Weekend Reading for Financial Planners (August 3-4)

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.

Looking For A Financial Planner? The Go-To Website Often Omits Red Flags (Jason Zweig & Andrea Fuller, Wall Street Journal) - The huge industry buzz this week was a bombshell investigative journalism report on Monday that the CFP Board's Lets Make A Plan website for consumers to "Find A CFP Professional" includes a substantial number of listings of CFP certificants who themselves have material disciplinary disclosures reported on FINRA's BrokerCheck... but not revealed on the CFP Board's own website as a "red flag". Specifically, in its analysis, the Wall Street Journal noted more than 6,300 CFP brokers with undisclosed blemishes from their FINRA regulatory records, of which more than 5,000 had faced formal complaints from clients, 324 had left a prior broker-dealer after allegations of misconduct, and over 140 faced or currently face felony charges. Which raises serious consumer concerns, given the CFP Board's nearly-decade-long public awareness campaign that the CFP marks represent a "Gold Standard" and that "Certified" = "Qualified" when it comes to the public finding a credible financial planner. In response to Monday's WSJ article, the CFP Board immediately stated that it would begin to cross-reference CFP professionals against SEC and FINRA databases when their certifications are renewed going forward (rather than just relying on self-disclosure), and was adding a section to every CFP's profile to link out directly to BrokerCheck and IAPD for consumers to delve further on their own. In addition, the CFP Board announced that it was creating a Task Force to further "Strengthen and Modernize" their enforcement practices, to be led by former Texas Securities Commissioner (and current public Board of Directors member) Denise Voigt Crawford. Still, though, many in the CFP community expressed frustration that CFP certificants themselves have long complained that there are many who use the CFP marks but don't live up to the CFP Board's standards in practice (despite even being highlighted previously in the media), and that it was a virtual inevitability that conducting a $10M/year public awareness campaign to promote the standards while doing little to actively enforce them would eventually invite in bad actors who would be discovered and undermine the credibility of the marks. The question now is what further steps the CFP Board will take to actually improve enforcement, especially given that the enforcement stakes are only higher in 2020 as the CFP Board's new higher "fiduciary at all times" standard takes effect.

SEC Sues Commonwealth Over Revenue Sharing From Fidelity Unit (AdvisorHub) - On Thursday, the SEC announced that it was suing independent broker-dealer Commonwealth Financial for failing to disclose to customers its conflicts involving payments it was receiving from third-party mutual fund providers through their National Financial Services (NFS) custody/clearing provider, to steer customers towards certain mutual funds over others. In one instance, the SEC stated that Commonwealth received a $515,000 fee from NFS in 2016 for $174M of client assets invested in the "Class D" share class of a particular No-Transaction-Fee (NTF) fund which had a 30bps higher expense ratio (ostensibly to help cover the cost of the revenue-sharing payment), while failing to use two other share classes of the same fund that had lower or no revenue-sharing and consequently lower expense ratios (either a 55bps expense ratio with an 8bps revenue-share, or a 45bps version with no revenue-share). And cumulatively, the SEC alleges that Commonwealth received a total of $136M in such payments from mid-2014 through the end of 2018. Notably, though, the SEC's complaint isn't necessarily that Commonwealth received the payments, but that Commonwealth failed to disclose the payments were being received (given the material conflict of interest they present) and for failing to tell clients that there were other less-expensive share class alternatives (effectively incentivizing Commonwealth to steer its advisors' clients towards particular funds and share classes that create such revenue-sharing payments, over other funds that would not). Although ironically, NFS did not make any revenue-sharing payments on behalf of its own parent-company mutual funds (Fidelity), and consequently NFS itself was not named in the lawsuit, only Commonwealth for failing to disclose the NFS-shared back-end payments.

