Weekend Reading for Financial Planners (August 4-5)

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.

Investing Crosses The Rubicon As Fidelity Launches Free Index Mutual Funds (Jeffrey Ptak, Morningstar) - This week, Fidelity announced that it was launching two new index mutual funds with an expense ratio of zero: the Fidelity Zero Market Index, and the Fidelity Zero International Index. Notably, the funds appear to truly be an expense ratio of 0% - no expense ratio, no ancillary changes - and the funds are actually filed with regulators as a 0% expense ratio (not a higher one that is just temporarily being fee-waived). And notably, the investment minimum is also $0, although the new Fidelity Zero funds will not be available in its 401(k) platform. The significance of this is not simply the "free" index fund cost, in a world where many broad-market index funds were already down to just a few basis points anyway, but the symbolic impact that gaining broad access exposure to the markets is now "free"... which significantly ups the ante on any and every active manager to justify every point of their expense ratio in whether they add value (or not). Of course, Fidelity does still have to make money somehow, and industry commentators suggest it will most likely be through a combination of securities lending on the underlying assets, and perhaps the hope that Fidelity can "upsell" assets on its platform into other funds (that generate more revenue), or into one of its advisory programs (for which a separate fee is charged). Nonetheless, the Fidelity change both puts pressure on competing index fund and ETF providers, particularly market-share leaders Vanguard, Blackrock, State Street, and Schwab (with several experiencing immediate stock price drops in response to the Fidelity news), though it arguably puts even more pressure on other smaller fund providers that simply cannot compete with the sheer size and scale of the move to zero expense ratios. In the meantime, though, the primary questions that are now arising are how fund providers will generate their revenue in the future - and whether the pressure of Free Indexing could tempt them to riskier revenue streams or simply further accelerate the shift of platform providers to offer fee-based accounts and advice to get paid - and whether the zero-cost of indexing itself will make customized technology-driven indexing alternatives (e.g., Direct Indexing 2.0) even more appealing as a technology alternative that competitors can actually get paid for.

Trump Administration Mulls Unilateral Tax Cut On Capital Gains (Alan Rappeport & Jim Tankersley, New York Times) - Earlier this week, the Trump administration floated a proposal that would alter the tax treatment of capital gains by indexing the cost basis to inflation over time, effectively taxing only real growth in assets, in what would amount to a nearly $100B tax cut for the economy. For instance, if a stock was bought long ago for $100,000 and sold today for $1 million, it would have a $900,000 capital gain; the proposal would adjust that original $100,000 cost basis for inflation, which might make the present day cost basis $300,000, reducing the capital gain to just $700,000 instead. The proposal is controversial, not only because the Trump administration is reportedly mulling its options on whether it can implement the change unilaterally through the Treasury without Congressional approach - by having Treasury simply write a regulation to change the definition of "cost basis" to one that makes inflation adjustments - but also because estimates are that the benefits of the tax cut would go almost entirely the affluent where capital gains comprise a much larger percentage of income (where an estimated 97% of the benefits would go to the top 10% of income earners, and 2/3rds of the benefits would go to the top 0.1%). Notably, the idea of potentially indexing the cost basis of investments to inflation is not new, and has lingered as a possibility for years, though prior administrations had already dismissed trying to implement such a change solely through the Treasury and Executive Branch as being too prone to a likely court challenge without Congressional approval, and concerns loom about potential unintended consequences (such as making retirement accounts relatively less appealing as there is no "basis adjustment" for IRA contributions). Either way, though, at this point the proposal is still a proposal, and formal regulatory guidance to actually make the change has not (yet?) been issued.

With New Standards Approved, CFP Board Goes To The Masses With Public Forums (Andrew Welsch, Financial Planning) - Now that the CFP Board's new Standards of Conduct are finalized and set to take effect next October of 2019, the focus of the organization is on how to train nearly 81,000 CFP professionals on the new rules to get them up to speed. And so, in addition to launching a recently announced Standards Resource Commission that will produce guidance for CFP professionals, the CFP Board has announced that it will host a series of public forums (to be coordinated with the FPA and NAPFA) in nearly two dozen major cities over the next 16 months (including Philadelphia, Baltimore, New York, Boston, Miami, Orlando, Charlotte, and Atlanta this fall alone), for the purpose of both providing additional training, and for the CFP Board to have an opportunity to gather further feedback from CFP professionals about where further guidance and training is needed. CFP professionals who wish to sign up for the CFP Board Public Forums can register here.

