Weekend Reading For Financial Planners (August 12-13)

Massachusetts Launches Investigation Into Brokers' Use Of AI

(Ryan Neal | InvestmentNews)

Developments in Artificial Intelligence (AI) and related technologies have been making headlines regularly for the past several months, as companies roll out new product offerings and observers consider whether (or not) these technologies will enhance or displace certain industries or jobs. Yet while there are many potential benefits to AI (from creating marketing content to speeding data analysis), some finance industry regulators have worried about the potential for AI to be used to harm consumers (whether through outright fraud, deceptive marketing practices, subpar standards for service, or simply training the algorithms to provide recommendations that may favor the firm and its offerings over other alternatives), an extension of numerous recent regulatory actions against robo-advisors by the Securities and Exchange Commission (SEC) that similarly found that algorithm automation hype didn't always live up to its promise.

For instance, the SEC in late July released a proposal (now in the midst of a public comment period) aimed at addressing potential conflicts of interest associated with the use of predictive data analytics by investment advisers and broker-dealers when working with clients. Specifically, the SEC proposal would require a firm to eliminate or neutralize the effect of conflicts of interest associated with the use of predictive analytics technologies. Further, the proposal would require firms that have client interactions with these technologies to have written policies and procedures in place to abide by the rules and would implement recordkeeping requirements.

Following on the heels of the SEC's proposal, Massachusetts Secretary of the Commonwealth William Galvin this month announced that his Securities Division would launch an investigation into how firms are using AI to engage with Massachusetts investors, sending letters to 6 companies (including larger broker-dealers such as JP Morgan Chase and Morgan Stanley, as well as to advisor technology platforms, including Savvy Advisors and Hearsay Systems) seeking information on how they are using AI in their business activities. Echoing some of the SEC's concerns, Galvin expressed interest in how advisory firms are ensuring that the technology they use is not putting the firm's interest ahead of their clients' – in essence, scrutinizing not the AI itself, per se, but how the company's developers are programming and training the AI to ensure it really gives best-interests advice.

Ultimately, the key point is that while technological advancements offer significant promise for advisors in supporting their clients, they also raise the specter of potential abuse by steering clients to investments or other products that would be more financially favorable to the advisor or their firm – a problem that the industry has long struggled with when sales organizations masquerade as advisors, and is now extending into the domain of AI-driven interfaces as well. Which means that the SEC and (perhaps increasingly) state regulators will ultimately have to weigh whether current regulations regarding conflicts of interest are sufficient to protect investors (as 'conflicted advice' has already been under scrutiny), or whether the potential benefits of new regulatory proposals outweigh the compliance costs it would impose on advisory firms using these AI technologies (potentially discouraging well-meaning firms from using them in ways that could help their clients?).

Bill To Allow Use Of 529 Funds For Advisor Credential Courses Gains More Support

(Mark Schoeff | InvestmentNews)

When it comes to education planning, 529 plans are generally considered one of the most, if not the most, tax-efficient ways of saving for future expenses. Contributions to such accounts receive no special tax break at the Federal level (though many states offer a deduction or credit for such contributions, particularly if made to an in-state-sponsored plan), but distributions, including earnings, that are used to pay for qualified education expenses are not subject to Federal income tax.

Qualified education expenses eligible for this tax-free growth treatment are typically expenses associated with higher education, such as tuition, fees, books, and supplies for college or graduate students, as well as room and board expenses for those enrolled at least half-time. In recent years, qualified education expenses have been expanded to also include other expenses, such as up to $10,000 of tuition expenses annually for K-12 education (via the Tax Cuts and Jobs Act) and up to $10,000 of lifetime qualified student debt (via the SECURE Act). And for those who were not able to use up the funds in their 529 plans for any of these purposes, SECURE Act 2.0 introduced the possibility of (Iimited) 529-to-Roth IRA transfers.