Do Vanguard Clients Pay 12b-1 Fees Or Not? (Jessica Mathews, Financial Planning) - One of the fundamental differentiators - and points of tension with the rest of the industry - is that Vanguard does not add 12b-1 fees to its mutual funds, which allows their funds to be less expensive than most competitors, but also eliminates any potential for platforms that make Vanguard funds available to be compensated the way they can for offering other funds (that do have 12b-1 fee revenue available to share). Yet the irony is that on Vanguard's own brokerage and Personal Advisor Services "robo" platform, other funds made available to Vanguard clients often do include 12b-1 fees, in which Vanguard participates financially (as disclosed in their Form ADV), along with shareholder servicing fees (which Vanguard also often refuses to pay to other providers even while collecting them on Vanguard's own platform). Notably, this is not an improper use of 12b-1 fees themselves, which were created to support everything from distribution to shareholder servicing of mutual funds. Instead, the tension is simply that Vanguard pressures competitors to offer their funds without 12b-1 fees on third-party platforms, while collecting the same fees for funds to be made available on Vanguard's platform. Yet unfortunately, the reality is that 12b-1 fees are largely ubiquitous, with over 6,000 funds charging such fees. Still, though, growing pressure and backlash against the fees, the consumer and advisor drive towards funds with lower expense ratios, and regulatory actions against firms that participate in (and fail to properly disclose) back-end 12b-1 fees, appears to be slowly but steadily leading to an "unbundling" of mutual funds, with funds paying 12b-1 fees reporting $288B of net outflows in 2018 and those without reporting $183B of inflows. Although ironically, even fund companies that don't charge 12b-1 fees still often make some form of revenue-sharing payments for platform access, which means eliminating 12b-1 fees and allowing behind-the-scenes revenue-sharing payments to be negotiated may actually just reduce consumer transparency of the industry standard practice?

A Brief Guide To The Equifax Settlement, And How To Get What You're Owed (J.D. Roth, Get Rich Slowly) - Back in 2017, credit reporting agency Equifax reported a huge security breach, allowing hackers to gain access to Social Security numbers, credit card details, and other personal information for nearly 150M Americans (or almost half the entire U.S. population). Now, two years later, the Federal Trade Commission (FTC) has announced a settlement agreement with Equifax to provide compensation to those affected by the breach. How much individual consumers will get, though, depends on how exactly they were impacted by the breach; if there was an actual identity theft event, that caused real financial losses, affected consumers are entitled to a cash payment of up to $20,000; for those who had to spend time dealing with the data breach, they're entitled to up to $25/hour for up to 20 hours (but have to provide proof if it was more than 10 hours); for those who did not have their identity stolen but were still impacted by the breach itself, they can either receive 10 years of free credit monitoring (4 years at the 3 major bureaus, and then 6 more years of Equifax-only monitoring), or if they already pay for credit monitoring can opt for "alternative reimbursement" of up to $125. The latter option in particular has become the focal point of the media, with some going so far as to say there's a "moral obligation" to claim the $125 to make sure the company pays given the sheer size and breadth of the data breach. The caveat, however, is that while Equifax overall committed to pay nearly $700M as part of its settlement with the FTC, about $425M is allocated to reimburse those impacted by the data breach (e.g., had their identities stolen, or spent time addressing the issue), and only $31M is set aside for the "Alternative Reimbursement Compensation" program, which would only cover $125 for a mere 248,000 people (out of almost 150M who were affected). Consequently, if millions of people actually claim the $125 of cash, the $31M pool divided amongst more people may result in materially less than $125 per person after all. On the other hand, though, given that credit monitoring services typically cost about $25/month, the 10 years of 'free' credit monitoring is worth $3,000 anyway, making it worth far more than even the full $125 of cash. For those who actually want to file a claim - for the $125, or the 10 years of free credit monitoring - the starting point is to verify eligibility on the Equifax data breach settlement website, and then actually submit to file a claim for the Equifax settlement.

