Weekend Reading for Financial Planners (Aug 26-27)

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 August 26th/27th:

New FiduciaryPath Survey: DOL Fiduciary Rule Does Not Cost Investors More or Limit Investor Access to Advice or Products (Kathleen McBride, LinkedIn Pulse) - One of the most widely debated issues around the Department of Labor's fiduciary rule is whether, as many broker-dealers claim, the new rules will limit the ability of financial advisors to serve "small" investors or reduce access to advice and products. A recent survey of 777 financial advisors from FiduciaryPath, though, finds all the hand-wringing about consumer access may be for naught. For instance, the survey results found that when advisors are asked directly whether it costs consumers more to work with a fiduciary advisor than a broker once all-in financial advisor costs are considered, a whopping 73% say "no", fiduciary advice is not more expensive, and 57% state that a fiduciary duty for brokers would not reduce product and service availability. In fact, 80% of financial professionals indicated that they expect their Assets Under Advisement to stay the same or increase under the new fiduciary rule. Notably, though, the results did indicate that commission-only advisors (understandably) have more concerns, with only 48% expecting their assets under advisement to increase or stay the same, although advisors engaged in a blend of fees and commissions remain optimistic (at 78% anticipating no decline in AUA after the fiduciary rule takes effect). And of course, the reality is that brokers who operate on a commission-only basis are technically not in the business of advice in the first place (as their advice must remain solely incidental to their brokerage services to avoid the requirements to register as an RIA!). Nonetheless, the bottom line was that in the end, a mere 3% of financial advisors of any compensation type actually agreed to the statement that they will stop providing advice on qualified retirement accounts in a fiduciary world.

A New Kind Of Doctor's Office Charges A Monthly Fee And Doesn't Take Insurance (Lydia Ramsey, Business Insider) - While most consumers are accustomed to getting their health care by visiting a local doctor's office, submitting insurance information, being seen by the doctor, and then paying any co-pay or coinsurance obligation (while the doctor's office files a claim for the rest), in recent years a new type of doctor's model is emerging: dubbed "direct primary care" and around since the late 1990s (but gaining more momentum in recent years), the practices don't accept insurance at all, and instead simply charge an ongoing monthly membership fee that covers everything from doctor's visits themselves, to many types of prescription drugs and lab visits that can be purchased at 'wholesale' prices (plus perhaps just a small 10% markup). Part of the competitive advantage for direct primary care physicians is that, thanks to less overhead for handling insurance filings and claims, they can generate similar revenue but see fewer patients (with direct primary care doctors keeping no more than 500 - 1,000 patients, compared to 2,000+ for typical family practice doctors), allowing more time for each visit, and more flexibility for scheduling appointments. Notably, direct primary care is different than the emerging "concierge medicine", where the former may cost no more than $100 - $200/month, and the latter may cost thousands per month; the distinction is that direct primary care isn't meant to replace the full spectrum of health care needs, but simply a different way to access primary care doctors directly, and in fact most people who purchase direct primary care subscriptions also still maintain at least some level of health insurance (for the major health issues that can still crop up and require more than just a primary care doctor). Notably, though, while direct primary care itself is still not full-scale health insurance, the IRS does treat the monthly fees as a form of insurance payments, which means those who participate in direct primary care can't contribute to an HSA (nor are the direct primary care fees eligible for tax-free HSA withdrawals).

The Doctor Is In. Co-Pay? $40,000. (Nelson Schwartz, New York Times) - Offering high-end services for the wealthiest Americans has become an increasingly popular model for industries from airplanes to cruise ships and amusement parks, and now it's coming to the medical world, in the form of a new movement dubbed "concierge medicine". Although notably, while concierge medical practices that offered private access to doctors for guaranteed same-day appointments has been around for decades, a newer form is emerging that blends together both boutique doctors, and high-end hospital wards, in a service offering that looks more like a "family office for medicine" model. Doctors are limited to no more than 50 families each, who will see patients at their home, workplace, or even an airport if necessary and pressed for time, and may help coordinate the health care of all family members (e.g., from a teenager at college who needs a local psychiatrist for depression, to grandparents who need coordination of treatment in a nursing home). And if a serious health issue arises, the private doctor will work to locate top specialists nationally, secure appointments, and then travel with the patient on the visit (even if it's across the country). And the top concierge doctors may also be able to help get more rapid access to specialists who otherwise have long waits, leveraging their personal networks of doctors. The costs, however, are substantial, ranging from $25,000 to $80,000 per family, which covers everything from access to and visits with the doctor themselves (but does not include the costs for hospitalization, and the emerging "high-end" VIP wards of certain hospital facilities), though such annual costs are still "moderate" for the wealthy in ultra-affluent areas (e.g., Silicon Valley in northern California).

