Weekend Reading for Financial Planners (Aug 27-28)

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 27th/28th:

DOL Issues Final Rule To Help States Establish Workplace Retirement Savings Programs (Mark Schoeff, Investment News) - This week, the Department of Labor issued its Final Rule on "Savings Arrangements Established By States For Non-Governmental Employees", which was written to clarify that states can offer state-run retirement plans for workers in the state, without being subject to (or running afoul of) ERISA. In order to qualify as a non-ERISA plan, the state-run retirement program would have specific limitations, including that it be established and administered by the state (though it may contract with others to operate the program), limit the role of employers (to just ministerial activities such as collecting payroll deductions and remitting them to the plan), and be voluntary for employees (though providing for automatic enrollment with voluntary opt-out is permitted). The final rule comes as eight states - California, Connecticut, Illinois, Maryland, New Jersey, Oregon, Massachusetts, and Washington - have already approved legislation to establish state-run retirement plans, and several were preparing to actually implement the plans (pending this DoL guidance). Ultimately, the primary focus of the rule is to make it easier for employees who do not already have access to an employer retirement plan, and don't necessarily contribute voluntarily to an IRA, to have an easier and expedited process using payroll deduction to contribute to a state-run plan, and for states to even implement an automatic enrollment provision (a proposal that at the Federal level has remained mired in Congress for years). Notably, though, the financial services industry has largely opposed the rule, suggesting that employees already have the opportunity to open their own IRAs, that some employers may drop private-sector employer retirement plans to opt for the likely-to-be-cheaper state-run plan instead, and that the DoL exempting state-run plans from ERISA while private-sector plans remain exposed to fiduciary liability creates an uneven playing field. In addition, the Investment Company Institute criticized a particular provision, dubbed "Hotel California", which would allow states to impose restrictions that limit employee withdrawals, potentially barring workers from easily moving their money to private-sector IRAs if they wish. Notwithstanding the objections, though, the DoL rule is now final, and Labor Secretary Perez noted that the aforementioned private market options have already been failing to get a large swath of Americans to enroll into IRAs or their employers to offer them workplace plans; in fact, with the final rule, the DoL also issued a follow-up proposal that would further extend the "state-run" option to any large city/municipality that is at least as populous as the smallest state (Wyoming), potentially opening the path to another 30+ large cities to implement their own version of the new rule if they wish.

A Seven-Step Plan To Transform Your Practice (Bob Veres, Advisor Perspectives) - The world of financial advisors is in a state of flux and transition, from the looming generational shift from Baby Boomer to Millennial clients (who have very different needs and expectations), to the rising role of technology, and the challenges of training new financial advisors in a world that is not as sales- and product-centric as it once was. Veres suggests that advisors have seven key areas that they need to consider, in evaluating this interlocking set of challenges: 1) embrace "robo" technology, especially for the "accommodation" clients below your minimums, using tools like Betterment Institutional, Vanare/NestEgg, Schwab's Institutional Intelligent Portfolios, or Jemstep (or use an outsourced TAMP provider) to reduce your costs to service clients, and get familiar with efficient technology tools that you may ultimately use for all of your clients in the future; 2) add "self-planning" tools to your website, that let clients to engage more in the planning process (and see for themselves when market volatility is not actually endangering their retirement); 3) sunset your AUM fees and begin transitioning to retainer fees instead, at least or initially for your least profitable clients (which you can evaluate by creating a spreadsheet to determine your revenue and cost to service each client); 4) create new services that are relevant for Millennial clients, including debt consulting for those with student loans, spending plans (a/k/a "budgeting"), and guidance about how their managing their career as an asset can have a significant financial impact on their future; 5) begin marketing to the next generation of clients (who will need/demand the better technology and different business models noted earlier); 6) create a strategic vision for serving Millennials (recognizing how your business will change in the coming decade as they soon become the majority of your clients); and 7) reflect on your success, and the fact that changing and adapting your business to the future is not about a failure in what you've built, but simply the next natural stage of your business' evolution.