Buy Yourself A F*^king Latte (Barry Ritholtz, The Big Picture) - Earlier this year, Personal Finance consumer celebrity Suze Orman warned investors that if you "waste money on coffee, it's like 'peeing $1 million down the drain'" (having calculated what a $100/month coffee habit could have accumulated if it was saved into a Roth IRA for 40 years of accumulation). However, as Ritholtz points out, the caveats to Orman's not-drinking-coffee-as-a-path-to-retirement, include: 1) Orman's projection to $1M assumes 12%(!) annual returns for 40 years, while a more realistic 8% return would be "just" about $300,000 in the future (or worse, given today's high valuations as a starting point); 2) with 40 years of inflation, $350k won't go nearly as far as it does today, either, given that over the past 40 years median income has more than tripled and the median house has nearly quintupled, which means that $300k of coffee savings is only about $80k - $100k of future purchasing power; 3) if you actually earn the median income of $61k/year and get a 3%/year raise, it's almost $5M of earning power over the next 40 years (or $7.5M at 5%/year annual raises), which makes the $80,000 coffee habit look rather small in comparison; 4) the real driver for actual economic outcomes is not small discretionary expenses, but large fixed ones like housing, cars, health care, and education, so be certain to put the focus where it's due (and where it will have real impact); and 5) given that we only have so much mental bandwidth to handle 'tough' decisions and acts of willpower in the first place, is resisting your favored cup of coffee really where you want to spend your mental energy anyway?

When Is It A Bad Choice To "Go Cheap"? (Trent Hamm, The Simple Dollar) - One of the challenges when trying to manage and reduce household spending is to decide when, exactly, it's best to "go cheap", and when it's still worthwhile to spend a little more to get a little more enjoyment (or simply something that will be a little more durable, last longer, and not need to be replaced as often). Especially since many aspects of financial spending are also social, which means going cheap today can have negative interpersonal ramifications, beyond merely being a bad long-term investment (e.g., hosting a friend who's visiting from out of town, and serving up a cheap meal of home-cooked rice and barely-seasoned beans). Of course, it's possible to make a list of items that are worth spending a little more for (e.g., shoes, mattresses, kitchen equipment, and heavy-use appliances), but it's virtually impossible to list all the possible expenses that one might need to consider in the future. Accordingly, Hamm sets forth a series of principles to figure out when it is (or isn't) appropriate to Go Cheap, including: don't go cheap on friends and family, especially when the expense is irregular (and you want to maintain a positive relationship!), such as special dinners or family trips; don't go cheap on items you're going to literally use every day and will be reliant upon (e.g., shoes, mattress, toiletries, and the chairs you sit in every day); don't go cheap on hygiene, as in the end, soaps, brushes, and floss are cheap in the grand scheme of things, far more so than the impact that bad hygiene can have on your professional and social life; and recognize there's a spectrum between the cheapest and the most expensive, and that in general, it's better to aim for what's a cost-effective value than just what is the outright lowest cost (though it might require a little additional research to figure out where the value inflection point is).

RIAs On Course For Record M&A Activity In 2019 (Karen Demasters, Financial Advisor) - According to the DeVoe & Company "Deal Book" for the first half of 2019, merger and acquisition activity amongst RIAs face outpaced the first half of prior years since at least 2013, with a total of 65 deals already in 2019 (compared to just 50 in the first half of 2018). In fact, 2019 is now on pace to set a new record for total RIA transactions as well, which would make it the 6th consecutive year of new highs, driven by a combination of the lack of succession plans, the interest of more advisory firms to reach scale, and high valuations that are enticing more sellers to sell (yet not scaring away buyers from buying). Notably, though, DeVoe points out that there will always be some room for small and mid-sized firms (that are more niche and nimble); overall, the consolidation trend appears to be largely bringing together mid-to-large-sized firms (with an average acquired firm holding $714M of AUM, albeit with an increasing number in the $250M to $500M range) into an ever-shorter list of "mega-firms" with aspirations for a national brand and reach. In fact, RIAs buying other RIAs have become the dominant buyer category (over consolidators or other strategic acquirers). Still, DeVoe reports that advisory firm valuations have "surged" to all-time record highs, with demand from buyers continuing to outstrip the supply of sellers. Though notably, in a world where there are tens of thousands of RIAs overall, an RIA deal flow approaching 100+ firms a year still represents a trickle of firms being sold relative to the size of the total advisor landscape.

