Weekend Reading for Financial Planners (August 25-26)

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.

IRS Throws Salt In The SALT-Deduction-Limit Wound (Jeff Levine, Forbes) - This week, the IRS released new Proposed Regulations responding to States' recent attempts to convert their state income tax payments into charitable contributions in order to circumvent the State And Local Tax (SALT) deduction limit put in place by the Tax Cuts and Jobs Act of 2017. In its guidance, the IRS declared invalid the strategy being considered in several states, including New York, New Jersey, and Connecticut, to allow citizens to donate to State-run "charities" that would fulfill state government services in exchange for a tax credit against their state income taxes... which would have produced the same end result for the state (dollars collected to fulfill state obligations) but converted a potentially-capped state income tax deduction into an uncapped charitable contribution deduction instead. The issue from the IRS' perspective is that the receipt of a tax credit against state income taxes in exchange for making a charitable contribution is the equivalent of a "quid pro quo" transaction... and existing regulations on charitable contributions have long stipulated that taxpayers can only deduct the excess of their charitable contributions over and above anything they receive in reduce as a quid pro quo transaction. Thus, donating $1,000 and getting a T-shirt is technically only a $995 charitable contribution (offset by the $5 t-shirt received in return), and in the context of state-run charities, receiving a 100% dollar-for-dollar credit for the charitable contribution would amount to a 100% offset under the quid pro quo rules. The IRS notes that in the past, it had simply "never bothered" to formally address the issue, because it didn't actually matter whether someone took a state income tax deduction versus a charitable contribution (although technically, it might have mattered for AMT taxpayers), but with the new $10,000 SALT cap under TCJA, it matters now - and so the IRS updated its regulations accordingly to make it clear that such state-charitable-contributions-in-exchange-for-state-income-tax-credits would not be deductible as a charitable contribution going forward. Which means if impacted states are going to "beat" the SALT cap, they're going to have to more substantively restructure the way they generate their tax revenue (e.g., by shifting more of the tax burden from SALT-capped individuals to employers who still get an unlimited deduction for their state and local taxes).

Here's What May Happen To Your Taxes If Democrats Win The House (Laura Davison, Bloomberg) - The GOP had originally anticipated that the success of their tax cuts would carry positive momentum into the fall mid-term elections, but in practice, the tax cuts continue to poll negatively (with a higher disapproval rating than approval rating), such that many Democratic candidates are campaigning against the tax cuts and talking about ways that they might be undone, raising a new layer of tax uncertainty for 2019. The primary tax provisions being placed on the table include: 1) increasing the Corporate Tax Rate that was just set at 21% to something higher (potentially 23%-25% to generate additional revenue for funding infrastructure projects, or even to the high 20s to also help shore up the risk of future reductions to Medicare, Medicaid, and Social Security); 2) increasing capital gains taxation, either by simply outright increasing the top rate above 20%, by introducing a tax on each investment trade (0.5% on stocks and 0.1% on bonds) to cut down high-frequency or generally excessive trading, or at least by blocking the recent Republican proposal to index investment cost basis to inflation; and 3) repealing the Carried Interest break that allows certain hedge fund and private equity manager profits to be converted from ordinary income to capital gains (which President Trump had also previously vowed to end, but ultimately just stretched the required holding period from one year to three); 4) altering the pass-through business deduction, although some Democrats are calling for its repeal while others are calling for it to be expanded as a way to shift more tax stimulus away from large corporations and towards small businesses; and 5) undoing the SALT cap altogether (especially given that in practice, it disproportionately hits Democratic states over Republican states). Of course, the reality is that even if Democrats can gain control of Congress, they will not control the White House, nor have sufficient votes to override a veto, so it remains unclear whether or how much of a potential tax agenda they may realistically be able to push through in 2019 anyway.

A Surprising Bulwark For The U.S. Economy: The Personal Savings Rate Is Going Up (Paul Kiernan, Wall Street Journal) - One of the challenges of the booming growth in asset prices in advance of the last two recessions (rising real estate prices before 2008 and rising stock prices and especially tech stocks before 2001) was that, as consumers felt wealthier and more upbeat about their job prospects, they tended to save less, resulting in dips in the Personal Savings Rate that left them ill-prepared for the actual recessions that followed. And economists in recent years were raising concerns that the pattern was repeating again, with the personal savings rate falling in half (from over 5% to barely 2.5%) in just the past 3 years. But major revisions to the Personal Savings Rate just released from the Bureau of Economic Analysis paints a startlingly different picture... instead, the BEA now estimates that the Personal Savings Rate is holding steady at a whopping 7.2%, which exceeds the 6.4% savings rate average for the past 30 years, and suggests that the savings rate has largely held steady since 2009 and the aftermath of the financial crisis. The major data revision is significant not only because it suggests that consumers may actually be far better prepared for the next downturn than prior ones, but because it undermines the so-called "wealth effect" that economists have long viewed as a stable and predictable consumer behavior (that as household wealth climbs, consumption rise and savings falls). On the other hand, the fact that a wealth effect is not playing out, and that consumers may actually have undergone a more "permanent" behavior change since the financial crisis, raises forward-looking concerns about whether personal consumption growth that powers future economic growth will be able to sustain in the face of greater savings tendencies, and/or whether a consumer spending slowdown may be imminent, especially once the initial stimulus effects of the Tax Cuts and Jobs Act begin to dissipate. And some concern for lower- and middle-income households remains, as it appears the bulk of the higher savings rate revisions came from interest, dividends, and business owners' profits (which are concentrated in wealthier households), and not from (more lower- and middle-income) wage savings itself.