In March, bipartisan legislation was introduced in both the House and the Senate that would expand the uses of 529 plans further, to include covering the fees and expenses associated with acquiring or maintaining postsecondary credentials. Under the proposed legislation, 529 plan funds could be used for tuition, books, and testing costs for programs accredited by the National Commission on Certifying Agencies or the American National Standards Institute (notably, such programs include the CFP and CPA certifications). Since the legislation was introduced, the companion bills have received a wave of bipartisan support, with the House version up to 53 cosponsors and the Senate bill having 8. The bills have also received support from industry organizations, including CFP Board and the Financial Planning Association (which has encouraged its members to write to their legislators to encourage passage of the bill).

Altogether, while the legislation has not yet been scheduled for a committee hearing in the House or Senate, there appears to be strong momentum behind this effort, which, if passed, would further expand the opportunities for using 529 plan funds, not only for financial planning clients, but also for aspiring CFP professionals (as the costs of meeting the education and examination requirements for CFP certification can add up!) as well as experienced advisors considering a new (qualifying) professional certification!

Investors Expect Investment Returns Twice As High As Advisors: Survey

(Alex Padalka | Financial Advisor IQ)

Experienced financial advisors typically come to the table with years of experience in financial markets that help them have a longer-term view of market performance. However, prospective and current clients might have different expectations for their portfolios, whether as a result of incomplete knowledge of market returns or perhaps a bias towards returns experienced in recent years.

Reflecting this scenario, a recent survey by Natixis Investment Managers of 700 investors with at least $100,000 of wealth found that respondents expect average annual returns of 15.6% above inflation(!) over the long term, more than double the expected returns financial advisors reported in a separate survey. The recent survey also identified a disconnect between investors and advisors in terms of defining risk, as only 9% of investors define risk as failing to meet their financial goals, whereas 3X as many advisors view it this way (investors were more likely to associate risk with market volatility, loss of assets, or underperforming market benchmarks).

The survey results also show the potential need for advisors to educate prospective clients about how certain investments perform in different environments. For instance, while 56% of investors claimed to understand what happens to bonds when rates rise, only 3% correctly identified that present bond values typically go down while future income potential goes up when rates rise. In addition, some investors might have overly skewed expectations about index funds, as 59% assumed index funds are less risky than other investments, and 66% think index funds will help minimize losses (which could result in disappointment when the index a specific fund follows falls in value).

Overall, the survey shows that while investors and advisors might have some mismatched expectations, investors are still looking to professionals for financial advice, with many respondents expressing interest in receiving retirement income planning/advice (cited by 53% of those surveyed) as well as general financial planning (42%). Further, 89% of respondents with advisors expressed trust in their advisor, suggesting that when advisors are giving advice (perhaps even advice that goes against the client's initial expectations), their clients are likely to be receptive to it!

ESG Strategy Receives Tough Feedback In Latest Bloomberg Survey

(Tim Quinson | Bloomberg News)

Environmental, Social, and Governance (ESG) investing saw a boom in the wake of the pandemic, with assets in ESG funds growing 53% to $2.7 trillion in a single year between 2020 and 2021. But more recently, skepticism of the practice has increased, driven in part by broader questions about the criteria that different funds use and, more specifically, exactly what the term ESG means.

According to a recent survey by Bloomberg of users of its terminals, those who are not directly engaged with ESG are (perhaps unsurprisingly) skeptical of the concept, with almost 90% expecting ESG funds to lag behind market benchmarks in the next year and almost 70% calling it nothing more than a fad. And even among those respondents who are engaged with ESG, 55% were pessimistic about these funds' ability to beat the broader market. Further, of those who were engaged, only 18% expect ESG issues to become more critical in business and markets, down from 25% the last time the survey was conducted.

Survey respondents, particularly those based in the United States, predicted that the moniker 'ESG' could be changing. For instance, some respondents called for the separation of the 'E', 'S', and 'G' factors, as they are not unified criteria, making it more difficult to create coherent funds. Others suggested that the political backlash from some legislators towards ESG investing could lead some firms to stop using the term 'ESG' (while perhaps still supporting efforts that lead to positive environmental, social, and governance outcomes without the ESG label).

Ultimately, the key point is that while there appears to be skepticism towards ESG investing among some investment professionals, interest among some investors in aligning their investments with their values (ESG or otherwise) is likely to continue. Though given the time required to craft and implement an ESG strategy (e.g., determining whether a specific fund actually meets their client's goals), some advisory firms might decide to make ESG investing central to their investment process and value proposition while others, taking into account the growing time commitment needed to effectively implement an ESG strategy, might decide to eschew it altogether!