How To Work Effectively With The Media (Ric Edelman, Financial Advisor) - As the saying goes, "it's not what you know but who you know that counts", but Edelman suggests that the real key to success as an advisor is about who knows you instead. After all, prospective clients can't find you and hire you if they've never even heard of you; financial services is not an "if you build it, they will come" kind of business. Accordingly, getting media exposure can play a key role in success as a financial advisor. Edelman shares his tips, as someone who has had tremendous success establishing a media presence, including: always ask right away what the reporter or anchor's deadline is (because if it's soon, they'll move on immediately if you can't respond in a timely manner!); do some basic due diligence on their identity and who they actually are (as reporters take a different approach than freelancers, and "columnists" are different than reporters because they can and often do infuse their own opinions into the story, rather than just reporting the facts); while you might not end out being quoted at all, be prepared to have anything you say appear in the story (i.e., assume everything is always on the record, unless fully agreed up front before the conversation begins); try to talk in sound bites (as if you can't make the point in a sentence or two, your quote will not appear, or only part may appear and it may not be the part you wanted!); remember that the media is in the information and entertainment business, so being smart and correct are great, but you have to be interesting, too; and remember that whatever you say is going to end out on the internet forever, so don't say anything you aren't completely positive is accurate and correct and will reflect well on you! Ultimately, even all of this goes well, though, recognize that you will be misquoted at some point (usually inadvertent, though sometimes driven by the bias of a columnist), and that if you're provocative in what you say, it may get attention but it will also likely draw competitors who will speak back at you (so consider who or what you criticize, especially if you don't have a thick skin!).

How Advicent's New Portal Product Stacks Up (Joel Bruckenstein, Financial Planning) - Offering some kind of "portal" for advisors and clients is a hot topic for advisor technology firms, and the latest entrant in this space is Advicent (maker of NaviPlan and Profiles and Figlo financial planning software tools), which recently launched its own portal product called Narrator, which has three different components: Narrator Client (the client portal), Narrator Advisor (the advisor portal), and Narrator Connect (for larger firms that want to use the available API to widgetize Narrator capabilities into a custom planning experience). For advisors, the Narrator portal provides a central dashboard to track pertinent client details, such as AUM of clients (both managed and held-away), a client-by-age profile, and when client financial plans were last modified. Further tracking tools available as widgets for advisors to pick and choose, but broadly the goal is to provide both business intelligence, and an understanding of how clients are progressing towards their inputted financial plans. The client portal includes access to their financial plan information, and account aggregation capabilities (powered by Quovo), and information about their current financial position (net worth and cash flow statements). Notably, Bruckenstein did find some minor but important technology glitches and challenges in the new software, most notably that the "recommended" browser is Internet Explorer (even though Microsoft doesn't even use IE anymore!), and the Microsoft-recommended Edge browser did not work with Narrator, nor does Chrome at this time. More broadly, Bruckenstein notes that the portal capabilities of Narrator Advisor are very similar to what a growing number of advisor CRM solutions are also providing these days, raising the question of which software should be the "central" advisor portal (as it's redundant and unproductive for advisors to have multiple overlapping portals), and the same challenge arises for clients who may have a portfolio portal and now a financial planning portal (rather than having one just pass information to the other). Nonetheless, Bruckenstein concludes that Narrator is a worthy product, though it still needs more customization and integration capabilities to be fully competitive (especially if you're not already a Figlo or NaviPlan user). Currently, Narrator is included in the $1,495 retail price of Figlo financial planning software, or can be added for NaviPlan advisors for a standalone $1,495 fee (in addition to the cost of the NaviPlan license).