Youth Unemployment Hits 52-Year Low (Andrew Duehren, Wall Street Journal) - This summer, the unemployment rate amongst young Americans (aged 16 to 24) was just 9.2%, a drop from the 9.6% young unemployment rate in the summer of 2017, and the lowest mid-summer joblessness rate for young Americans since 1966. Similarly, the unemployment rate amongst older Americans who don't have a high school diploma also fell to a record low, the jobless rate fell sharply for those who completed high school but never attended college as well, and the unemployment rate for Latinos fell to 4.5% (the lowest rate on records that date back to the 1970s) and 16.5% for black youth (slightly up from a 16.2% record low earlier this year). Notably, the overall labor force participation rate for young Americans is still low by historical standards (at 60.6%, the same as last year, just slightly higher than 2009, and drastically lower than the 77.5% peak back in 1989); however, researchers suggest that the decrease is occurring at least in part because of the popularity of extracurricular activities and the rise of unpaid internships, and not necessarily due to a lack of employment opportunities. In fact, the record or near-record lows in unemployment rates across so many groups that traditionally struggle more to find jobs suggests that the labor market may actually be getting especially tight, forcing employers to become more expansive in considering who they will hire for potential job openings.

To End Corporate Short-Termism Don't Report Profits Semi-Annually, Report Them Daily Instead (Barry Ritholtz, Bloomberg) - Recently, both JP Morgan Chase CEO Jamie Dimon and Berkshire Hathaway CEO Warren Buffett called on companies to move away from providing quarterly earnings-per-share guidance, suggesting that it leads to an unhealthy focus on short-term profits over long-term strategy, growth, and sustainability. Earlier this month, President Trump went even further, asking financial regulators to consider allowing public companies to share information with investors less often, such as moving reporting requirements from quarterly to just semi-annually (twice a year) instead. Yet Ritholtz points out that the less frequently we do something, the more significance we assign to it - thus why a New Year's Eve celebration is far more momentous than a married couple's weekly date night, and suggesting that twice-a-year earnings reports would just make analysts obsess about the earnings results and guidance even more and cause any deviations from expectations to have an even more dramatic impact on short-term stock prices. Instead, Ritholtz suggests that if we really want to make Wall Street analysts and investors pay less attention to each earnings report, the key is to make them more frequent, releasing earnings reports monthly with the goal of eventually moving to real-time daily updates on fundamentals (given that many companies automate such data points and tracking internally already through technology). After all, with daily reporting, short-term earnings and guidance would become irrelevant, replaced instead by a focus on the underlying trends in the numbers and deeper analysis of the (now-continuously-available) fundamentals (and significantly reducing unhealthy incentives to dress up quarterly data that in some cases has even led to accounting fraud). And notably, the issue is equally relevant for financial advisors with our own clients as well - if you want clients to focus less on their portfolios and investment returns, the key is not to limit how often you send them performance reports, but to give them continuous daily access instead.

When Clients Don't Follow Our Advice (Ross Levin, Financial Advisor) - In the recent book, "Advice Not Given", psychiatrist (and Buddhist) Mark Epstein makes the key point about psychotherapy that, "being right is not the point of this profession... being useful is." Which, arguably, is equally true in the case of financial planners providing advice to clients, where in the end, the real value is not merely in being "right" about the advice, but being "useful" in getting clients to change their behavior and actually implement the advice. In turn, this is difficult because, as a trained and educated financial advisor, it's only natural to want to have our own egos validated that we gave the most right and accurate advice. Yet when the focus on being "useful" instead of just "right" changes, Levin notes that a lot else changes with it - suddenly, it's more valuable to help guide clients through uncertainty than just trying to give them the answer to prevent it, and it's more useful to make sure the right questions about being answered, instead of focusing on the questions we're simply most comfortable answering. In fact, Levin states that sometimes when clients ask questions, he outright asks "do you want our advice or our support?" For instance, if clients join a country club - which Levin notes is almost always a suboptimal decision from a purely financial perspective! - are we really better off showing them the financial ramifications of the decision and how they could better obtain similar services and value, or should we simply help them feel OK about staying and figuring out what else to adjust if necessary to live with their decision (again, do they really want advice or support?). In many cases, though, Levin suggests that the starting point is for us, as advisors, to become more self-aware about our own unconscious influences... are we really ready to feel fulfilled as professionals ourselves by not offering advice, and instead "just" giving the support instead when that's actually what clients want and need?

