Weekend Reading for Financial Planners (August 23-24)

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 23rd/24th:

TD Ameritrade Offers Refunds To Managed-Accounts Customers With Losses (Trevor Hunnicutt, Investment News) - This week TD Ameritrade announced a new "guarantee" for investors in its Amerivest managed-accounts service (which is backed by Morningstar asset allocation models): if the portfolio posts negative returns (before advisory fees) in two consecutive quarters, TD Ameritrade will rebate the client's AUM fee for that time period. The new program, which will apply to new accounts and any existing accounts that deposit at least $25,000 in new assets, follows on the heels of a similar "accountability guarantee" program announced by Charles Schwab last year (covered in a previous Weekend Reading), though TD Ameritrade claims its rebate program was planned long before Schwab's guarantee. Notably, because the Investment Advisers Act of 1940 limits ways that investment professionals can share in the gains/losses of their clients, TD Ameritrade sought out a "no action" letter from the SEC to affirm that the SEC would not block its rebate program (the program appears to have been upheld in part because TD Ameritrade does not directly select the investments in the portfolio, relying instead on Morningstar's managed accounts division, which in turn is compensated by licensing and asset-linked compensation but not direct performance fees). For further detail on the refund program itself, see this letter that TD Ameritrade's lawyers sent to the SEC. The ultimate question: with behemoths like Schwab and TD Ameritrade offering some form of refund guarantee, will the pressure build on independent RIAs to offer a similar program?

5 Ways to Grow Referrals from Centers of Influence (Julie Littlechild, Julie Littlechild's Blog) - In this article, Julie Littlechild looks at the ways that "typical" advisor referral strategies with Centers of Influence typically fail, from not nurturing the relationship with the COI enough (or giving it enough time), to failing to prove yourself and establish credibility first, to not clearly articulating your ideal client and in what situations a referral from the COI is appropriate. But Littlechild makes the point that the biggest blocking point may be the fact that advisors view COI relationships as a business-development-first strategy, when instead it should be viewed as a client-first strategy; in other words, build relationships with COIs first to simply provide a better comprehensive solution to clients where you can work jointly with the COIs, and then let the referrals come second. And of course, recognize that not all COIs will necessarily be a good fit in the first place (which is OK!); find those who have similar clients, a similar client service philosophy, and a willingness to collaborate on clients (and ideally to reciprocate referrals). And remember that many COIs may be concerned about the same issues in referring to you; have you done enough to assure the attorney or CPA that you will service clients up to their standards, rather than just assuming they will believe it to be true? To address this, Littlechild recommends several techniques, including creating a "report card" of your results on joint clients to share with COIs to remind them of your value, communicate your service standards to COIs, schedule regular check-in meetings to maintain the relationship and communication channels, and be certain to reciprocate referrals yourself if/when the attorney or CPA does refer to you! You might even consider sending a survey to the new client that was referred, and then sharing the results (with client permission) with the referrer, to reinforce the value that you're providing.

Why Shock-And-Awe Over Low Succession Planning Rates Is Unhelpful And Distasteful (Todd Clarke, RIABiz) - This article criticizes the ongoing hype in the industry regarding the succession planning 'crisis', noting that while various studies show only 17% or 22% or 28% of advisors have a succession plan, a recent white paper by Clarke's firm also found that the average age advisors intend to retire is 71 (and that's just the average!), suggesting that in practice it may not be surprising so many advisors still don't seem very concerned or anxious about exiting their practices anytime soon. In fact, when we look to other professions like doctors and lawyers, it's quite common to remain an active professional into their 70s and 80s as their work is their life, and financial planning is arguably quite similar given that it is not a physically intensive job like being a construction worker; viewed another way, financial planning is a business where you can die with your boots on. As a result, advisors seem to be shifting from focusing on succession planning or selling to a third-party buyer or roll-up (especially since many have a limited sale valuation anyway), to focusing instead on continuity planning in the event something unfortunate happens, and perhaps refining the business to improve lifestyle and maximize cash flow, but not necessarily preparing for a(n early) sale. But the bottom line may simply be that, like their clients, many advisors are realizing that a full-stop retiring is not all it's made out to be, and that they'd simply rather find a way to stay engaged, especially when many advisors firms attached a healthy paycheck to the effort, too.