A Comprehensive Guide To Biblically Responsible Investing

(Jake Ridley | Church Fiduciary)

When it comes to values-based investing, Environmental, Social, and Governance (ESG) criteria are often the first thing that comes to mind. But because investors might have a variety of other values-based criteria that they would like to implement with their investments, fund managers have created a wide range of actively managed funds to meet this range of needs. One set of values-based funds are those that invest on Biblically Responsible Investing (BRI) principles, also called faith-based investing, which have gathered estimated assets in the 10s of billions of dollars.

At its core, BRI seeks to align an investor's faith with their investments. But because interested investors come from a wide range of faith backgrounds and have different values-based priorities, finding a BRI fund that meets these specific criteria can be challenging, if not impossible. For instance, one investor might want to avoid investing in companies that produce alcohol but is fine with investing in gun manufacturers, another investor might have the opposite preferences. Further, while BRI funds state their objectives screening criteria in their prospectuses, investors might disagree with how certain companies are evaluated. For example, a fund might state that it invests based on the principle of respecting the value of all people, but an individual investor might disagree with how this criterion is applied when filtering stocks.

Beyond the challenge of identifying a BRI fund that aligns with a client's specific values, advisors can also help clients evaluate whether investing in these funds is worth the sacrifice in terms of expense-adjusted returns. For instance, like many actively managed funds, BRI funds tend to have higher expense ratios than broader-market index funds. Further, Ridley found that several popular BRI funds have experienced significant periods of underperformance compared to the broader market or a passively managed target date index fund.

Altogether, advisors working with clients interested in BRI can play an important role in helping them evaluate their investment options and the potential consequences of using this approach. Further, given the challenges of using funds to invest based on a BRI approach (from finding a fund that closely matches the client's values to the expenses associated with a given fund), advisors with clients interested in this investment style might instead consider implementing this strategy through direct indexing, which can allow for greater customization at the individual client level, potentially at a lower cost (though, given the adjustments being made to the index, performance could still deviate from the benchmark being used)!

Fractional Shares Democratized Investing, Now They're Making Things Personal

(Doug Fritz | Wealth Management)

Over the past decade, 'fractional share trading' has become an increasingly popular way to bring stock trading to the next generation of (still young and small-dollar-amount) investors. Popularized with young-investor-focused new stock trading apps like Robinhood and Stash, the ability to buy fractional shares makes it feasible to invest as little as a few dollars at a time into the stock market, as someone who doesn't have enough to even buy a single whole share of stock can still become a shareholder.

While fractional share trading might have been popularized as a way for young investors to 'get into the game', additional use cases are gaining in popularity, particularly related to direct indexing. These include personalization of portfolios, which has gained in popularity as more investors seek to invest based on their individual preferences or values, as investors can use tools like direct indexing to customize an index (buying [fractional] shares of selected index components rather than the full index itself). In addition, fractional share investing opens up direct indexing's tax benefits (e.g., tax loss harvesting, as a client can sell individual index components that have gone down in value even when the index itself has appreciated) to a wider pool of investors (as this tactic was only previously available to those who could purchase sufficient whole shares of component companies to match the weighting of the overall index). Finally, Fritz also suggests that companies might start offering fractional shares of their stock to their customers to build loyalty and a sense of ownership among their users.

In sum, fractional investing is no longer 'just' for younger investors, but rather can be leveraged by advisors (through tools like direct indexing) to support a broader range of clients, whether they want to invest based on their personal preferences or in a more tax-efficient manner!

Why COIs Don't Refer Business

(Penny Phillips | Wealth Management)

Financial advisors are often just one of a group of professionals (e.g., accountants, estate attorneys, and others) providing advice to a given client. Sometimes a financial advisor will identify a need to bring one of these professionals into the client's circle; for example, the advisor might recommend that a client meet with an estate attorney to have estate documents drafted. Often, an advisor will refer the client to a specific professional with whom the advisor's clients have worked in the past. And while an advisor might expect a reciprocal relationship with these Centers Of Influence (COIs) and receive referrals from these professionals, this is not always the case.

