Weekend Reading for Financial Planners (Aug 14-15)

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.

The Senate Passed A Tax And Infrastructure Bill. Here's What Comes Next... (Melanie Waddell, ThinkAdvisor) - The big political buzz this week was the bipartisan agreement for a $1 trillion infrastructure bill (the Infrastructure Investment and Jobs Act) in the Senate, with 19 Republicans joining all 50 Democratic Senators in voting for its passage. Notably, though, the infrastructure legislation is part of a two-track process for President Biden's broader "Build Back Better" agenda, which includes both the infrastructure bill, and a separate (and much larger) $3.5T budget proposal (as part of the annual Federal government budgeting process) that incorporates proposed Federal spending changes and also tax law changes (ranging in areas from family benefits to health care to climate change mitigation) that only requires the votes of Democrats themselves (as it is being passed under the Budget Reconciliation rules that are not subject to a prospective filibuster, as long as they do not increase the Federal budget by more than $1.75T over the next 10 years, and any tax law changes beyond that window sunset after 10 years). The House is expected to vote on the legislation later in August, with a target of completing the legislative process for both bills by September 15th. Ultimately, the exact provisions to be included in the budget reconciliation bill - which is where the tax law changes most applicable to financial advisors and their clients are likely to occur - remains to be seen, though current guidance indicates potential tax rate increases for high earners (above the $400,000 threshold that was part of President Biden's campaign-trail promise), a potential return or at least increase in the cap on the SALT deduction (for state and local taxes), along with potential adjustments to Medicare (though it appears that lowering the Medicare age is now off the negotiating table). Stay tuned for further tax-planning-and-other details next month?

Variable Annuity Settlement With State Regulators Could Lead Insurers To Ramp Up RIA Annuity Oversight? (Emile Hallez, Investment News) - Last week, the California Department of Insurance announced a settlement with Jefferson National Life for its role in approving and fulfilling a $690,000 annuity sale to the 86-year-old client of an RIA to replace two of the client's existing annuities. Notably, the annuities that were sold were Jefferson National's low-fee Monument Advisor variable annuities, which did not incur a commission to the advisor (who was solely an RIA and not licensed to receive insurance commissions). However, the advisor did subsequently include the annuity in their 1%-of-AUM fee, and the client incurred $14,000 of surrender charges to leave her existing annuities for the new ones that were managed by the RIA advisor. Ultimately, though, the California Department of Insurance fined not the RIA itself, but Jefferson National for failing to sufficiently review the recommendation of the otherwise-independent advisor, fining Jefferson National $150,000 in addition to a requirement that the company reimburse the client for the surrender charges she incurred (though the company still denies that the annuities were unsuitable for the client given her overall needs and circumstances). The broader issue that the case highlights, though, is who is responsible for the oversight of annuity sales and recommendations as their use grows in the RIA channel; is it the responsibility of insurance product manufacturers to 'oversee' RIAs that use their products (since technically without an insurance license, the client is really buying 'direct' from the annuity company, who was 'referred' to the client from the RIA, such that the insurer would then bear some responsibility for ensuring the sale is appropriate), which may not be welcomed by RIAs themselves who would then be subject to an insurer's compliance department oversight, or should consumers be expected to hold the RIA accountable directly under SEC or state securities laws for the recommendation itself (e.g., by suing for breach of fiduciary duty if an inappropriate recommendation is made) and the annuity company is simply fulfilling the order? Either way, the settlement highlights the ongoing regulatory gap between the oversight of how products are sold, and how non-sales investment and financial advice is delivered when it also results in the purchase of a product but one the advisor themselves didn't actually sell.