Culture Matters To Clients And It Should Matter To Planners (Meir Statman, Journal of Financial Planning) - Culture is defined as a shared set of beliefs, values, and expected behaviors in communities... but notably, as communities change (across countries and regions, by gender and politics and more), so too does the culture. The significance of this is that because cultural norms can so define "accepted" behaviors within the community, and within families, and amongst friends, it's almost impossible to give effective financial advice without considering how that advice would apply (or not) in the client's own cultural context. For instance, in the U.S., it's increasingly common to support children up to and through college, but then encourage them to be cut loose into independent adulthood once they graduate (if possible!), but in other countries and cultures, it's common for parents to continue to support adult children long after college, sometimes until the children actually get married (where parents may provide substantial assistance not just for the wedding, but in certain cultures, funding the down payment for their house after the wedding, too!). Similarly, in some cultures like the U.S., parents may gratuitously support their children (but the children don't support their parents unless they really need it), while in other cultures it's the children who naturally support their parents (and the parents don't support their children unless they really need it).  In fact, the U.S. is somewhat unique in being a country with the most "individualistic" culture of any country, while others are far more "collectivistic," where friends, family, and communities are expected to engage in more shared support of each other. Of course, exceptions also exist in any culture as well - i.e., not all Americans have universally individualistic attitudes - but the point remains that culture can play a significant role, advice that is relevant and "normal" in some cultures may be seen as a complete opposite in others, and if advisors don't at least ask and consider cultural context, they risk giving advice that seems totally logical and reasonable to them, but comes across as irrational, unrealistic, and out-of-touch with reality for the (culturally different) client receiving it!

There's Only One Way To Truly Understand Another Person's Mind (Ephrat Livni, Quartz) - The conventional wisdom is that if you really want to understand someone else's point of view, you should try to put yourself in their shoes. However, a recent research study by Tal Eyal and colleagues finds that in practice, when we try to imagine ourselves "walking in another person's shoes", we still tend to walk in their shoes from our perspective, and react not based on trying to understand how they actually see or feel the situation, but instead by just literally imagining how we personally would feel in their situation. In fact, not only did their experiments find absolutely no evidence that the cognitive effort of imagining yourself in someone else's shoes actually increases your ability to understand their minds and what they're thinking and going through, the results actually showed that such perspective-taking decreased accuracy overall, and even worse, sometimes increased confidence in judgments as well (which meant people who tried to imagine themselves in the other person's shoes thought they were becoming more accurate even though the exercise was actually making them less accurate!). Fortunately, though, the researchers did find an alternative approach that actually does improve our insights into other people's lives - gaining perspective by simply asking the other person to share their own views and opinions, rather than trying to gain perspective by imagining ourselves in their situation. Or stated more simply, the key to understanding someone else's perspective is not trying to imagine what it's like to walk a mile in their shoes, and instead to simply ask them to explain it themselves and really listen to the answer.

Using A Behavioral Approach To Mitigate Panic And Improve Investor Outcomes (Stephen Wendel, Journal of Financial Planning) - When allocating client portfolios, there is a fundamental tension between taking on more risk in the portfolio to potentially achieve higher growth rates which in turn will make it easier to accomplish the client's goals, versus taking less risk to avoid the danger that clients panic and abandon the growth plan at the worst possible time (the bottom of a bear market). In practice, these risk trade-offs are operationalized in a two-dimensional approach of looking at a client's risk capacity (their wealth, goals, and time horizon) to determine how much risk they can afford to take, and then evaluating their risk tolerance to understand the level of risk they're willing to take (without panicking). However, Wendel suggests that there is a third more "behavioral" approach to helping clients. The starting point of the behavioral approach is to recognize that the path to panicked selling occurs in 5 stages - first investments themselves are volatile, then the investor receives information about the volatility, then that information triggers an emotional response, which in turn leads to a decision that a change must be made, and an action to execute the change (often to the investor's detriment). The significance of this framework is that it highlights there are many ways to deter investors from making "bad" panicked sale decisions - from choosing Investments less prone to accident (e.g., target date funds that roll all the volatile asset classes together, or choosing managers that aim to limit volatility and downside risk), to changing how Information is presented to clients to downplay the volatility, educating clients about investment biases to mitigate their Emotional responses, use pre-commitment devices where clients write down their plans to help them avoid making a short-term adverse decision, and creating circuit-breakers that limit their ability to take hasty Action (e.g., requesting a delay period between decision and execution, or suggesting a spouse needs to sign-off on a change as well). In other words, Wendel suggests that the key to constructing effective portfolios where clients don't panic isn't merely about choosing a level of risk at which the panic won't occur, but recognizing that there are proactive ways that advisors can systematically intervene to reduce the danger that a panicked moment actually leads to a panicked sale (or not).

