Weekend Reading for Financial Planners (Apr 8-9)

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 8th/9th:

DoL Fiduciary Rule Delayed, But It's Not Entirely What Was Expected (Fred Reish, National Law Review) - This week, the Department of Labor officially released its newly OMB-approved final regulation to delay the applicability of the fiduciary rule by 60 days, pushing the applicability date from April 10th out to June 9th instead, despite receiving almost 193,000(!) comment letters about the delay, of which a whopping 90% opposed any delay. However, the regulation that was ultimately approved wasn't merely a simple 60-day delay; instead, it was a 63-page regulation that included several notable surprises. In particular, during the 'transition period' between the applicability date and January 1st of 2018, firms will no longer be required to comply with the full-BIC exemption and provide the originally-required fiduciary disclosures nor declare fiduciary status to clients, and instead advisors themselves must simply adhere to the Impartial Conduct Standards (to provide Best Interests advice, for reasonable compensation, while making no misleading statements); in addition, during the transition period, annuity agents will not be required to comply with the Best Interests Contract Exemption, and instead can continue to rely on PTE 84-24. The end result of these changes is that firms struggling with the original April 10th applicability date to comply with the Best Interests Contract Exemption will really have until January 1st of 2018 to implement most substantive compliance requirements, and won't have to fear DoL enforcement nor class action lawsuits in the interim (as if the advisor doesn't have to acknowledge fiduciary status during the transition period, there's no exposure to a private right of action); the delay provisions also mean that independent annuity agents won't need to worry about finding a "Financial Institution" to work under for full-BIC compliance until 2018. The good news for the industry is that this means the 60-day delay was really more than a 60-day delay for many key compliance provisions. The "bad" news, however, it that this makes it less likely for any additional delay beyond the 60-day period, given the 90% negative comment letters against the delay, and the fact that the industry has already been granted additional transition relief, making it more likely that the DoL fiduciary rule will still stay on the books. In the meantime, though, there's still the possibility that the rule will be adjusted further, with the comment period still open for President Trump's requested review of the fiduciary rule, and time through the end of 2017 to make at least modifications to the rule before its full-BIC provisions take effect next year.

CFP Board Launches New "I'm A CFP Pro" Campaign To Promote Industry Diversity (Kenneth Corbin, Financial Planning) - With the percentage of female CFP professionals stubbornly stuck at 23% for a decade (and the percentage of CFP people of color "significantly less" than that), the CFP Board is launching a new initiative to try to grow the ranks of new CFPs, particularly amongst Millennials, women, and people of color. Dubbed the "I am a CFP Pro" campaign, the CFP Board will try to communicate the benefits and opportunities of becoming a CFP professional (both financial, and the non-financial benefits like building relationships with clients and the potential for a career with good work-life balance), particularly by highlighting the stories of a diverse range of successful CFP practitioners through a combination of videos (highlighted below) and a new (still-under-construction) website. The initiative is intended to both help attract more young people to financial planning overall – given the looming shortfall of financial planner talent given the high average age of financial advisors – and also to better reflect population trends, with the US projected to become a majority-minority nation by 2043.

SEC Explores Ways To Strengthen Compliance Of Independent Advisers (Mark Schoeff, Investment News) - At a recent compliance conference, the acting director of the SEC's Office of Compliance Inspections and Examinations (OCIE) noted that the SEC has increasing concern about the rise of independent advisers affiliating with RIA platforms as "1099" advisers, as opposed to investment adviser representatives who are salaried employees of the RIA. The problem is that SEC examiners are finding a different level of compliance amongst employee representatives versus independents, who almost by definition are more independent and less tied to the parent RIA, and therefore may be less tied to the firm's compliance oversight and processes, not unlike the challenge of overseeing independent 1099 brokers at an independent broker-dealer. As a result, acting director Peter Driscoll suggested that the SEC may soon publish a Risk Alert about the issue, implying that RIAs with independent 1099 advisers may soon get more scrutiny about how they exercise compliance oversight of those advisers in their upcoming SEC exams (which, although infrequent, are trending higher as OCIE tries to increase its exam cycle frequency). Notably, though, the top SEC concern for advisors at this point is still cybersecurity, and there will likely be more guidance forthcoming on that issue soon as well.