The Price of Dithering (Mark Tibergien, Investment Advisor) - Making a good decision about when to exit a business is hard for any business leader, though waiting "too long" will undoubtedly limit the time it takes to create the right infrastructure for an orderly transition (not to mention the rising danger of a 'disorderly' transition due to death or disability). In the case of financial advisors, though, there still seems to be little momentum towards these issues, as many continue to state that they "plan to work until [they] can't" and that they will make more money by staying than by selling. Yet Tibergien suggests that this may be hypocrisy for advisors, who encourage their clients to face the sometimes hard realities and challenges, yet seem in denial themselves about addressing the issue (if only from the business continuity perspective). Ultimately, Tibergien suggests that there are 6 key blocking points that advisors should look at tackling: 1) lack of vision (since our businesses often define us, it becomes difficult to envision a life beyond the business); 2) lack of time (if we don't take the time to think about the future, there can be no opportunity to plan for it); 3) lack of commitment (it's easier to plan when you make a commitment to the issue, but since planning our own transitions is "both distasteful and scary" we don't commit to planning); 4) lack of context (succession planning is often viewed as all-or-none and is therefore rejected, but there are midpoint solutions that can be negotiated!); 5) lack of courage and lack of consideration (for employees, clients, and family who may be impacted by the lack of planning). While Tibergien does acknowledge that this may sound a bit "preachy", he also acknowledges that too often the industry and commentators lack compassion for the tormenting difficulty this business planning process can have on advisory firm owners, and in fact suggests that perhaps we need to spend more time focusing on the emotional issues advisors face in the decision to sell and exit a practice.

Helping Advisors Boost Their Social Security Skills (Mark Miller, Wealth Management) - Last year, the National Social Security Advisor (NSSA) designation was introduced (the organization claims to have trained 800 advisors now), and in September a new Social Security specialization will be added to the mix, called the CSSCS (Certified in Social Security Claiming Strategies), in addition to existing non-designation-based programs like "Savvy Social Security for Boomers" from Horsesmouth. The new designations are part of a broader trend towards solutions to help advisors better do Social Security planning, as more advisors (including some large offerings like Financial Engines) roll out advice solutions to retirees on Social Security claiming strategies.  The article also notes that Social Security software tools to assist with the analysis are on the rise, from spreadsheet-based tools from the aforementioned Horsesmouth program, to standalone offerings like Social Security Solutions.

What "Smart Beta" Means To Us (Rob Arnott & Engin Kose, Research Affiliates) - As Research Affiliates has led the charge for "smart beta" (though they point out the term was actually coined in a Towers Watson report), Arnott expresses his concern that the term is becoming overused and as companies roll out their own "smart beta" products they are further stretching the definition of smart beta to fit their product offering. Accordingly, Arnott seeks to (re-)stake the ground for what "smart beta" really means; the latest Towers Watson's definition is "Smart beta is simply about trying to identify good investment ideas that can be structured better... smart beta strategies should be simple, low cost, transparent, and systematic" (a threshold that Arnott notes many recent smart beta strategies fail, as they are overly complex, opaque regarding the source of their value-add, or may incur high implementation costs, not to mention that many simply don't work). But Arnott suggests the definition should still go deeper, framing it as "a category of valuation-indifferent strategies that consciously and deliberately break the link between the price of an asset and its weight in the portfolio, seeking to earn excess returns over the cap-weighted benchmark by no longer weighting assets proportional to their popularity, while retaining most of the positive attributes of passive indexing." Arnott then reiterates his views that cap-weighted indices - while by definition representing the market - still systematically overweight popular overvalued companies and underweight unpopular undervalued companies, creating an implicit alpha opportunity, and in fact suggests that almost any systematic investing approach that breaks the link between price and weight (e.g., equal weighting, minimum variance, etc.) can outperform cap-weighted indices in the long run. While critics have suggested that Arnott's style of smart beta is little more than a value tilt, Arnott points out that their fundamental indexes have performed well over the past decade despite the fact that value has generally been unfavored, because the primary benefit is not actually the value tilt but the systematic rebalancing back to (non-cap-weighted) neutral allocation.