Wealth Is What You Don't See (Fervent Finance) - The imagery we see in the media and movies suggests that "wealth" is something that can be seen, in the form of a big house (or a second/vacation home), a fancy car (or several in the garage), expensive jewelry, etc. Yet the reality is that financially, the greatest pathway to wealth is not buying this kind of "stuff" (much of which tends to depreciate over time), but instead to invest in assets that grow and appreciate (and might someday, in the future be converted into prized "stuff"). The challenge, though, is that means the greatest wealth is created in what most others don't see - the cars not purchased, the fancy clothes forgone, the upgrades that are declined, and the assets in the bank that no one else even knows are there. In fact, the irony is that many of the things we attribute to "wealth" are actually what people purchase that move them further away from real wealth! Nonetheless, in practice, it remains far easier to visualize wealth by literally visualizing the life of luxury goods, and it's often impossible to identify which neighbor has a modest house and old beat-up car because they have to (lacking any wealth to buy more), from those who choose to and the decision to spend far less than they make it generating substantial invisible wealth that no one else can see. Thus, perhaps, why the "Millionaire Next Door" phenomenon was so shocking when first discovered. The point simply remains, though, that it's an important mindset shift - ideally that we teach our children when they're young - that the real pathway to wealth isn't about acquiring the outward signs of wealth because real wealth is created in a form that other people usually can't actually see.

Time Or Money: Which Is More Important (Joe Duran, Investment News) - In Spain, it's common to take an afternoon 'siesta'... a break, where most stores close for several hours (from 2 PM to 5 PM) so people can have a late lunch and recharge, rather than just focusing on keeping businesses open to make money. Duran suggests that this is an excellent way to view the intersection and trade-off between time and money... particularly in a world where, in the U.S., the weight tends to be overwhelmingly towards "making money" over "time" (as businesses just keep increasing their hours of availability!). In fact, Duran suggests that time is one of our most significant limited resources to manage - right alongside money itself - and that we need to learn to better consider the value of trying to manage the scarce resource of our time the same way we manage our scarce resource of money, and perhaps a future domain for financial advisors to assist is in helping clients make better decisions not only about how they allocate their money, but also how they allocate their time, and in particular how they can allocate their money in order to free up their time (especially given the growing base of research that one of the primary ways money can contribute to happiness is by using money to buy us time!). Or alternatively, advisors shouldn't only focus on helping clients to prudently save, but also in looking at how to prudently spend (in ways that can save time and increase happiness), how to better balance when they use their time (e.g., spending money now to take time for a long vacation or sabbatical instead of just saving money to get more time for later), and facilitating conversations about these trade-offs between spouses who may themselves have different views about how they should allocate their scarce money and time resources in concert with one another.

Be Rich, Not Famous: The Joy Of Being A Nobody (Financial Samurai) - The "Financial Samurai" retired early by earning a good payment in the finance industry straight out of college, saving aggressively, and then converting his wealth in his 30s to a growing stream of passive income. As he geared up for his transition, he launched his "Financial Samurai" blog, which initially was done anonymously because he hadn't quit yet, and then remained anonymous for 5 more years because he didn't want the risk of his financial writings to impair the payout of his 5 years of post-employment deferred compensation. Yet as the window for his severance payments wound down, and he considered whether to come out of anonymity as a successful blogger to grow his platform further, he decided instead to remain anonymous, effectively choosing to remain rich but not be personally famous. The notable reasons include: 1) it helps you focus on what truly matters (as when you're anonymous with respect to what you created, you can't get stuck in the cycle of self-validation trying to get more attention and appreciation for what you've created, which can distract you from focusing on doing the work that made you so proud in the first place); 2) you become impervious to insults (because it's easier to blow off insults when they're coming at you anonymously anyway, and it's hard for someone to tear you down when you've remained anonymous and haven't put yourself up on a pedestal in the first place); 3) you can live your life in private (as the challenge for many celebrities is that so many people want something from them, either their money or time or both); 4) there are no expectations of you, which makes it easier to feel good about surpassing expectations that others may lay upon you, having no idea who you actually are; and 5) it's easier to raise children to be their own people, not burdened by the spotlight of their parents. For some advisors who are financially successful, this may be a challenge they face themselves, but at a minimum, it's valuable insight into the minds of an affluent client about why they may prefer continuing to keep their wealth and financial success a secret (or at least not being outwardly public about it)!

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

In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.