Say Goodbye to the 1% Investment-Adviser Fee? (Neal Templin, Wall Street Journal) - While the ongoing decline of expense ratios on mutual funds and ETFs, and the collapse of trading commissions, has raised the specter that the traditional 1% AUM fee of the financial advisor may be next to face fee compression, recent research by Cerulli finds that, in practice, the average investor with $750,000 paid 1.04% of invested assets in fees in 2020, which was actually up from 1.02% in 2015 (and high-net-worth client fees on a $10M portfolio were up even more, from 0.54% in 2015 to 0.62% in 2020!). However, the ongoing evolution of financial advisor business models is causing at least some clients to begin to shift. Templin highlights the story of one HNW client with "an eight-figure portfolio" who dropped their AUM advisor and hired a new one who "just" charges $450/hour... cutting his annual advice fees by more than 80%(!), for which he states he's getting more services for that fee as well! On the other hand, the story also profiles AUM advisors who serve clients with significant wealth and complexity who absolutely do value the service they're receiving for the (AUM) fee they're charging. Still, though, the rise of other non-AUM models, from flat annual fees to charging monthly subscription fees, or simply charging hourly fees, all of which can now be automated with technology similar to the 'automation' of the AUM fee from client portfolios, is opening the door for at least some clients who feel comfortable handling their own portfolio (or simply buying basic index ETFs themselves, or using a low-cost provider like a robo-advisor to get a basic diversified portfolio) and would rather pay non-AUM fees for non-investment financial planning advice from advisors with non-AUM models. Ultimately, per the data from Cerulli itself, fee compression still doesn't appear to actually be manifesting amongst AUM advisors - at least with the subset of clients who are willing and interested in delegating their entire portfolio to be managed. Nonetheless, when the discussion of non-AUM models - from annual fees to monthly subscription fees to hourly fees - reaches the Wall Street Journal, it's a signal of growing interest from at least some clients in alternative fee models?

Why You Should 'Trial Run' Your Retirement (Christine Benz & Susan Dziubinski, Morningstar) - The traditional approach to retirement planning is to create a vision of what we want retirement to be, determine the financial resources it takes to achieve that vision, and then do the saving and investing necessary to succeed. The caveat, though, is that because the lifestyle of retirement is so different from our working years, sometimes it turns out that we don't actually enjoy what we thought we would. Accordingly, Benz suggests that a better approach is to engage in a "Trial Run" for retirement, to affirm that it really is the lifestyle we want. For instance, those who have a lot of vacation time saved up, have an employer who provides sabbaticals, and/or who work for a small employer who may be more flexible to allow extra (unpaid) time off, consider taking several weeks or a month or two to trial what retirement would actually be like. This provides an opportunity to see if the hobbies of our working years are really what we want 'full-time' in retirement (e.g., "occasional golf that you wish you could do more often may not seem as special if it's all you have to do every day, day after day!?"), and more generally to watch for what new patterns emerge in how we spend our time and focus when we have an extended period of time off from work (not to mention how we spend our dollars to keep our time engaged?). In fact, Benz suggests that for those looking at new activities in retirement, it's a good idea to at least try to start incorporating them before retirement by making incremental adjustments to our time; e.g., if you think you'll do more reading in retirement, start planning more reading time into your day and see if you really enjoy the new cadence (or ditto for more exercising or more volunteer work in retirement). After all, if you're not able to elevate its priority while your life is busy... it may not be something you really want to fully occupy your 'retired time' in retirement?

