Weekend Reading for Financial Planners (Aug 7-8)

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.

LPL Axes Rep Over Allegedly Racist Hiring Practices (Christopher Robbins, Financial Advisor) - The big industry buzz this week was the story of a financial advisor, Ellen Cure of Cure & Associates, who was called out by a high profile TikTok contributor, Denise Bradley ("auntkaren0"), for the firm's hiring practices, publishing screenshots of a Skype chat between Cure and a staff member that were reportedly leaked to the TikTok influencer, where Cure allegedly stated "Also I wanted to tell you i specifically said no blacks, I’m not a prejudice person, but our clients are 90% white and i need to cater to them … so that interview was a complete waste of my time, so please don’t second guess me or go against what I ask, listen to me and give me what i ask for, please." Given Denise Bradley's significant reach on TikTok, with more than 1M followers who follow her "racist of the day" video shares, the shares ignited a firestorm across social media platforms, leading participants to contact both Cure's firm directly, and her broker-dealer LPL. In response, Cure has stated that she is asking for a criminal investigation into Bradley's TikTok account, citing "threats of violence and bodily harm towards me and my staff and acts which are being investigated as criminal in nature". In the meantime, LPL announced that it would be severing ties with Cure's firm (though broker-dealer recruiters have suggested that she'll likely find another broker-dealer to work with). More broadly, though, Cure's incident has sparked broader conversations amongst the advisor community, about both advisor diversity and hiring practices, and what advisors should do if they are confronted with 'racist clients' who don't want to work with advisors of color, with some claiming that dealing with such clients is simply a challenging business reality that must be accommodated in the financial services industry, and others suggesting that advisors should outright terminate racist clients to put their own employees/teams first.

Advisors Are Utterly Failing To Explain Fees To Clients (Michael Thrasher, RIA Intel) - According to the recent State Street "Low-Cost Investing Survey", nearly half of investors (47%) believe that the management costs (i.e., expense ratios) of mutual funds and ETFs are included in the fees they pay to their advisors or investment platforms. And awkwardly, the percentage was even higher - at 60% - amongst those who are currently working with and paying an advisor, especially amongst younger investors, with 71% of Millennials believing that underlying expense ratios are included in an advisor's or platform's fees. On the other hand, only 51% of Gen Xers and 36% of Baby Boomers believed that their advisory fees included the underlying investment costs, suggesting that investors with more experience working with advisors do eventually learn/discover that mutual fund and ETFs expense ratios are typically a separate and additional cost. Still, though, consumers also have a very different perspective on what constitutes a "low cost" for such funds, with even investors who are familiar with investment costs stating that an expense ratio below 0.61% would be considered "low cost", despite the fact that the asset-weighted average expense ratio of open-ended mutual funds is only 0.51% (and for ETFs, it's only 0.20%!). On the other hand, the survey also highlighted that investment costs still aren't even the primary factor that consumers weigh, with more than half of investors instead prioritizing "risk compared to return" and "quality of stocks in the fund", along with performance compared to peers (46%) and compared to benchmarks (42%). All of which suggests that consumers are perhaps not actually as fee sensitive as many pundits claim... and also that there's still an educational opportunity amongst financial advisors themselves to teach clients how to consider the total cost of an investment relationship with a financial advisor?