Advisor Creates Platform For Lifetime Health Care Planning (Christopher Robbins, Financial Advisor) - Given the availability of health insurance in the workplace, most financial advisors don't focus on health insurance issues until clients retire, and must navigate the decisions of post-employment health insurance and Medicare enrollment. To help support advisors on a wider range of issues, J. Heywood Sloane of Diversified Services Group launched HealthStyles.net, which aims to offer tools that foster better discussions between advisors and clients (and their doctors) about health care decisions, including educational modules about the various options that may be available at various stages of life (and the software itself segments into those in their 20s and 30s as individuals, in their 30s and 40s in their "family years", and for those in their 50s and 60s and beyond approaching and entering into retirement). Although the solution is aimed primarily as an offering that advisors (or other large firms) might offer to clients to help them be more educated on health care issues, the educational tools also give information for advisors to help them be "fluent" in relevant medical topics. Of course, the reality is that most advisors historically haven't delivered on health care and health insurance planning with this level of depth, but Sloane suggests that as investment management becomes increasingly commoditized, that health care planning (i.e., planning for the finances around health care) may become an appealing value-add opportunity for advisors.

First Look: Whealthcare Planning (Joel Bruckenstein, Financial Advisor) - While the advisory industry has been increasingly focusing on the "risk" of clients passing away and bequeathing their assets to their next generation heirs (who the advisor may lose as a client), the reality is that the more immediate threat for many clients is simply the risk of health- or age-related issues that impact their finances before they die. Yet unfortunately, financial advisors tend to have very limited training and tools to help clients with health care planning, beyond recommending that they get health and long-term care insurance. To bridge the gap, doctor and CFP Carolyn McClanahan has launched a new platform called Whealthcare Planning, to help advisors work with clients on health care issues. The software is broken up into three modules: Financial Caretaking Plan (a 30-question exercise about the client's current financial caretaking arrangements, and then helps identify gaps and set parameters about engaging financial caretakers), the Whealthcare Risk Profile (which covers not investment risk, but the risk of cognitive decline and deteriorating financial literacy that can impact decision-making in the later years), and the Proactive Aging Plan (which allows clients to specify their living preferences, quality-of-life directives, and attitudes towards medical treatment, along with providing an estimate of personal longevity). The idea is not only to help clients plan around their future healthcare needs, but specifically to understand how their needs might vary from other clients (for instance, clients who are healthy but prefer proactive medical care may still incur more costs than others who are less healthy but more hands-off on their medical treatment). And with an increasing focus from regulators on being able to assess and assist older clients facing cognitive decline, Whealthcare may also help advisors establish a framework for handling older clients in such situations.

Wall Street Profits By Putting Investors In The Slow Lane (Jonathan Macey & David Swensen, Wall Street Journal) - Legally, institutional brokers are supposed to execute stock trades on the exchange that offers the most favorable terms to their clients (e.g., best price, highest likelihood of execution), but the rise of order routing rebates, which provide kickbacks to brokers for routing orders to particular exchanges, is potentially distorting the marketplace for best execution. The compensation for order routing is so miniscule – fractions of a cent per share on each trade – that no individual investor is likely to notice, even though the aggregate kickbacks for order routing amounts to billions of dollars a year to brokerage firms. And the data suggests that the incentives really are having an impact on the decisions of brokerage firms, as publicly available trade and quote data shows that the queues to buy and sell stocks are considerably longer on exchanges that offer kickbacks (implying that brokers are routing orders to those exchanges, despite knowing that the queues to trade are shorter at non-kickback-paying exchanges). Notably, the launch of the IEX exchange (highlighted in Michael Lewis' "Flash Boys") was intended to expose this problematic behavior, and in fact the exchange is quickly coming to dominate... in its first full month of operation, it offered the best effective spread on 412 of the S&P 500's stocks, rising to 497 out of 500 stocks a few months later, and 500-out-of-500 stocks in June; by contrast, before IEX's arrival, the Nasdaq led the effective spread rankings with "just" 169 to 216 of the 500 stocks. Yet despite the narrower spreads, and the fact that competing exchanges have 96% higher spreads than IEX's for stocks in the S&P 500, so far IEX still has just 2% market share... suggesting, once again, that the fact it doesn't offer order routing kickbacks, while other exchanges do, is distorting order execution in favor of brokerage firms and at the cost of investors. Which raises the question of whether order routing kickbacks may soon see increased scrutiny, and whether the SEC will begin to more vigorously enforce its existing best-execution rules.