Buyers Galore For FA Firms, But Challenges Remain For Small Sellers (Christopher Robbins, Financial Advisor) - Notwithstanding the large volume of financial advisors in their 50s and 60s who theoretically should be approaching retirement, sellers still drastically outnumber buyers when it comes to advisory firms. However, the tide is starting to shift, and the past year has seen an emerging surge of selling interest from independent advisors, particularly smaller firms with older advisors being acquired by larger firms run by younger advisors. And this dynamic is creating challenges for sellers, who are outnumbered by the buyers (which generally favors the seller), but are typically less experience with the dynamics of mergers and acquisitions (than the buying firms who often have done multiple transactions already). As a result, while buyers outnumber sellers by as much as 50:1, M&A market prices are arguably still tilted in favor of buyers. To help fill the void, David Grau of FP Transitions has written a new book, entitled "Buying, Selling, and Valuing Financial Practices" to help advisors looking to sell understand how to value their practices appropriately (particularly those who are selling "practices", defined as firms that include some support staff and infrastructure, but aren't self-sustaining beyond the founding owner). The book draws on the more than 1,500 completed transactions that have occurred through the FP Transitions platform.

The Intertemporal Persistence Of Risk Tolerance Scores (John Grable & Wookjae Heo & Michelle Kruger, Journal of Financial Planning) - A long-debated question in the world of financial planning is whether or how stable an investor's risk tolerance is over time; after all, if risk tolerance is not stable, there's arguably little value to measuring it in the first place, if it isn't going to be an accurate predictor of behavior when a risky event actually occurs. And ironically, while psychologists tend to view risk tolerance as being stable, it's financial advisors themselves who often report that clients alter their behavior and financial plans during times of market stress, despite the fact that financial advisors regularly use risk tolerance questionnaires. To evaluate this dynamic, the researchers drew upon actual (but anonymized) client data from FinaMetrica, a psychometrically validated and reliable risk tolerance questionnaire, measured from 4,066 individuals over 5 years from 2010 to 2015, who each had taken the test more than once (on average about 2 years apart). This allowed the researchers to measure how often retest scores were similar to the original risk tolerance score, to evaluate the stability of risk tolerance itself. The researchers found that for initial test scores, both gender, age, and country were predictive (with females showing less risk tolerance than males, older respondents less risk tolerance than the young, and those in the UK with less risk tolerance than in the US). When measuring subsequent re-test scores, the results also showed that women and older respondents were not only more conservative, but tended to trend even more conservative in subsequent retests. However, the overall effect was very small, and overall retest scores varied by less than 1% from the original score, implying that risk tolerance actually is very stable and persistent. Which in turn suggests that to the extent client behaviors do vary in times of market volatility, other factors like risk perception may be the cause, not changing risk tolerance itself (presuming that risk tolerance was measured with a quality questionnaire in the first place, of course!).

Understanding Components Of College EFC (Fred Amrein, EFC Plus) - The Expected Family Contribution (EFC) is the driving factor that determines eligibility for college financial aid. Yet while the EFC is ultimately a single number that quantifies a family's expected financial contribution, it is actually derived from four underlying components: parent's income (which for most is the larger contributor to the EFC, and the higher the income, the greater the percentage that is assumed to be available); parent's assets (including non-retirement assets, but excluding small farms, small family businesses, and home equity) of which 5.64% are assumed to be available; the student's income (which for dependent students is included at a 50% rate, after a small income allowance); and the student's assets (which are counted at a 20% rate, but be cautious about liquidating assets to eliminate them, due both to the kiddie tax, and because the income tax consequences of capital gains can be even more adverse in the EFC formula than the asset itself!). Notably, in addition to the EFC calculation (which comes from the Federal FAFSA form), some schools have their own "institutional methodology" to determine financial aid eligibility (most commonly, one called the CSS Profile), which usually will result in less aid by including types of assets or income than the FAFSA does not consider (and it's up to the school to decide if the CSS Profile will be used or not).