Competing for Growth (Kai Upadek, Joshua Zwick, and Kamil Kaczmarski; Oliver Wyman/Morgan Stanley) - This study by Oliver Wyman, in conjunction with Morgan Stanley (informed by interviews with 23 executives at firms representing $34T), identifies four key growth opportunities for wealth and asset managers: Customization, Private Markets, ESG, and Crypto. They forecast AUM by 2025 as $1.5T, $13T, $6.5T, and $0.3T, respectively. With that as a backdrop, what should RIAs view as table stakes and differentiators as it relates to their investment offerings in the coming decade? Thus far, customization is quickly becoming a hot trend, as evidenced by the recent deals by JPMorgan (55ip, OpenInvest), BlackRock (Aperio), Morgan Stanley (Parametric), and Vanguard (Just Invest), with large asset managers, banks, and retail brokerages all preparing for the shift to custom indexing. Notably, direct indexing has been around for a couple of decades, but it’s only in the past couple of years that enabling technology (from technology to manage a large number of stocks, to technology driving the cost of trading commissions down to $0) has come online to give advisors the ability to offer custom indexing at scale, delivering tax alpha, cheap beta, greater client personalization, and/or the ability for advisors to customize their offering (e.g., custom risk exposure, sustainability, tax-efficiency, factor tilts), which is projected to grow at the expense of mutual funds and ETFs. With respect to advisor participation in Private Markets growth opportunities, the report identifies an array of options with various pros and cons that may make more or less sense depending on a firm's scale. As advisors increasingly look to alternatives in a low-interest-rate environment and to respond to client demand, helping to fuel an explosion in funding for platforms like iCapital and CAIS, there are now a broad array of options, including those platforms, going direct to fund-of-funds or alternative managers or, for larger firms, developing their own in-house capabilities. On the ESG front, while adoption in the U.S. has lagged markets like Europe, all signs point to investor interest rising sharply, especially among the younger and more affluent. Oliver Wyman offers up a useful view of ESG success factors along the client engagement lifecycle encompassing how we educate clients, facilitate discussions with clients to uncover their views and objectives in terms of ESG, access solutions, and provide client reporting. Shifting to crypto, the report says it is time for wealth managers to "Decide and Act". They identify six areas to focus on, including Advocacy, Advisory, Access, Portfolio Construction, Portfolio Management, and Custody. Fortunately, an entire cottage industry has sprung up for independent advisors to tackle these and devise their approach. While financial planning may be our ultimate value, and conventional wisdom implies that investment management is commoditized, that doesn’t mean that differentiation in terms of how we personalize portfolios doesn’t exist, and it doesn’t mean that what are table stakes doesn’t continuously evolve. If you haven’t reviewed your investment offering in a while and ignore what’s happening elsewhere in the market, you do so at your own risk?

How RIAs Are Using Direct Indexing, And Why Some Are Steering Clear (Andrew Foerch, Citywire) - With an explosion of high-profile deals where big incumbents have acquired direct indexing solutions, from Morgan Stanley acquiring Parametric to Vanguard acquiring Just Invest, buzz continues to grow for the potential of direct indexing, where firms eschew mutual funds and ETFs and instead use technology tools to buy the underlying stocks of an index directly for client portfolios. For some firms, the approach is becoming a way to implement a more customized or more firm-proprietary approach to ESG (e.g., where a firm starts with an S&P 500 index, but then applies 'personal values' filters and other ESG preferences to adjust the weightings for a more customized allocation). On the other hand, some firms are implementing direct indexing as a way to generate tax alpha on an otherwise passive strategic index fund, as when the client's portfolio holds each of the individual stocks of the index, tax-loss harvesting can occur at the individual stock level to generate ongoing tax alpha (i.e., even if 'the index' is up for the year, if at least some of the underlying stocks of the index are down, there is still an incremental opportunity for tax-loss harvesting that couldn't be done with the index funds but can be applied to the individual stocks that are down). Notably, though, some advisory firms are still naysayers on the direct indexing trend, citing everything from the potential for higher trading costs as firms try to implement a high volume of stock trades themselves, to the risk that clients object to more cumbersome statements that may suddenly have hundreds of line items, and the fact that some direct indexing platforms still have asset minimums of their own that make them not a fit for every client (though ongoing advances in trading operations and fractional shares suggests that direct indexing minimums will fall further and become accessible to more clients in the years to come?).