How Fair Is Stock Trading? The SEC May Soon Decide (Annie Massa, Bloomberg) - In light of recent debates about the fairness of current market exchanges given the commonality of order-routing kickbacks, the SEC is considering a pilot program that would test an alternative to the current "maker-taker" pricing approach used by NYSE, CBOE's BATS, and the Nasdaq. The concern of the current approach is that, as the exchanges pay certain traders to participate on the exchange (to "make" a market), while charging others for execution (to "take" the trades), there may be incentives that discourage brokerage firms from ensuring that the takers/traders actually get routed to the best exchange for execution. The alternative is a "taker-maker" model, where those who trade against the open orders get paid, and those who want to make the market must pay for the opportunity to do so – roughly akin to charging a cover to enter a desirable nightclub, the goal is to equalize the entrance fee to participate, and reduce the incentives for investors to be steered towards one exchange over another. Notably, the popularity of the current maker-taker pricing model, and the order routing rebates it includes, was itself a 'disruptive innovation' of the 1990s, and something that electronic upstarts of the time used to loosen the grip that the NYSE and Nasdaq had on stock trading at the time. Nonetheless, regulator scrutiny on order routing, and the impact it may be having on brokerages properly pursuing best execution for clients, is now on the rise, most recently with an investigation launched by the Massachusetts State Securities department exploring whether the incentive payments are creating inappropriate conflicts of interest. Other alternatives to address the issue include reducing the limits on what exchanges can dole out in rebates, offering flat rates for order routing, and/or simply forcing brokerages to release more information about where they send orders so investors can better hold them accountable.

How To Get A Free ETF: Forget The Fee Wars, Find Short Sellers (Camila Russo, Bloomberg) - While the primary focus of ETF price competition is simply on lowering expense ratios, another way that investors can manage their costs is simply to allow their ETF holdings to be used by short-sellers, as the securities lending fee that is paid can offset 40% to 100% of an ETF's underlying cost. Notably, the securities-lending strategy is common to stocks, but impossible for mutual funds; it works for ETFs, though, and the volume of ETF short selling is on the rise as hedge funds increasingly use ETFs to manage their (short) market exposure, which creates opportunities for investors to profit by making their ETFs available to short sellers. Yet in practice, just 5% of ETF assets are actually held in funds with securities-lending programs, far behind conventional equities (as by comparison, over 25% of the Russell 3000's market cap is now sitting in securities lending programs). Of course, it's important to note that securities-lending to short sellers does entail at least some operational and counterparty risk, which may be why some ETFs have not yet been engaging in the practice. And short-selling ETFs really only works for the short-sellers themselves when there's enough depth and liquidity to the ETF's marketplace, which is why the bulk of ETF short selling happens with "larger" ETFs that have at least $1B under management. Nonetheless, the opportunities remain significant; for instance, investors in the iShares iBoox $ High Yield Corporate Bond ETF (ticker symbol: HYG), generated $21M from securities lending on the shares, which is actually more in income than iShares generated from the expense ratio to offer the fund in the first place!

Performance Fees: An Idea Whose Time Has Come (Jeffrey Ptak, Morningstar) - Most mutual funds (and the financial advisors who use them) levy fees as a fixed percentage of AUM, which at best may decrease as assets increase, but short of that are fixed... regardless of the actual performance of the investment manager. Yet arguably, the fact that fund managers are getting paid the same thing, regardless of whether performance is good or bad, is part of why consumers are increasingly adopting passive index funds instead – after all, if the average fund manager gets paid the same regardless of whether he/she outperforms or underperforms, why bother paying for a poorly-incentivized active manager at all? So what's the alternative? Performance-based fees, also known as "fulcrum fees", which only pay the investment manager some specified amount or percentage after beating a specified benchmark index. And if the investment manager doesn't outperform, the performance-based fee isn't paid. The hope is that a shift to performance-based fees can shift the incentives of investment managers to focus more on the long term; after all, if the only way they get paid is to beat a benchmark, there's little appeal to index-hugging (as even just slight underperformance to the index due to index-hugging and low active share would drive the manager's compensation straight to zero!), and increased trading activity due to window-dressing isn't really appealing to the manager either (as it's not about showing a volume of activity... just investment results!). Similarly, fund managers would be better incentivized to manage the size and capacity of their funds, as a larger fund that can't be deployed effectively to beat its index would pay less to the manager than keeping the fund smaller and more nimble to actually be able to outperform. Notably, there aren't many academic studies that have proven that performance-based fees actually work to incentivize and produce better performance, although in part this appears to be because so few use performance-based fees, it's been difficult to implement an effective study to analyze them. Nonetheless, some early movers are already experimenting with the approach – as Ptak notes that the AllianceBernstein "AB FlexFee" family of funds will soon be launching with performance-based fees, where the fund's management fee can fluctuation from 0.05% to 1.05% depending on the prior year performance against a (legitimately challenging) benchmark. Though ironically, Ptak notes that one of the challenges of getting the industry to shift to performance-based fees is that, because it's so hard to outperform, fund managers themselves may be reluctant to make a switch... which means it will likely take a rising consumer demand for such products to really create an industry shift.