No Going Back [For Broker-Dealers] (Dan Jamieson, Financial Advisor) - With the rise of the fiduciary era and the shift to fee-based accounts, which transcends "just" the DoL fiduciary rule, broker-dealers are experiencing radical transformation as they are forced to quickly evolve into robust solution-providers for advisors, not simply product intermediaries for hire providing basic back-office and technology. Thus, for instance, independent broker-dealer Commonwealth Financial characterizes itself as a service company first, a technology company second, a giant RIA third, and a giant broker-dealer as fourth; similarly, Cambridge Investment Research is also moving away from calling itself an (independent) broker-dealer, given that it now offers services through multiple B/Ds and RIAs, along with specialty units to support consulting, practice management, and technology. In fact, because of this channel convergence, many broker-dealers are especially eager to see a uniform fiduciary standard emerge that captures all broker-dealer and RIA activities under a single compliance framework, to simplify the process of oversight across less-and-less differentiated channels. The challenge, however, is that the roots of brokers at broker-dealers is still with a product-centric (or at least, investment-centric) value proposition, which means as the advisor value proposition shifts to becoming more advice- and financial-planning-centric, not all broker-dealers have the advisors on board, nor the right systems to support them. In turn, this is leading broker-dealers to refocus on what they can really do well, or not, which will likely lead to some broker-dealers to merge for economies of scale, others to leveraging outsourcing, and still others paring down their offerings or technology stack, trying to go deeper and get better at supporting advisors (or a particular type/style of advisor) than just proliferating the range of available products (as was so common in the past) and trying to compete on price and payouts. And all of this looming change means there's also likely to be a substantial uptick in advisors changing broker-dealers in the coming year or two, as firms settle on their new strategy, and advisors decide whether their now-current platform does or does not fit their business needs of the future.

Not All 90% Payouts Are Created Equally (Mark Elzweig, ThinkAdvisor) - Unlike the world of wirehouses, where payouts to advisors are often in the 45% to 55% range, the world of independent broker-dealers typically offers payouts that begin at 80% and can rise as high as 90%. However, as Elzweig notes, just looking at the payout rate can be deceiving, because at independent broker-dealers there are typically three components to advisor payouts, that can substantially impact the net amount that comes to the advisor's bottom line. Beyond the stated payout rate itself – e.g., 90% – advisors must also be cognizant of: ticket charges on trades (e.g., for stocks, bonds, mutual funds, alternatives, etc.), which might be $20/trade at one broker-dealer and $28/trade at another, or have a cheaper trade amount but a lower payout (e.g., only 75% to 80%) on transaction business; fees to custody assets, which might be combined with ticket charges, or have its own bps fee for use of the platform (or a requirement to use certain mutual funds or ETFs that are providing sub-TA fees, 12b-1 fees, or other revenue-sharing or shelf-space agreements to the broker-dealer to subsidize its income); and monthly fees that may be assessed for various services and solutions, from E&O liability insurance, to paying for compliance oversight, or paying for various components of the B/Ds technology stack (and in some cases, they're all grouped up into a single 'association' or 'affiliation' fee). Which means ultimately, it's crucial to consider what services and technology the advisor will use, and how the B/D charges for them, or there's a risk that the firm with the highest payout rate might combine with the highest costs and actually produce a smaller bottom-line take-home income for a particular advisor.

Big RIAs Now Face Their Own Breakaway Movement (Matt Sonnen, Financial Advisor) - The "breakaway broker" movement began in the 1990s, as discount brokerage plus the rise of the internet created the first really robust RIA custodian platforms that could provide an ecosystem for brokers to transition to if they left a wirehouse to become an independent RIA. Notably, that meant most of the early RIAs were still people who had cut their teeth at a wirehouse to learn the business as a captive employee, and went out later to become an independent advisor. As this first generation of breakaways gained momentum, "middleware" platform providers and aggregators began to emerge that would offer transition assistance and a "plug-and-play" technology stack to help breakaway teams get up and running quickly. However, in recent years, a new secondary "breakaway" trend has been emerging – where brokers who broke away from a wirehouse subsequently break away, again, from their middleware provider, once they've successfully navigated the transition, and get their feet under themselves as an independent RIA, leading to slowing growth of those platforms (and even a total shutdown in the case of Sanctuary Wealth after an 8-year run). And now, as the RIA community continues to grow, Sonnen notes that there is a third generation of breakaways emerging – teams within an independent RIA, that break away to form their own standalone RIA, taking with them a subset of junior advisors and administrative staff. Ironically, the emergence of "Breakaway 2.0" and now "Breakaway 3.0" are both testaments to the success of the RIA channel itself. But they also raise the specter of troubling new challenges for large RIAs, and the platforms that serve them.