The Alphabet Soup Of Medicare Enrollment Periods (Katy Votava, Investment News) - Medicare has a number of different enrollment periods where seniors can sign up for coverage, but failing to do so in a timely manner and missing out on the enrollment window can result in coverage gaps and a lifetime of higher premiums, so it's important to understand the rules. The first opportunity is called Medicare's "Initial Enrollment Period" (IEP), and it begins three months before the individual's age-65 birth month, and concludes at the end of the third month after the birthday month (though if the birthday is on the first day of the month, the IEP starts and ends one month earlier). Enrolling requires an affirmative action to enroll in Medicare Part A during the IEP. If a person is already receiving Social Security retirement benefits (or more than 24 months of disability benefits), they will automatically be enrolled in Medicare Part A upon reaching the IEP. Either way, the individual must also make a choice of whether to enroll in Part B, and begin paying the Part B premium. If Medicare Part B is declined, it's possible to re-enroll later, but it will be more expensive, unless the individual currently has their own Medicare-equivalent private health coverage (which will make them eligible for a Special Enrollment Period when that coverage ends). However, to be eligible for the Special Enrollment Period (SEP) that comes when Medicare-equivalent private health coverage ends, the coverage needs to be with a group of 20-or-more insurance-eligible members (otherwise it's still necessary to enroll in Medicare Parts A and B to avoid higher premiums later), and it also needs to be "Part D creditable" (providing prescription drug benefits comparable to Part D as well). The SEP itself begins 3 months before employer coverage ends, and winds down 8 months after, but those who need coverage should enroll as soon as possible, or they may have a coverage gap after employer coverage ends (even if they have signed up for COBRA, because COBRA pays secondary to Medicare).

Most FLP Valuation Discounts Would End Under Proposed Treasury Regulations (Michael Kitces, Nerd's Eye View) - Earlier this month, the Treasury issued new proposed Regulations under IRC Section 2704, intended to close a number of "loopholes" in how family businesses obtain valuation discounts for gift and estate tax purposes. In fact, under the new rules, most family businesses will no longer be able to obtain discounts on intra-family gifts or bequests, if the family controls the business before and after the transfer; common discounts that impact valuation, like minority (lack of control) and marketability (limitations on liquidation), would no longer permitted, as the restrictions that trigger the discounts would become "disregarded restrictions" under the new rules. Instead, intra-family transfers would have to be valued using a new "minimum value" formula, which is essentially the fair market value of the entity, reduced by outstanding debts, but ignoring most types of discounts. In addition, if an owner transfers shares within 3 years of death, such that he/she only has a minority stake remaining, the minority discount at death would also be disregarded, if the transfers happened within 3 years of death. Notably, the new rules are not effective yet; a public comment period runs through November 2nd, followed by a public hearing on December 1st, and after comments are considered and a final rule is issued, it still wouldn't be effective until 30 days after being entered into the Federal Register. Nonetheless, given that the IRS and Treasury have been pushing for a crackdown on perceived abuses for more than a decade, it seems highly likely that the new regulations will pass in some form or another, which means the clock is ticking for what may be no more than 6 months until intra-family transfers lose most of their valuation discounts.

What FINRA's CEO Shuffle Reveals About Its Waning Viability (Natalie Carpenter, RIABiz) - Richard Ketchum is now winding down a seven-year tenure as the CEO and Chairman of FINRA, and those who have worked with him over the years are very positive about his legacy of presiding over FINRA during an especially challenging time in the aftermath of the financial crisis. However, FINRA itself still faces a challenging environment, from the Department of Labor's fiduciary rule treading on its 'turf', to some nearly mutinous broker-dealers who see FINRA as more concerned about appearing to crack down on their misdeeds than representing their interests as a self-regulatory organization. More generally, the broker-dealer community continues to lose headcount to registered investment advisers, and while Ketchum made a play during his leadership term for FINRA to become the overseer of RIAs, the organization seems to have admitted defeat on that effort, at least for the time being. Going forward, it's notable that Ketchum is being replaced not by 1 by 2 people: Robert Cook, the SEC's former director of trading and markets, will take over as the CEO, while Jack Brennen, former CEO of the Vanguard Group, will become FINRA's chairman. While some suggest the split roles will be problematic to execute, others suggest it's simply a sign that FINRA is trying to find a path to new leadership and a new vision for itself. Which is important, because FINRA's greatest challenge now appears to be an uncertainty about its vision, and where it fits into the financial services industry overall, as the organization continues to crack down on its own members, small firms complain that FINRA's rules favor their larger competitors, and the world of financial advice continues to shift from FINRA-registered brokers to SEC-registered investment advisers, leading to a 12% decline in FINRA membership over the past 5 years and year-over-year declining revenue.