Components Of An RIA Acquisition Deal (Ryan Grau, FP Transitions) - While the "typical" value of an advisory firm is often reported with a rule of thumb like 2X revenue, it is not surprising that in practice, advisory firms transact at a wide range of valuations. Notably, though, what varies from one deal to the next is not just the valuation multiple itself, but also the "terms" of the deal, that can have a material impact for both the buyer and the seller as well. Especially since the bulk of what is purchased in an advisory firm transaction is "goodwill" - literally, the good will of the clients to stick with the firm and its new owner after the founder has sold and left. Accordingly, other key components worth recognizing as part of a purchase deal include: the Deal Structure, which includes how much is a down payment versus financed over time (which FP Transitions data finds is most commonly about 1/3 down, and the other 2/3 financed over 5-7 years); who does the Financing, which historically was a Seller note (i.e., the other 2/3 was payable to the Seller over 5 years at a 5% interest rate, with a price adjustment if not all the clients transition and retain beyond a certain buffer threshold), but now increasingly are bank-financed instead (where the bank may require a 25% down payment or at least 25% held in escrow, and finances the other 75% to 100%), to the point that the seller may receive mostly or entirely upfront cash (although a "true" all-cash deal paid at closing usually leads to a 15% - 35% discount); and the Tax Treatment, which itself varies depending on the terms, as often as much as 85% of the sale price is allocable to Goodwill (which is a long-term capital gain to the seller, and 15-year-amortizable to the buyer), with the remaining 15% allocated to the seller's post-closing transition assistance (taxable as ordinary income with FICA taxes to the seller, and deductible as a normal business expense to the buyer) and a non-compete (taxable as ordinary income to the seller, and 15-year-amortizable by the buyer). Notably, the fact that Deal Structure, Financing, and Tax Terms can all alter the risk-sharing between the Buyer and Seller, or outright change the net after-tax dollars, means that even when two deals are valued at the same 2X revenue amount, the actual net after-tax dollars to the seller, and the risk (or not) that those payments will be received, can still vary greatly from one deal to the next!

6 'Must-Know' Items When Selling Your Practice (Mark Elzweig, ThinkAdvisor) - With advisory firm valuations reaching all-time highs, and buyers becoming increasingly aggressive in the search for firms that may be willing to sell, more and more advisors are faced with the question of whether to sell or not, even if they hadn't been actively considering and looking for a buyer. Accordingly, Elzweig provides several suggestions of issues to consider and be aware of when fielding the 'unanticipated' inquiry about buying an advisor's firm: 1) remember that the advisor can remain engaged even after selling the firm, whether that's a scaled back role to do a limited set of tasks he/she prefers to retain, or simply being able to delegate business and other responsibilities the founder doesn't want to deal with anymore in order to stay focusing on simply serving clients; 2) the emergence of bank financing makes it easier for sellers to get far more in a down payment up front (from 10% to 30% in the past, to as much as 65%+ now, as the bank provides the financing to the buyer, who in turn then brings cash to the seller), effectively reducing the risk of the transaction for the seller (who no longer has to worry as much about the solvency of the buyer); 3) sellers can get capital gains treatment on the bulk of the purchase (treated as a sale of goodwill), but savvy buyers will often try to characterize the bulk of the purchase as consulting income to the seller in order to get more beneficial tax deductions as the buyer (even though it converts the seller's proceeds to ordinary income); 4) sellers and buyers can often consult together about where overhead might be trimmed, which ultimately increases the free cash flow of the business and can increase the value to the seller; 5) sellers should be prepared to defend the depth and quality of their client relationships, as buyers will often be highly concerned about whether clients will really stick around (as there are few other assets to secure the purchase price of the firm beyond client goodwill to retain!); and 6) sellers should vet their buyers to ensure that the buyer can really execute, and has a transition team with sufficient bandwidth to actually assimilate the purchase (especially if the seller is selling a sizable firm).