Journey To 100X Returns In Private Markets (Meb Faber) - When Snapchat IPO-ed back in 2017, the venture capital firm that invested $8M in their early stage growth saw the value of their stake grow to $2B, a return of 24,900% or nearly a "250-bagger" (i.e., where the value increased by 250X the original investment). On the one hand, such returns are truly extraordinary - most investors will never even see "just" a 100-bagger, much less 250X growth. Still, though, the appeal of the potential Snapchat-style 100-bagger is what drives an immense amount of venture capital investing into other risky early stage companies... recognizing that with the potential for a 100X return, a majority of the companies can outright fail and combined returns can still be extraordinary. In fact, Faber notes that he has personally been involved in more than 250 "angel investments" (ultra-early-stage investments into companies that may go big or completely bust). Cumulatively, investing in 250 companies over the past 7 years has involved looking at more than 3,000 companies (which means only about 8% of the companies he looks at ever get an investment)... which already has led to three total wipeouts (loss of 100%), and about 20 companies that have sold and exited (the biggest for a nearly 20X return), resulting in an overall cash-on-cash return of just over 100% over an average holding period of 3 years (which is a strong return, albeit arguably in-line with the level of risk). The key, though, is recognizing that it still only takes one 100-bagger to make it all worthwhile for 'extraordinary' returns, as companies in competitive new spaces often become winner-take-all scenarios with huge returns but huge risks (e.g., with robo-advisors, Betterment is still growing, Wealthfront is struggling, and virtually every other of the zillions of robo-advisor startups are gone now). Ultimately, Faber suggests that being successful in such a private investing space requires not only dollars that you're willing to put at risk (to put at total risk), but also the significant time that it takes to evaluate prospective investment opportunities, which can be done through third-party platforms that help to source deals like AngelList, WeFunder, and EquityZen.

My 'Too Hard' Investment Pile Is Pretty Big (Christine Benz, Morningstar) - Charlie Munger of Berkshire Hathaway coined the term the "too-hard" pile for prospective investments that Berkshire was considering but determined weren't worth the effort because it was outside the firm's circle of competence. Benz notes that in her own investing context, commodities-tracking funds are in her "too-hard" pile, noting that commodities may well turn out to be a good investment, but trying to determine their intrinsic value, investment outlook, and the various vehicles that offer commodities exposure (which can have their own underlying complexities), means that finding the 'right' commodities investment just isn't worth the time it would take to determine the right one (i.e., it's in the "too-hard" pile). Ironically, Benz points out that as her investing knowledge has grown, her "too-hard" pile is actually getting bigger; the more we become consciously aware of what we don't know, the more we realize how limited our own circle of competency actually is, and how much belongs in that too-hard pile. Specifically, Benz's current too-hard pile includes: individual stocks (working at Morningstar herself, Benz has access to all of Morningstar's equity research resources... but also recognizes that her upside return potential is limited given the time it would take compared to just buying a mutual fund or ETF); most actively managed funds (not because funds can't outperform, and Morningstar again publishes ratings on funds, but it's still very time consuming to try to find and vet a fund manager that may only produce a limited level of outperformance); leveraged investing tools (from securities-based lending strategies to leveraged ETFs); and frequent rebalancing (recognizing that once at least some ongoing rebalancing is done, the incremental value of higher-frequency rebalancing is limited at best). What's in your too-hard pile (or perhaps should be)?

4 Tips for Getting Clients Engaged in the Financial Planning Process (Kathleen Boyd, XY Planning Network) - One of the ironic challenges of financial planning is that even clients who reach out to us as financial advisors and hire us to create and deliver a financial plan to them still drag their feet when it comes to engaging in the financial planning process. In some cases, it's because even though they know they need the financial advice and help, the financial planning process (and the big financial plan deliverable) can seem overwhelming; for others, it may be that they simply had 1-2 more 'immediate' issues to solve for and weren't necessarily looking for an entire comprehensive financial plan. So what can advisors do to try to improve engagement with clients through the financial planning process? Boyd offers four strategies: 1) create an "Initial Engagement Plan" one-page deliverable that highlights to the new client what problems the advisor will solve for over the next 12 months (as a more concrete way to demonstrate the near-term more 'tangible' value and why it will be worthwhile for the client to engage in the process); 2) try breaking the financial planning process into smaller, more digestible bites, as it can actually be easier to pursue a series of smaller more near-term achievable goals than one big long-term goal; 3) re-design the firm's data-gathering process to turn it from an advisor-centric process ('get all the data needed to construct the plan') into a more client-centric "Get Organized" meeting that is about helping clients organize their own finances (and in the process, the advisor can glean all the data they need, too); and 4) instead of jumping directly to analyzing how clients can achieve their goals, instead start with an "Explore Possibilities" meeting with a preliminary financial planning project that helps clients figure out what kinds of goals they could achieve if they engage in the process and put their mind to it!