Phillips suggests that financial advisors who are frustrated with a lack of referrals from COIs can consider several steps to be more intentional about their relationship with these professionals. First, because COIs sometimes are unsure of the actual work a given financial advisor does, advisors can gain traction by clearly explaining to COIs what they do and who they do it for (without using financial industry jargon that might be unfamiliar to the COI). In addition, advisors can be more direct in asking COIs to make referrals, with a pitch that highlights, among other things, how the advisor's ideal clients are similar to the COI's clients as well and that such a relationship could be mutually beneficial to both advisors (and their clients).

Given that nurturing COI relationships takes time, advisors can gain efficiency by conducting an audit of their current COI relationships. For example, a COI who has never made a referral back to the financial advisor or one who serves clients that do not fit the advisor's ideal target client profile might not be good candidates for outreach. In addition, advisors might find success reaching out to COIs beyond 'traditional' partners. For example, wedding planners, divorce attorneys, or business coaches could all become valuable sources of referrals, depending on the advisor's target client.

Ultimately, the key point is that referrals from COIs do not happen automatically, even if an advisor regularly refers clients to the COI. But by being selective about the COIs with whom they engage, clearly explaining their potential value to the COI's clients (and to the COI themselves), and staying in regular communication (treating them like valuable clients), advisors could potentially increase the number of high-quality referrals they receive from these allied professionals!

If Your Referral Network Isn't Working, Check Your Connections

(Charles Ratner | Wealth Management)

An important skill for financial advisors is to understand their client's unique attributes, from their goals to their risk tolerance, which are almost certain to be different from the advisor's own preferences. But when it comes to working with Centers Of Influence (COIs), advisors sometimes assume that they share similar goals to serve their own clients well and to make referrals to each other where possible. However, Ratner suggests that those taking this transactional view can miss the underlying motivations of these COI partners, which can lead to a disconnect between the 2 sides and fewer reciprocal referrals.

Advisors can start by listing COI partners with whom they are having trouble connecting and then put themselves in the COI's shoes, asking questions to which the COI would want to know the answers before making a referral (and to get as specific as possible). For example, the COI might want to know how they will work together with the financial advisor on a common client situation (e.g., what tax planning services will be provided by the financial advisor, and what will be the role of the accountant?). Relatedly, COIs will likely want to know how they will benefit from working with the advisor, for example by providing a higher level of service to clients or receiving referrals themselves. COIs might also want to know when and how to engage the financial advisor (and vice versa), which can help them identify the right time and circumstances to make a referral.

In sum, financial advisors can develop better relationships with COIs by considering the key questions the partner would want to ask before making a referral and crafting a 'pitch' that conveys this information in a way that helps the COI recognize the value the financial advisor can provide and the potential for a mutually beneficial relationship!

A Can't-Miss Way To Build COI Relationships

(Stephen Boswell | Wealth Management)

While many financial advisors recognize the value of relationships with COIs, their communication with these professionals is often ad hoc (sometimes occurring only when a client has a specific need related to the COI). Without a regular process for communication, these relationships can grow stale over time and the flow of referrals from these partners can dry up.

In order to help these relationships thrive (for all parties), Boswell suggests a 3-part process that advisors could use to nurture relationships with COIs in a range of fields as well as their clients. The first step is to hold 1-on-1 educational calls with the COIs where each party can offer current insights into their respective spaces. For instance, a financial advisor could offer an update on the investment environment while an accountant could discuss trends they have identified in clients' tax returns during the previous year. Next, the financial advisor could organize roundtables with non-competing COIs (e.g., an estate attorney, accountant, and real estate agent) to discuss key issues in their fields that might be of interest to the rest of the group. Finally, the financial advisor can approach selected COIs to conduct client-facing webinars, which can provide exposure for the COIs to each other's clients.

Together, this process not only can help financial advisors show their value to COIs, but also to the COIs' clients. Which could not only lead to future referrals from the COIs themselves, but also to direct inquiries from their clients who are attracted to the advisor's expertise and value proposition!