The Mystery of Lofty Stock Market Elevations (Robert Shiller, New York Times) - The Cyclically-Adjusted Price-Earnings ratio (or CAPE), which Shiller helped to develop, is now hovering at a "worrisome" level over 25, a threshold that has only been surpassed three times in history (1929, 1999, and 2007), and each precipitated a major market drop. However, Shiller notes that the CAPE was never intended to indicate exactly when to buy and sell, given that valuations can remain elevated (or depressed) for years; nonetheless, we are in an "unusual period" now, both for how high the CAPE ratio is, and for how long it's been high in the past several decades (above 20 or almost all of the last 20 years, except for 20 months mostly in the midst of the 2007-2009 recession and financial crisis). A survey of investor views about valuation has still reflected variability over time, as surveys showed Shiller's "valuation confidence" index hit record lows in 2000 (as the CAPE peaked at 44) and has been again falling recently. Still, Shiller raises the question of whether there's anything more that can be done to explain the sustained heights of CAPE. One explanation is that valuations have been able to remain lofty because inflation and interest rates are so low as bond prices remain high, yet it's equally perplexing why bond prices would stay as high as they are. Is it the role of central banks? Do people have more anxiety about the future, and therefore show a greater preference for bonds even at today's high prices and low yields, or a willingness to invest in stocks even at lofty prices to desperately pursue growth to reach retirement? Ultimately, though, Shiller suggests that the real explanation may lie in the realms of sociology and social psychology, and that what we may be witnessing is still a temporary phenomenon, like irrational exuberance of the 1990s, that will eventually fade away... though it seems to be taking longer than expected to happen!

Investors Pour Into Vanguard, Eschewing Stock Pickers (Kirsten Grind, Wall Street Journal) - Vanguard has recently announced that it is now approaching a whopping $3 trillion of AUM, as investors continue to shift away from actively managed mutual funds and into passive vehicles; Blackrock (which owns iShares ETFs) and Dimensional Fund Advisors (DFA) are also seeing big inflows lately. Vanguard's Total Stock Market index fund is now the biggest mutual fund in the world, at nearly $300B of AUM, having passed PIMCO Total Return fund last year which has declined to $223B of AUM given recent outflows for 15 consecutive months. Overall, investors poured a whopping $336B into passively managed stock and bond funds in 2013, beating out a 'mere' $53B in flows into traditional mutual funds of the same type (this year it's $177B into passive vs $74B into active). The trend seems to have been firmly underway since the financial crisis, as retail investors (and many advisors) have been abandoning traditional mutual funds who failed to protect against losses during the 2008-2009 market decline, and have similarly failed to outperform in the bull market rally since then.

The Hidden Costs of Partial Premium Payments (Alan Lavine, Wealth Management) - For many clients, it's common to pay annual insurance premiums in smaller, more frequent bites, such as monthly, quarterly, or semi-annually. However, most insurance companies will apply a slight markup to the premium amounts if paid more frequently, which relative to the size of the premiums can be quite significant. For instance, a policy with a $1,000 annual premium might have a quarterly premium of $270/quarter, which actually amounts to $1,080/year, an 8% increase. And in fact, because the excess $20/quarter must be paid each quarter (not just as a lump sum in the end), calculating an "Annual Percentage Rate" (APR) would show the fractional premium amounts to a whopping 21.5% APR (or about 13.2% when calculated as an internal rate of return on the cost of money). The magnitude of implied APRs for various premium modalities does vary from one company to the next, but most are large; one company in an Insurance Forum survey came in with a whopping 95% APR for its fractional premiums, and another survey found a simple 20-year term policy's fractional premiums could cost policyholders an IRR between 19% for monthly premiums up to 27% for semi-annual payments. The bottom line - if clients have the financial wherewithal, insurance premiums should be paid annually, as today's cash (or even portfolio) returns can't handle a candle to the implicit "interest" cost of financing premiums in smaller monthly, quarterly, or semi-annual increments!