Buy, Borrow, Die: How The Richest Americans Live Off Their Paper Wealth In Retirement (Rachel Ensign & Richard Rubin, Wall Street Journal) - While ultra-low interest rates have been a boon to mortgage refinancing and reducing the amount of interest that homeowners pay, and have helped to stoke more margin investing in brokerage accounts to similarly take advantage of the low-rate leverage potential, and alternative strategy is emerging for ultra-high-net-worth clients in the low-rate environment: borrowing against their portfolios, or even their privately held company stock, as a way to generate liquidity for their retirement or other spending purposes (from buying a retirement home to a boat to even another business to invest into), but without actually selling the stock (thereby avoiding capital gains taxes, and for business owners the risk that they lose control of their companies), in what's being dubbed the "buy, borrow, die" strategy. After all, the reality is that if the underlying asset can appreciate at a higher rate of growth than the loan charges in interest, the strategy actually increases wealth over time, in addition to avoiding a capital gains triggering event (now with the loan, and potentially in the future by holding until death for a step-up in basis). On the other hand, recent Biden tax proposals have included the potential to eliminate or at least limit the step-up in basis at death - which would convert the "buy, borrow, die" strategy from capital gains avoidance to 'mere' capital gains deferral until death. Yet still, even proposals in Washington are mostly focused on the capital gains side of the equation itself, and not the ways in which borrowing at ultra-low interest rates itself is being used to defer those gains. In the meantime, though, banks are increasingly taking advantage of the lending demand to expand their loan portfolios and generate loan interest, often going so far as to limit the paperwork or credit checks (deemed unnecessary when there is a substantive equity asset available to secure the loan), and even allowing the loan to accrue its interest indefinitely (recognizing that it will ultimately be repaid by an appreciating asset anyway, especially when loan-to-value ratios are often 'just' 25% to 50%), with terms from one bank as low as 0.87%/year (albeit for those with >$100M of assets, for which the bank may also earn an AUM fee to manage those assets).

Why Annuities Work Like a ‘License to Spend’ in Retirement (David Blanchett & Michael Finke, ThinkAdvisor) - To some extent, spending 'conservatively' in retirement is a requirement, given that it has an unknown time horizon that could last years or decades, and that spending may rise a little or a lot depending on what future inflation turns out to be (not to mention the uncertainty of returns on those retirement assets). Nonetheless, the reality is that some retirees really struggle to spend and enjoy their money in retirement... the natural outcome of having spent a lifetime being frugal and diligent in their savings habits, which are hard habits to break once the retirement transition occurs! Accordingly, Blanchett and Finke suggest that aside from some of the potential economic benefits of using annuities as a vehicle to hedge retirement spending uncertainties, that one of the ancillary benefits is that the guaranteed payment from an annuity can serve as a form of "psychological license to spend" their retirement savings, where the annuity payments are viewed as a form of "income you cannot outlive" and retirees have a tendency to want to spend 'only some but not all of' their income (because the rest is preserved for an uncertain future). In fact, the retirement researchers found in a recent study that households that had a higher percentage of their income coming from guaranteed sources (e.g., pensions, Social Security, annuitized income) were more likely to spend their available income in retirement, while those with a more wealth-based retirement income approach spent less of their wealth (even and especially when holding household wealth constant between the guaranteed- and portfolio-based-spending retirees), with a nearly 2:1 difference between the two (i.e., additional retirement assets generated about twice the additional spending behavior when converted to guaranteed income that ostensibly made the retiree more comfortable to spend the income).

A Quick Test Of Your Referability (Steve Wershing, Client Driven Practice) - A wide range of industry studies, including our own Kitces Research, shows that client referrals are the most cost-effective way to grow an advisory firm. However, many financial advisors are frustrated that they're not receiving the level of referrals that they wish. Wershing suggests that for advisors who aren't getting the referrals they want, one of the best strategies is to get a better understanding of how "referrable" you are in the first place... by asking your clients. Specifically, Wershing suggests asking a group of key clients (e.g., from a client advisory board) the simple question "who do you believe are the ideal people to work with our firm?" And see how they respond. If you hear responses like "people who are unhappy with their portfolio" or "someone who needs a financial plan"... you may have a problem. Because while those are certainly benefits of working with an advisor, they're not very unique as to why your clients would refer you, nor are they clear about who exactly would be a good fit (after all, if they're unhappy with their $7,000 IRA portfolio, or they need a financial plan to pay down their credit card debt, they're still probably not actually a good fit for most financial advisors). As Wershing notes, a referral ultimately happens when someone you know is talking with another who could be a prospective client, where that prospect brings up a problem in their lives, and you come to mind as the solution to be referred. And the irony is that if you could be a solution for almost 'anyone', you may not come to mind for anyone in particular. Which is why it's so important to have a clear picture of your ideal client - and to communicate that to your current clients. Because if you're not clear on who our ideal client really is... how could any of your existing clients possibly know who is best to refer to you in the first place?