What Clients Want Is Not What They Need? (Brendan Frazier, Advisor Perspectives) - Imagine for a moment a client who goes through your entire financial planning process from beginning to end, and completes everything on time without ever needing a reminder or follow-up about sending in documents or meeting with their CPA or a nudge about opening a new account. If it sounds like a fantastical unicorn, that's the point. Simply knowing what to do - having the information, and even being told exactly what to do - doesn't necessarily yield results and help clients actually achieve their goals. Instead, it takes help in execution to succeed... which Frazier argues is the true value that financial advisors provide. Of course, the recognition that "behavioral coaching" for clients is valuable isn't exactly new; there have been numerous industry studies highlighting the "behavior gap" and the value of advisors in helping clients follow through on their financial strategies and stay the course in times of stress. Still, though, Frazier notes that remarkably few advisors actually promote this value, and don't include any information about their personal coaching... for instance, a value proposition that states, "Hey Mr. Client, if you want to retire in 5 years, you've come to the right place. We'll build a plan to get you there and show you how to invest. More importantly, though, I help you do the things you need to do and avoid the things you shouldn't!" Of course, the caveat is that even when people need help, they don't always ask for it; for instance, even if someone needs a personal trainer, no one says "I want to go to a personal trainer so that I can actually get out of bed in the morning when my alarm goes off and to make sure I do a few extra reps when I'm tired." Even though that's the exact value a personal trainer provides. In fact, a recent Morningstar study affirmed that the value of "Helps me stay in control of my emotions" ranks last on the list of benefits that consumers see in a financial advisor. So what's the alternative? Frazier suggests a strategy from the playbook of "How To Get Kids To Eat Their Vegetables" (hint: blend the spinach into a smoothie): focus first on the issues that are most top-of-mind to the client themselves (what they want), and then deliver what they need to achieve the positive outcomes they'll actually tell their friends and family about.

The Real Reasons Clients Pay Advisors (Lou Harvey, ThinkAdvisor) - In a world where financial advisors often struggle to concretely articulate their value, Harvey suggests that the value of a financial advisor's expertise can ultimately be boiled down to two core domains: 1) providing useful knowledge the client doesn't have; and 2) helping clients to avoid mistakes. In this context, "useful knowledge" can be "a change in approach, the solution to a problem, or an opportunity"... for which the successful advisor develops a repertoire of techniques and strategies that can be applied to and tailored for each client. Notably, because we often don't appreciate new knowledge until we realize the gap in our current knowledge, Harvey actually suggests that it's the more knowledgeable clients who end out appreciating useful knowledge from an advisor the most. Similarly, while advisors add value by helping clients to avoid mistakes, it's often clients who have already made mistakes in the past who most appreciate the value of an advisor in helping them to avoid a similar or otherwise-unforeseen mistake in the future. In fact, Harvey argues that the key to framing advisor value around useful knowledge and avoiding mistakes is to translate that advisor value into concrete scenarios that relate to the individual client. For instance, to not just discuss a tax strategy in general, but specifically how it would apply in the client's world and the concrete value that would be created. Or to not just share how the advisor helps the client avoid mistakes, but to invite them to talk about their challenges and mistakes that have been made in the past, so that the advisor can understand the financial consequences that have occurred, and explain how they would help the client achieve a better outcome in a similar situation in the future. Because once the value of the useful knowledge or avoided mistake can be quantified in the context of the client's own past experiences, it's easier to show how that value can far exceed the fees that the advisor charges for their services!

It Is Okay To Be Profitable (Tony Vidler) - In recent years, the ever-growing focus on cost, from the expense ratios of financial products to the impact of commissions and the advisor's own fees, has led to a growing feeling of fee pressure amongst advisors, and a concern about appearing to be 'too profitable' and being viewed as 'overcharging' clients. Yet Vidler notes that while it is true that some parts of the financial services industry arguably have too much cost and bloat - that competition and fee compression hopefully will whittle away over time - it's important to recognize that the financial advice business is a business... and it's OK to be profitable as a business! Especially since the financial advice business is still a relatively 'volatile' business, from the ebb and flow of commissions, to even the AUM model which does provide recurring revenue, but can still experience a 20%+ revenue decline in a bear market (which for a firm with 20% profit margins, can result in profits crashing by -100% in any particular year!). In fact, Vidler suggests that the focus and ire today is far too much on the compensation of advisors themselves, and not the 'upstream' costs of the financial institutions and product manufacturers that the advice business is built upon, which seem to experience even more stable and ongoing profits at the cost of the small-business advisors who are experiencing fee scrutiny. In turn, Vidler suggests that in the end, even many of the 'woes' of the advice business - including and especially the sale of certain high-commission products - is simply a recognition that this is a hard business to succeed in, much less to be profitable in... such that unfortunately, some advisors find the only viable path to survival (especially in the early years) is to sell higher-commission products. Which isn't meant to be an excuse for the existence and sale of such products, but simply a recognition that while the financial advice business can be lucrative, it is one with highly volatile income, long hours, and a great deal of hard work... which means advisors should have healthy profit margins (at least and especially in the 'good' years) to compensate for the risk-taking and time-intensive nature of growing an advice business?