The Best Spot In The Office Is A Phone Booth, If You Can Get Into One (Sarah Needleman, Wall Street Journal) - As more and more businesses have adopted Open Floor office space, it has become increasingly popular to create "phone booths" - glass-enclosed spaces with a seat, and sometimes a table (but usually not a phone), that become the "privacy pods" that works sometimes need if they don't want to conduct certain calls or meetings entirely out in the open. In fact, the irony is that in some businesses with open-floor plans, the phone booths end out with long waiting lines, as employees camp out in them to get a moment of peace and quiet to do work (or have a more private conversation). In some businesses, access to the phone booths have even become a point of negotiation for work favors (e.g., "I'll process your contracts first if you'll give me the phone booth!"). Yet with the rise of the phone booths, come the unintended consequences as well - from the realization that glass-enclosed spaces aren't always fully sound-proof (i.e., co-workers outside might still hear at least some of what's being said), to the challenge that employees don't always clean up after themselves (leaving behind anything from used tissues to leftover food and unpleasant body odor). Still, though, as the open-floor-plan movement has gained pace, so too has the counter-movement towards creating at least some kind of private space, such that in the past 4 years, the number of workspace-phone-booth makers at the popular NeoCon commercial design conference has exploded from just one to more than a dozen.

Do You Really Need Another Computer Monitor? Yes. (Angela Lashbrook, OneZero) - In many office spaces, having multiple computer monitors, often fitted out on large metal stands, has nearly become a status symbol. But as recent research is finding, it's also just a flat out improvement in productivity. One early study found that workers using two monitors instead of one worked 16% faster, and had 33% fewer errors; several more recent studies found users themselves also preferred multiple monitors once they got used to them. To some extent, multiple monitor arrangements are simply a way to have more "physical" workspace when work is increasingly done on computers, the digital equivalent of choosing to work at a big conference table rather than an airline tray table when you're managing a lot of papers and documents for a big project. Which can be especially helpful for those who have to use multiple applications at once in their work environment... such that having multiple monitors makes it possible to see all the relevant applications at once, rather than switching between tabs that often leads to an increase in mistakes. Accordingly, workers are increasingly springing for a wide range of "multi-mon" setups, from buying multiple large computer monitors, to working on a laptop that has an extension monitor attached to it (to the point that it's often hard to revert back to a single laptop screen after becoming accustomed to the multi-monitor arrangement)! And notably, the benefits of multiple monitors appear to specifically require multiple monitors; while it may be possible to tile multiple windows on a single large monitor, research shows that in practice people actually use different screens to organize and partition their work (e.g., one screen for 'primary' activities like a current work document, and another for 'secondary' activities such as email or team communication tools like Slack).

How The Sound Surrounding You Affects Your Mood (Lakshmi Sandhana, BBC Future) - From the way whispers travel the circular dome of St Paul's Cathedral, to the click of heels walking through a deserted hallway, or the way the shower stall makes our singing sound better, there is an "aural architecture" to spaces that can directly impact how we feel in a space, and therefore the mood that it evokes. In some cases, the aural footprint simply mimics the physical layout, as small rooms that feel claustrophobic often sound claustrophobic as well (as the low ceiling and close walls literally cause sound to reflect back to us faster, which our brain processes as a more cramped space), and large rooms that dissipate sound just feel larger when our voices get lost in them. The significance of these auditory impacts, though, is that sometimes the sound of a space doesn't align with the purpose and function of the space, from a 'restful' home space that creaks and groans (hauntingly distressing us!), to the 'focused' work place that has a distracting rattle. In fact, research has found that noisy work and home settings in general have been proven to annoy people, and noise annoyance itself is linked to depression and anxiety. Not to mention the ways that noise can outright reduce our productivity... while rooms with loftier ceilings encourage more abstract thought. Certain sound frequencies can even calm us, or makes us more emotionally attuned, and some researchers now are even exploring "sonically interactive structures" as paths to therapy for conditions like PTSD, depression, and Parkinson's disease. Ultimately, though, the key point is simply that architecture and the way physical home and office spaces are laid out don't just impact the visual aesthetic of the space... how the space sounds can have a material impact on our mood and productivity, too!

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.