The Impact Of Guaranteed Income And Dynamic Withdrawals On Safe Initial Withdrawal Rates (David Blanchett, Journal of Financial Planning) - Most research on safe withdrawal rates looks "just" at the retirement portfolio itself, appending those retirement distributions on top of available sources of guaranteed income. However, Blanchett notes that incorporating guaranteed income directly into the picture can alter the "safe" initial withdrawal rate, especially for retirees who have any level of flexibility to their retirement spending. After all, those with guaranteed income sources face limited impact to their total spending if their retirement withdrawals have to be trimmed slightly – for instance, a 10% spending cut from the portfolio is only a 5% total spending change if the portfolio only fuels half the retirement spending on top of guaranteed income in the first place – as contrasted with those who rely solely on their portfolio and therefore any change in portfolio withdrawals is a direct impact to total retirement spending. In fact, for those with a healthy level of guaranteed retirement income, and at least some income flexibility (as measured by a utility function with moderate risk aversion), Blanchett finds that safe withdrawal rates of 5% may be quite reasonable with historical returns, and 4% withdrawal rates can be reasonable even with reduced future return assumptions. In fact, once the desire (or not) for income stability is considered, the percentage of total wealth that is allocated to guaranteed income is the greatest driver of sustainable withdrawal rates from the non-guaranteed portfolio portion, and has a larger impact than the breakdown of discretionary vs nondiscretionary spending needs, return assumptions, or the percentage allocated to equities. Notably, the point here isn't necessarily about allocating all retirement assets to guaranteed income, which may not produce enough cash flows to satisfy the retirement goal in the first place, but simply that as the base of guaranteed income rises, so too does the reasonable safe withdrawal rate from the portfolio that is paired with it.

Why Advisors Should Scrutinize Mutual Funds That Hold ETFs (Bryan Borzykowski, Financial Planning) - Adoption of ETFs continues to grow, not just amongst consumers and financial advisors, but also with mutual fund managers, with an estimated $150B of ETFs already purchased in 2017 by institutional and retail fund managers. However, a new study recently published by Sherrill, Shirley, & Stark entitled "What Do ETF Positions Tell Us About Mutual Fund Ability?" finds that actively managed mutual funds that hold ETFs underperform actively managed mutual funds that hold stocks and bonds directly, by 0.41% to 1.63%/year. The problem is not only that, compared to owning stocks and bonds directly, even low-cost ETFs still add another layer of cost (which can drag down performance if they have low active share), but also that mutual funds trading in ETFs with higher active share are more likely to execute poor market timing and produce inferior results. Notably, the study found that small allocations to ETFs within a larger mutual fund weren't necessarily problematic; it was the mutual funds that held the largest percentages in underlying ETFs that were the most likely to exhibit subpar results. Which means, at a minimum, if you're going to consider using a mutual fund whose manager buys ETFs – instead of engaging in direct security selection and purchases of stocks and bonds – you'd better be really, really sure they're able to add value above and beyond just buying those ETFs directly (or another manager that doesn't add an ETF cost layer)!

HNW Clients Find Tax Shelter In Conservation Easements (Donald Jay Korn, Financial Planning) - A conservation easement occurs when a property owner "donates" the development rights on a property to a preservation charity, ensuring that the property will not be developed in the future, and allowing the donor to obtain a charitable contribution deduction for the value of the easement. Of course, the caveat is that the individual must own a substantial tract of land in the first place, in order for the strategy to be worthwhile; nonetheless, for those who do own large plots of land, the strategy can be appealing. Notably, donating development rights as a conservation easement means the owner keeps the property itself, which can subsequently be kept in the family, bequeathed to the next generation, or subsequently sold – although the value of the property itself will likely be reduced with the development rights already donated away (as it's the reduction in value itself that generates the charitable deduction in the first place). In fact, to execute the strategy, it's important to get proper third-party appraisals of the property, of its highest and best use both before and after the easement is put in place, to substantiate the value of the deduction. And the deduction itself is generally capped at 50% of the individual's AGI (with the right to carry forward the unused deductions up to 15 years, or absorbed by other income-creating offsets like partial Roth conversions). But for those who plan to keep the property anyway, and want it to remain undeveloped and preserved, the opportunity to obtain a substantial tax deduction for donating a conservation easement can be very appealing. Especially since some states will supplement the tax benefits by providing a state-level deduction or credit, on top of the Federal charitable deduction for donating the conservation easement. Though advisors and their clients should beware the recent IRS Notice 2017-10, which warns that there are some promoters aggressively trying to syndicate conservation easement transactions as a pass-through entity that can leverage up the value of the tax deduction, which may not be substantiated.