You Might Really Be A Salesperson [And Not An Advisor] If... (Bob Veres, Financial Planning) - Most people who provide any form of financial advice self-identify on their websites, business cards, and other marketing materials, as financial advisors or financial planners (or perhaps a "vice president of investments"). Yet in reviewing the surveys of the broker-dealers where many of them work, the data clearly shows that even the dually registered reps still typically generate more revenue from commissions on product sales than from fees for advice, raising the question of whether those individuals are perhaps fooling themselves about where their focus really lies. Accordingly, Veres has assembled a number of interesting statements that "financial advisors" sometimes say, that suggest they're really still operating as (and thinking of themselves as) salespeople... for instance, you might still be a salesperson if: your wall is adorned with sales awards instead of certificates showing your professional education and training; you're still accepting upfront recruiting bonuses to switch brokerage platforms or choose broker-dealers based on their product payouts; you talk about your "book" (and are referring to your clients, not something you authored); your solutions are products, rather than advice that helps clients change their behavior; most of the session presenters at the national conferences you attend are wholesalers; your financial planning software's primary output is how much of your products the client needs to buy; the income you earn is called your [sales] "production", and qualifies you for all-expenses-paid sales reward trips; and your meetings with allied professionals focus more on trading new clients than serving existing ones. Ultimately, the point of reflecting on the list is not necessarily to "bash" salespeople, but to recognize that the transition to true professionalism means leaving the salesperson roots, and the sales terminology, behind.

Why The Fiduciary Standard Exists (Blaine Aikin, Journal of Financial Planning) - The more personally invested we are in a personal relationship with someone we trust, the more damaging a potential betrayal can become; we are most vulnerable to those we trust the most. Accordingly, society has long recognized the importance of professional relationships of trust, given that many will admit information to their doctor or lawyer that they don't even admit to fellow family members. And given that some issues will inevitably require a skillset beyond our own personal capabilities - necessitating the engagement of a third-party professional - it becomes necessary to have a means to hold accountable those who operate from such a position of trust. In fact, the modern roots of being a "fiduciary" date back more than 1,500 years to Roman times, where it was already recognized that someone in the position of a trustee should be held accountable to a high professional code of conduct, avoiding conflicts of interest and having a way to mitigate unmanageable conflicts in a manner that serves the client's best interests (the fiduciary duty of loyalty). And given that most conflicts of interest are such because of the potential for the professional to benefit financially from the trust relationship, it seems especially appropriate that a financial advisor would be subject to a fiduciary duty. And in point of fact, many financial advisors already are - under both ERISA, and the Investment Advisers Act of 1940 - though Aikin notes that due to the way those laws are written, and the unintentional "loopholes" that were included, large swaths of financial advisors today do not operate under a fiduciary standard. Instead, they hold out as financial advisors, but operate as brokers facilitating transactions, even though there's a fundamental difference between a transactional broker and an actual advisor, and the Investment Advisers Act stated 75 years ago that brokers can only avoid the fiduciary standard if their advice is solely incidental to a brokerage transaction. In this context, Aikin suggests that the recent fiduciary resurgence, most notably under the DoL's fiduciary rule, is actually not a new or unusual phenomenon at all, and instead it's been the overlap of brokers into the territory of financial advice that was the unusual exception-to-the-rule of our nearly-two-millenia of fiduciary history.

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!

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!