Why Prospects Choose You (Dan Solin, Advisor Perspectives) - Sometimes the best way to improve your sales process is not to look at how to improve what you're currently doing, per se, but to consider what works and doesn't work when a vendor is trying to sell something to you (and then reflect on how that compares to your own process). For instance, Solin went through a process recently in finding new vendor partners for his own digital marketing platform, when they made a decision to switch from WordPress to Webflow and had to find design agencies that specialized in the new platform. After narrowing down to the 3 finalists - all of whom were prospects trying to sell Solin on their own services - the distinguishing factors of the winner included: they insisted on not just interacting by email or even telephone but by Zoom video, which resulted in a deeper personal connection (such that Solin wanted to work with them simply because he liked them better based on the relationship they formed with the more casual video interactions); and when asking for flexibility on pricing, the winning firm presented an upfront fee schedule with a sliding-scale discount based on the amount of business, while they although two simply said they'd revisit discounts after a certain number of projects (which made it feel like a more guarded and less trusting relationship). Notably, though, it wasn't necessarily just the design capabilities and pricing alone that determined the winner - all three were competitive in those categories either way. Instead - and in effect, because they were so similar in their core capabilities - the winner was the platform that did the best job of establishing a personal connection and mutual trust, instead.

The Three-Question Survey To Send To All Prospects (Sara Grillo, Advisor Perspectives) - When it comes to financial advisors, it's quite common to have 'check-in' meetings with clients and even with prospects, to the point that many advisors have no specific agenda for the majority of their meetings. But Grillo suggests that ultimately, not having an agenda for a meeting effectively means that you will have no control over that meeting, which can be challenging with clients and outright destructive when establishing a relationship with a new prospect. By contrast, the more you understand about the other person and their objectives before the meeting, the lower the risk of failure (and the higher the perceived level of professionalism from the prospect themselves). Notably, though, this doesn't mean that advisors should try to send their entire data gathering form to prospects to understand their entire financial and other situation before the first meeting - that's too much information to request before the relationship is fully established. In fact, because a prospect hasn't yet agreed to commit - by definition of still being a prospect - getting anything out of them in advance of a meeting requires making it as simple and easy as possible for them (which means no clunky fillable PDFs before the first meeting). So what should you ask? Grillo suggests three (and only three) core areas to cover: 1) find out why they are coming to you at this point in time (what are the triggers that have led them to action, because that's where you must start the conversation); 2) find out why they want to work with a professional third party like an advisor instead of doing it themselves (which clarifies how serious they are about hiring a professional); and 3) ask them to describe their strongest professional relationship, and why it's so strong (which helps you get a sense of how they work with professionals, and what their expectations are going to be upfront). And if you're feeling bold, ask one more question - "do you have a need for any accommodations during this meeting" - which may not be relevant to most prospects, but will be a big deal for those who turn out to be visually or hearing impaired, or have food or other allergies, or a back injury, or some other issue that is important to them (and that hardly anyone else ever asks about in advance!).