My Financial Planning Practice: Ten Things I Did Right And Wrong (Allan Roth, Advisor Perspectives) - Having spent his entire adult career as a financial planner (first in a corporate environment, then doing individual financial planning), Roth reflects on his own journey of "what worked and what didn't" in running an advice business. Positive highlights include: the decision to bill hourly (which Roth acknowledges may not be the right model for all advisors or consumers, but was happy with the reduced conflicts he felt in giving a more 'pure' version of fee-for-service advice); his efforts to get quoted in the media, which helped bring in a flow of clients who read an article and wanted his help to solve that particular problem; creating an intake form that prospects must fill out before his initial meetings, that requires going to his website and affirming they've seen his philosophy first (to screen out bad-fit prospects upfront); offering a 'guarantee' in his services (that the client won't be billed until after the advice is provided, and the client can mark "cancel" on any invoice where they feel they haven't received value); not choosing a custodian (as an hourly advisor, he simply bills clients directly, and lets them custody their own assets on whatever retail brokerage platform they wish); and being willing to make enemies (because if you don't stand for something, you don't stand for anything). Challenges and mistakes that Roth experienced in his career include: underestimating the loneliness, especially as a solo practitioner; being overly sensitive to criticism (especially early on when he hadn't yet built his own self-confidence); designing his own website (having a lot of time on your hands early on in your career doesn't excuse do-it-yourself approaches that can undermine your perceived professionalism!); accepting clients he shouldn't have (it's hard to say "no" to bad clients early on when we're desperate for revenue, but advisor happiness rises with client selectivity); underestimating how much his own emotions would be stirred during times of market stress (e.g., rebalancing clients in the middle of the financial crisis!); and thinking the industry had many 'bad guys' and recognizing that often bad products are simply being sold by good people who don't even realize how bad the product actually is (because their sales manager told them it was great and they don't have enough experience yet to know otherwise!).

Play Your Own Game (Morgan Housel) - Different sports have different objectives that require different skills for success; thus why marathon runners and powerlifters have completely different training and exercise regimens, and golfers and mixed martial artists have substantively different skills (even as both compete at professional levels). Housel suggests that the same can be true when we look at "investors" as well, recognizing that in the end, people come to the investing world for sometimes wildly different reasons. Which is important, because if we view investing as having only one purpose, we'll tend to think of everyone else doing it differently as 'wrong'... even though in reality, doing so is akin to the marathon runner yelling at the powerlifter that they're not exercising the 'right' way. Because in the end, we all have different wants and needs, and our decisions are shaped by different prior experiences; thus, for instance, the headline "Is Apple undervalued" is read very differently by a 19-year-old daytrader than an endowment with a century-long time horizon (even though both might be buying the stock). Even Daniel Kahneman, the famed researcher on behavioral finance, once shared his own story of realizing that he felt he had "enough" and wanted to find a financial advisor who would not make him richer, but just help him maintain his current lifestyle... only to be told by at least one advisor "I can't work with you" because she was only focused on investing as a path to increase wealth. Ultimately, though, the key point is simply to recognize that because different people are playing different 'games' in the investing world, we should probably be less judgmental of others who play it differently (because they might not be 'wrong', just different). And that in the end, what's really important is to figure out the game that we want to play for ourselves, and focus on what works for us (even if others may do it differently). Which arguably holds for a wide range of personal and professional decisions in life!

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.

Gavin Spitzner contributed this week's article recap on "Competing for Growth".