How To Learn New Things As An Adult (Olga Khazan, The Atlantic) - Throughout our lives, we hear and 'learn' an extraordinary amount of information, but unfortunately most of it is long since forgotten (from the capital of a distant land, to how the Krebs cycle works). And in a world where more and more information is available at our fingertips – thanks Google! – there is worry that our personal knowledge is just going to get worse, as we can more easily rely on outside sources. To explore these dynamics, education researcher Ulrich Boser recently published a new book, aptly entitled "Learn Better", which explores what we can do to keep learning, especially as adults who are long since out of school. Notably, though, the starting point is just to recognize that "learning" something doesn't just mean memorizing it; the true application of learning is when the knowledge shifts our reasoning abilities, so we can actually think with and apply the knowledge. As a result, learning itself requires the application of knowledge; reading, re-reading, and highlighting material you read is actually quite ineffective at truly learning it, compared to answering questions about the material or otherwise trying to apply it. This is always why teaching or explaining ideas to other people is actually so effective for learning; because the process of assimilating the information to teach it also means you really learn it to the point of being able to apply it. Similarly, getting feedback about when you're doing something wrong (or applying the information wrong), is also critical to learning, because it forces you to think through why your answer was wrong, and apply the correct information and reasoning framework instead.

How To Read (Morgan Housel, Collaborative Fund) - One of the most common themes amongst those who are highly successful is that they tend to read, a lot. As Charlie Munger is known to say, "In my whole life, I have known no wise people who didn't read all the time. None. Zero." Yet the irony is that beyond learning the letters to read the words, most of us are never taught how to really read, in a way that we can actually learn. To explore this, Housel asked a series of people how they read – what are their habits and approach to reading, to meaningfully take in all the information. The responses are fascinating and worth a read (no pun intended!), but highlights include: try to read what's of interest, and don't worry about highlighting passages unless it's really meaningful to you (as you probably won't have time to go back anyway, and the really salient points will likely stick in your mind anyway!); if you're going to capture notes/highlights, type them up afterwards, both so you can file away the key points for future reference, and because the process of doing so helps to cement the learning process; look far and wide for ideas of what books to read (we maintain a list of recommended reading for financial advisors here on the blog for those seeking new ideas!); it's easier to read when you make reading part of a routine (e.g., read at night after the kids go to sleep, or on the subway during your commute); don't feel bad if your attention wanders to lots of different books, or if you get bored with a book and want to start skimming ahead (it's normal, even/especially amongst prolific readers, to skim or never finish books!), and many people engage in reading 2+ books at once (and shift back and forth to whatever strikes their mood at the time); and lots of prolific readers are using e-books on devices like the Kindle, although many active readers still prefer to get the physical books (to each their own!).

The 1 Percent Rule: Why A Few People Get Most Of The Rewards (James Clear) - Over 100 years ago, Vilfredo Pareto first noticed that a small number of the pea pods in his garden produced the majority of the peas, and found that the principle applied to other natural phenomena and even the distribution of wealth, leading to what is now known as the Pareto Principle, or more commonly as the 80/20 rule – where 80% of the results are attributable to just 20% of the participants... from 80% of Italian land being owned by just 20% of the people (when Pareto studied it), to the fact that 20% of the NBA franchises have won almost 80% of the championships (technically, 75.3%). Clear suggests that the reason these results continue to persist, across a wide range of scenarios, is known as the "Power of Accumulative Advantage" – the fact that if one participant in a competitive environment is even just 1% better, he/she gets a little bit more of the results/benefits, which allows them to reinvest for more growth/success, and the compounding effect over time leads to outsized differences in results; for instance, in the Amazon rainforest, there are 16,000 different tree species, but just 227 "hyperdominant" species (that grow just a little bit taller and faster, and end up getting more soil and sunlight as a result) end up accounting for 50% of the total trees (despite being just 1.4% of the tree species). In human competitions, the phenomenon even leads to winner-take-all scenarios; for instance, the Olympic racer who is 1/100th of a second faster doesn't just win a portion of the medals, but can win all the gold medals. The significance of this is that it means to win in competition – including in business – it may not be necessary to be drastically better than everyone else, as just identifying small opportunities to be just 1% better can, compounded over time, lead to outsized results. In other words, it's not necessary to be twice as good to get twice the results; just be 1% better for a sustained period of time.

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.