How The Advisor's Role Is Being Radically Transformed (Charles Paikert, Financial Planning) - In its latest "Global Wealth 2017" report, Boston Consulting Group predicts that the role of the financial advisor will be substantially transformed, from one that has a heavy focus on administrative tasks to support existing clients during normal office hours, to one that will increasingly delegate such administrative tasks to technology and require substantially more formal education. BCG predicts this shift will occur as a result of both the rising availability of technology tools, consumer demand for more value-add from advisors, and the possibility that even regulators themselves will begin requiring advisors to possess more formal financial education (beyond just the basic Series exams). In turn, this will lead wealth management firms to increasingly hire new advisors directly from universities, and put them through formal training programs. And at the same time, the actual role of the advisor itself will shift, into three main relationship manager archetypes: The Orchestrator (who caters to select HNW clients and serves as the trusted point of contact who orchestrates amongst specialists); the Enabler (who works with a large number of sophisticated self-directed clients and helps them navigate their available options and choices); and the Guardian (who services wealth clients who are uncomfortable with or uninterested in markets and digital tools, and would rather concentrate on personal interests over investments).

Financial Coaching Is A "Thing" (Saundra Davis, Medium) - Coaching is all about helping people to discover and clarify their goals and objectives, encouraging self-discovery of values and priorities, eliciting strategies and solutions, and then holding clients accountable. Notably, these roles may sound substantively similar to what most financial planners do for their clients, but a key distinction is that advisors are typically prescriptive – we try to tell clients what they should do – while financial coaching is typically focused on helping clients figure it out for themselves (recognizing that deep down, most people already know that they need to change certain behaviors, and that getting them to own the decision to change is crucial in getting them to actually follow through on it). Yet unfortunately, the reality is that financial coaching techniques have not been historically taught as part of the curriculum for financial planners. That is changing, though. The FPA Residency program teaches financial planners to deliver a financial plan without any planning software, and a heavy focus on coaching clients through the process. And Davis herself is now teaching a "Coaching Skills For Financial Planners" program through Golden Gate University. Other emerging coaching and training programs include a new Financial Behavior Specialist certification from Drs. Ted and Brad Klontz through Creighton University, and the conferences and other educational programs from the growing Financial Therapy Association. The bottom line: as financial planners increasingly focus on not only advising clients about what to do, but actually being their accountability partners in helping them to do it, expect the focus on "Financial Coaching" to continue to rise... and that advisors will increasingly be expected to actually learn and train in the techniques of how to be an effective coach!

The Youth-Led Rebellion Brewing In Financial Planning (Bob Veres, Financial Planning) - There is a growing generational friction emerging between the founders of advisory firms, and next-generation advisors (and future owners). The fundamental challenge is that advisory firm founders are often comfortable with and happy with the current results of their firms, and consequently are not very interested in changing – such as by expanding their services to younger (and potentially less profitable) clients, adding "robo" solutions, and changing their fee structure. Instead, the response is that the younger advisor can implement those changes after the founder retires. Yet the challenge is that the friction is leading those younger advisors to leave and start their own firms, before any succession plan can ever be implemented! Of course, the irony is that many of the Baby Boomer founders of today's advisory firms were themselves visionaries who wanted to buck the status quo of the time, leading them to create fee-only financial planning firms in an era that was entirely focused on commissions and product sales. Yet as the cycle plays out again, Veres predicts that soon, thousands of younger advisors will become fed up with the unwillingness of their current firms to change, and who are more intent on changing the (advisory) world than squeezing out a few more dollars of profit for their existing firms, and will all strike out on their own, following a similar path to the prior generation, of firms that initially will struggle, but eventually will adopt new tools and technology and win market share away from today's advisor incumbents... just as it played out with the last generational rebellion in financial planning.

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.