Decision Time

(Brett Davidson | FP Advance)

Being a business owner requires an individual to make a steady pace of decisions that not only affect the business, but also its employees and clients. But when it comes to making 'tough' decisions, particularly those that will disappoint a staff member or client, it can be tempting to procrastinate, hoping that the situation will resolve itself naturally.

However, Davidson suggests that this approach can be counterproductive, not only because the decision will likely need to be made eventually, but also because the business can suffer along the way. For instance, a firm owner might be reluctant to fire a long-serving employee whose performance has started to lag. Davidson notes that while letting the employee go might be painful (for both the owner and the employee), making the decision and executing on it can not only improve firm performance, but also support other employees (who possibly had to 'pick up the slack' for the underperforming staff member). Another example of a difficult decision firm owners face is whether to move on from clients who do not bring in revenue commensurate with the amount of time it takes to serve them. While the firm owner might be reluctant to move on from the relationship (and the revenue that it does bring in), it could ultimately be in the best interests of the firm, which will free up time to work with higher-revenue clients. And in this latter case, the firm owner can help soften the blow by helping the former client find a new advisor (because one firm's 'C' client might be another firm's 'A' client!).

Ultimately, the key point is that firm leaders are often faced with tough decisions regarding personnel, clients, and other relationships. But because, as Davidson notes, "Bad news doesn't get better with time", making the decision and following through on it sooner rather than later is often the best course of action for the firm!

5 Things You Must Stop Doing To Achieve Success

(Matthew Jarvis | Advisor Perspectives)

There is no shortage of 'new' ideas for how advisors can improve their craft and the success of their business. But Jarvis suggests that following pieces of 'tried and true' advice that has stood the test of time can help advisors avoid distractions and serve their clients more effectively.

For instance, it is important for advisors to recognize that there is a cost to saying 'yes' to every opportunity that comes their way. Because an advisor only has so many hours in the day, any time they add an additional responsibility or pursue a 'shiny object' is time that cannot be used for a potentially more productive task. Next, turning off device alerts can help advisors avoid distractions, whether they are in client or team meetings, or are engaging in focused work.

In addition, making a conscious effort to avoid being late to meetings can show respect for clients' and colleagues' time. Which could mean not just showing up on time, but rather arriving early and ready to go before the other participants join. Relatedly, following the adage of 'practice makes perfect' can help an advisor ensure that they will be prepared to perform at a high level during each client meeting. Finally, advisors can potentially boost their productivity by avoiding dwelling on the problems they face and instead look for opportunities and solutions to improve their practices.

In sum, these time-tested pieces of advice, while not the latest 'new' trend', can help advisors be more efficient and better serve their clients. And so, whether it is taking a moment to turn your phone alerts off or setting aside time to practice before delivering a financial plan to a client, adopting these simple actions and sticking with them could pay off with better productivity for years to come!

If All You Want Is Money, These Financial Advisors Might Say 'No Thanks'

(Joe Pinsker | The Wall Street Journal)

While new financial advisory firm owners might be willing to take on any client who is willing to pay their fee in order to 'keep the lights on', those with more mature practices often have the luxury of being more selective with the clients they take on. This often manifests itself in advisors moving 'upmarket' over time, serving increasingly wealthy clients who pay larger advisory fees.

But for some advisors, helping High-Net-Worth (HNW) and Ultra-High-Net-Worth clients build their (already significant) wealth is not particularly satisfying and instead seek clients that align with certain values. For instance, some of these advisors limit their client base to those with charitable intent, so that the advisor's planning work could benefit society as a whole rather than 'just' the clients and perhaps their heirs. Others who previously worked with HNW and UHNW clients decide to eschew this client category altogether, instead preferring to work with clients with lower net worths, where planning support could make a material difference in their lives (e.g., helping someone to maintain their lifestyle in retirement as opposed to enabling a client to buy a 2nd vacation home).

In the end, one of the benefits of working as a financial advisor is the opportunity to work with a broad range of clients. And while some advisors might enjoy helping HNW and UHNW with the planning challenges they face (and reaping the rewards in terms of higher fees), others might prioritize factors other than investible assets, such as charitable intent, when it comes to identifying the ideal target client type that will bring them the most professional satisfaction!

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We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog.