fortunately, regulators are starting to address).

How to Avoid Hidden Costs in Your Bond Allocations - On Advisor Perspectives, industry commentator Bob Veres looks at how the decision of many advisors to shorten bond maturities to defend against a significant spike in interest rates that hasn't happened may actually have been very costly to clients. In fact, Veres notes that it's quite concerning how significant the shift towards shorter duration bonds has been, which he suggests amounts to little more than making a huge sector bet as though there was certainty about the outcome, and that despite the fact the outcome wasn't certain at all (and many advisors have been wrong for three years as rates are actually lower in early March 2014 than they were in early March 2011) the "bet" continues to be on in many client portfolios. However, in the case of bonds - because there is a certainty to the payments and prices that doesn't exist for stocks - more effective modeling and risk management can be done (especially pertaining to interest rate risk), based on the range of possible changes in interest rates (which may go up, or down, or remain unchanged). So why does all this matter? Because it turns out that when modeling interest rates, it can be mathematically shown that certain strategies are fundamentally inferior in all outcomes based on the shape of the yield curve, and/or can help to quantify exactly what the opportunity cost may be to shifting towards shorter duration waiting for interest rates to rise (recognizing that may or may not happen in a 'timely' manner).  Given that this kind of bond portfolio "shape management" is beyond the scope of many advisors, Veres recommends exploring the tools from Performance Trust Capital Partners (who provide such bond management services).

Vanguard Personal Advisor Services Manages Your Accounts At An Affordable Price - Last year, Vanguard quietly launched a new service called "Vanguard Personal Advisor Services" (VPAS). For a $100,000 AUM minimum and a flat 0.3% AUM fee, the service provides not only an investment management strategy of indexing with Vanguard funds and ETFs with quarterly rebalancing (if investments are off by more than 5%), but also financial planning support from a designated financial advisor with CFP certification. The financial plan will be reviewed and updated annually if desired, and throughout the year clients can email their advisor and/or request a scheduled callback or web video conference. Notably, at a price point of "just" 0.3% (which amounts to a fee of just $300/year for accounts at the $100,000 minimum), Vanguard Personal Advisor Services is remarkably close in cost to many of today's "robo-advisors" but includes full access to a CFP-credentialed human financial advisor as well. For more information, you can check out Vanguard's details on its VPAS offering, or check out "Finance Buff" blogger Harry Sit's three-article review of his experience with VPAS (Part 1, Part 2, and Part 3).

Visual Tools Help Clients Make Complex Decisions - Behavioral economics research is finding that visual tools and analytics can be very effective in helping investors to make decisions, and with a growing range of technology tools it's becoming easier and easier to do so. The research shows that we tend to look at visuals more than written narratives, and can understand them more easily - which is important, because the brain is more likely to fully process information that is easier to understand. That doesn't necessarily mean that all written narratives - e.g., a written financial plan!? - are useless, but studies do suggest that if people are only presented information as a written narrative, they're less likely to act on it and make important decisions. Tools that are interactive and allow for engagement - rather than "just" provide information visually - appear to do even better, and allow people to really learn and master the information. The caveat, however, is that visual and interactive tools can be so powerful, there's also a risk than they may trigger other biases or misconceptions; for instance, one experiment found that mastering a visual interactive investment tool actually led people to be overconfident about their market interactions. The article also partially profiles a tool to help build their visualizations, called FinVis.

Finances and the Aging Brain - From the Wall Street Journal, this article from Jason Zweig looks at some of the latest research on financial decision making and the aging brain. As it turns out, what researchers are finding is that the tendency for increased financial fraud against seniors may be more than "just" a matter of dementia and mental decline; instead, it appears that as people age, their brains become more focused on maximizing positive emotions and social interactions, and more determined to block out negative experiences. This  "socioemotional selectivity" leads older people to pay more attention to those who make them feel content and comfortable (even to the point of neglecting warning signs that might have been obvious at a younger age). Similarly, research is finding that even amongst highly intelligent retirees with no signs of dementia, it may be getting harder for them to distinguish between safe and risky investments; the problem is even worse if/when dementia begins, as those who have been financially successful may remain confident in their abilities even if their actual capabilities have declined. And perhaps worst of all, not only does the quality of decision making decline, and retirees fail to recognize it, but the research also shows that we have little insight in our 40s and 50s into the trajectory of our future declines; in other words, at the point that we could plan further ahead to deal with these challenges, we're unlikely to believe we actually need to do so. The ultimate conclusion: retirees should train themselves to avoid making fast decisions, set up a simple plan and stick to it, and seriously consider having a [trustworthy!] advisor involved before making any important changes to a financial plan (and choose that advisor when the [pre-]retiree is still young enough to be able to make a good decision).

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!