Here’s Why Most Financial Planners Fail to Engage (Ronald Sier, See Beyond Numbers blog) - Most advisors believe (or would like to believe) that their clients choose to work with them for logical reasons; the client added up the costs and benefits of the service, compared it to others, and chose the solution with the most favorable cost/benefit outcome. Yet the reality is that clients often make decisions for far-less-rational reasons. For instance, if you add up the basic costs and benefits of a Visa card versus American Express, the AmEx card is more limited in where it's accepted, less flexible about when payments can be made, yet costs more to have; nonetheless, AmEx has 25 million cardholders, and the "trick" is that they make an emotional connection with cardholders about the prestige of having an American Express card, that is used to rationalize what ultimately are substantively similar benefits to other available credit cards. In other words, if AmEx made an appeal to customers based on rationality alone, it would have no appeal relative to the available alternatives. In the context of financial planning, Sier advocates that it is similarly crucial to make not just rational but emotional connections with prospective clients; for instance, Sier notes the importance of Simon Sinek's "Start With Why" and that in the end clients don't necessarily buy what you do, and instead tend to buy you based on why you do it.  Other tips include: communicate visually and with images, instead of just words and text/print; seek to understand a client's emotions and values (when clients feel understood, they emotionally connect); and tell stories and use metaphors. Once clients have connected emotionally, then they can be stirred to action.

Client Calendars Show Clients How Much You Do for Them (Angie Herbers, ThinkAdvisor) - As advisors, we often do a lot for clients "behind the scenes" that they never realize is being done on their behalf... not to mention that with everything done throughout the year, sometimes clients just fail to mentally keep track of all that was done. And the unfortunate reality is that if clients don't know, realize, or remember what's being done on their behalf, they may be less satisfied with your value and less willing to stay a client. Accordingly, Herbers suggests one solution to this issue is to craft a "client service calendar" that details throughout the year what will be done on behalf of the client, and can be a tool for communicating both service expectations upfront and a retrospective look at what was done for the client at the end of the year. For instance, the client service calendar might include statements, monthly portfolio review and rebalancing, monthly investment committee meetings of the firm on behalf of client portfolios, quarterly reviews, financial plan updates, periodic client newsletters, end of year tax planning, and more. A supplement might include additional items done or offered on an as-needed basis, such as additional articles or communication, extra meetings on planning issues that may arise throughout the year with the client or their attorney or accountant, etc. And the client service calendar can be provided to prospective clients as well, providing a visual guide to the depth and breadth of what they can expect and what will be done for them if they become a client.

Alpha For Financial Life Planners (Roy Diliberto, Financial Advisor magazine) - Advisors seem to often fret about their cost, despite the fact that many/most firms have client retention rates in the mid-to-high 90s, which in turn suggests that advisors may be more stressed about the issue than their clients who actually pay the fees. Accordingly, Diliberto suggests that perhaps we should spend less time focusing on our cost, and more time thinking about and talking about our value, particularly in the immeasurable ways that clients can be impacted beyond their portfolio and market returns. In fact, Diliberto points out that when you look at the most satisfied financial planning clients, the "value" they talk about from their advisor has little to do with portfolios, and instead is more about the value of the trusting relationship they have with their advisor; Diliberto goes so far as to suggest that if all a prospective client wants for "value" from an advisor is better returns, that advisors shouldn't take them on as clients in the first place, as they will inevitably be unhappy at some point when returns eventually lag (even if just for the short term). That's not to say that advisors can't or don't provide value to clients with respect to portfolio and returns, though Diliberto suggests the biggest value we provide in this regard is simply helping to keep clients from hurting themselves with poor market timing returns (a la DALBAR studies). But in the further search for "alpha" beyond that, Diliberto notes that perhaps the best alpha advisors can provide is not additional returns above the market, but the other "alpha" we provide in helping clients to reach and exceed their personal financial goals.

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! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!

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!