Our Brains Make Us Way Too Optimistic About Meeting Deadlines (Christopher Cox, Time) - In 1977, Amos Tversky and Daniel Kahneman - who are best known for their "prospect theory" that we dislike losses more than we gain pleasure from gains - coined a term for a somewhat lesser-known but similarly important behavioral bias, known as the "planning fallacy". At its core, the planning fallacy is the phenomenon that we tend to grossly underestimate how long most projects will take (which, in their case at the time, was a textbook that was supposed to be written in 2 years but actually took 9!), and often also involves underestimating the cost (e.g., the Sydney Opera House was commissioned in 1957 and was supposed to be done by 1963 with a $7M budget... instead it wasn't finished until 1973, in a 'scaled-back' version, and still had a final cost of $102M!). As Cox outlines in his book, "The Deadline Effect", the reason for this effect is simply that we tend to be very optimistic in the timetable (and cost table) of a project, and underweight or outright ignore the 'inconvenient' information that might (or should) make us revise the prediction. Such that one famous study found that even when students were asked to predict when their Honors thesis would be done "if everything went as poorly as it possibly could", they were still too optimistic and fewer than half finished by the worst-case-scenario date. So what's the alternative? The key is linking our anticipated goals to our past experiences with similar projects, as once we think about how likely something is to take while considering how long it took in the past to engage in a similar task... our estimates quickly improve. In fact, for tasks that we know will be repetitive, the best approach is to start with the deadline and work backward, setting milestones based on how long it took last time to accomplish the tasks... which both improves the estimate, and also helps us keep better track of whether we're on track along the way.

The Optimal Amount Of Hassle (Morgan Housel, Collaborative Fund) - Functioning as a productive human being in society requires at least some level of compromise; those who are 'allergic to differences in opinion, personal incentives, emotions, inefficiencies, miscommunications and such' have near-zero odds of succeeding in anything that requires other people. In other words, the world isn't perfect and it won't be, and being successful requires learning to put up with, deal with, and accommodate some level of 'BS' and hassle. As while in the 'ideal' world we might just eliminate all the hassles, in practice we wouldn't necessarily enjoy that outcome; for instance, a grocery store could eliminate all shoplifting thefts by strip-searching every customer leaving the store, but that will also drive away all the honest customers from ever wanting to shop there (so the store has 'no choice' but to accept a certain theft cost as a part of the hassle equation). Accordingly, Housel emphasizes that the real key is not learning to avoid hassle, but being able to identify the exact appropriate level of hassle you will (and can, and need to) tolerate... but not one jot more. Which is relevant both in our working lives - people having bad days, office politics, difficult personalities, and bureaucracy - and also in our investing lives (the 'hassle' of a market pullback, or a bad year, or a stretch of underperformance), where again hassle-free perfection simply isn't realistic. We can't eliminate the hassle, but we can try to at least find the optimal amount.

Addition By Subtraction (Bob Seawright, The Better Letter) - One of the most bizarre challenges of the human brain is that not only do we have a wide range of behavioral biases that can impair our 'logical' thinking, but that in many instances, smarter people are more vulnerable to thinking errors (and more generally, being aware of our own biases doesn't seem to help us better overcome them, it just leads us to concoct more plausible justifications for them instead!). Instead, even Kahneman himself, when faced with a question about the same issue of how to avoid being blindsided by our own biases, suggested that the best approach is "ask the smartest and least empathetic people you know to tear your ideas apart". Yet as Seawright notes, despite these seemingly overwhelming odds of being able to overcome our blind spots that at best limit our success, and at worst can get us killed... we're also the species that has figured out how to cure disease, split atoms, and send people to the moon and rockets to Mars. So how do we tilt the scales at least a little more towards being creative truth-tellers who move the world forward, and a little less towards being self-delusional confabulators that impair ourselves? Seawright suggests that the first key is to simply get a clearer perspective on the issue itself, subtracting out everything extraneous - which is a great challenge, because as the recent book "Subtract: The Untapped Science Of Less" suggests, we have an overwhelming tendency to add and complexify instead. How can this be applied in practice? Seawright offers a number of key suggestions, including: rather than trying to 'be better', focus on simply eliminating mistakes instead (e.g., NFL teams that simply turn the ball over less win nearly 80% of the time); automate as much as we can so that we don't have to make as many (potentially flawed) decisions in the first place; build more 'slack' into your life so there's room to be productive; eliminate noise (as distractions can quickly undermine our focus); and be less sure of (and less full of!?) yourself to keep a better perspective so you're more open to the external input that can save you from being blindsided by your own blind spots.

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 Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.