FPA Revises Primary Aim With An Eye On Elevating The Profession (Lauren Schadle, Journal of Financial Planning) - In an effort to more directly focus its efforts on elevating financial planning as a profession, the FPA has revised its Primary Aim from being "the community that fosters the value of financial planning and advances the practice and profession of financial planning," to a new Primary Aim of "Elevat[ing] the profession that transforms lives through the power of financial planning" instead. Of course, as a membership organization for CFP certificants, the FPA still aims to support and represent CFP practitioners, but the profession-oriented shift emphasizes its focus on being the Financial PlannING Association (as opposed to the Financial PlannERS Association), and signals an intended increase in Advocacy work from the FPA on behalf of advisors and the profession... as evidenced by both the FPA's recent Advocacy Day in Washington DC, and its rising number of state advocacy days coordinating through its various state chapters as well, and the launch last year of the FPA's Member Advocacy Council (MAC) that submitted official comment letters on behalf of the FPA membership regarding the CFP Board's recent changes to the Standards of Conduct.

RIAs Hit Record Client Growth In 2018, But Margins Shrink (Christopher Robbins, Financial Advisor) - According to the latest TD Ameritrade/FA Insight benchmarking study, client growth hit a record high of 7.8% in 2017, which, on top of a 6.8% increase in assets per client, drove the average firm to increase its AUM by 20% last year (compared to just 13% in 2016), with revenues up an average 16%. The ongoing growth, though, is forcing firms to reinvest further into staff hiring, which in 2016 caused average productivity of advisory firms to decline (measured by revenue per team member), but the robust AUM and revenue growth led to a 12% rebound in 2017. However, the overall rise in firm costs still led the median operating profit margin to drop, from 24% in 2016 to only 20% in 2017, with some indication that advisory firm AUM pricing may finally be starting to slip, as the average RIA made only 71 basis points on every dollar they managed (including all breakpoints and discounts), down from 78 basis points in 2015 (though 98% of the firms studied still charge exclusively AUM fees). On the plus side, the study showed that retention rates remain strong amongst advisory firms, and the narrower the firm's niche target market, the better for driving above-average growth rates going forward.

Schwab Advisor Services Signals A Potential Flood Of SEC Actions Against Custodians That Aren't Cracking Down On Their RIAs (Oisin Breen, RIABiz) - Last month, the SEC hit Schwab Advisor Services with a $2.8 million fine for failing to file Suspicious Activity Reports (SARs) against 37 of the 47 advisors it had also/already decided to dump from its advisor platform back in 2012/2013. The significance of this regulatory action is that it signals the SEC expects RIA custodians (who also function as broker-dealers in the services they provide to RIAs) to have more of an oversight role into the activities of the RIAs on their platforms, especially when it comes to anti-money-laundering statutes (for which SARs are meant to be filed). Notably, increasing regulator activism on AML rules isn't news, with both the SEC and FINRA hitting Merrill Lynch with separate $13M fines last December for failing to file timely SARs as well. Nonetheless, the fact that the SEC is now willing to sanction an RIA custodian for effectively failing to blow the whistle on the independent advisors who are merely custodying money with the firm and using it for brokerage services, is a concerning regulatory shift (especially by making an example of Schwab, which is already known for running a tight ship and being stringent on its regulatory oversight protocols). In fact, it is notable that Schwab itself was already terminating relationships with the advisors in question for concerns ranging from potentially using client funds to buy personal real estate, inappropriately cherry picking and allocating trade orders, operating without a license, and more. Nonetheless, the increased scrutiny raises concerns that both RIA custodian compliance oversight may have to increase in the future - more akin to the relationship that brokers have with their broker-dealers - and/or that RIA custodians will become even more wary of working with "small" RIAs, for whom the additional compliance costs may no longer be worthwhile.

SEC Clarifies 'Inadvertent Custody' (Thomas Giachetti, Investment Adviser) - Earlier this year, the SEC issued updated guidance on "Inadvertent Custody", providing additional clarifications regarding "inadvertent" violations of the Rule 206(4)-2 Custody Rule, specifically in situations where the custodial agreement between the RIA and its custodian (and between the client and the custodian where the RIA is also involved) may be "too broad", such that the RIA is deemed to have custody of client assets. The problem is especially common in situations where advisors manage participant-directed retirement plans, or subaccounts for variable annuities, that are required to be held via particular platforms (not necessarily the advisor's primary custodian). The good news is that the SEC states that in situations where the advisor doesn't have a copy of client custodial agreements, and would not have known the agreement triggers, the custody will not take action for failing comply with the additional Custody Rule requirements (e.g., to obtain an annual surprise audit). However, in practice, most advisory firms work with a particular custodian (which they require their clients to use), and in such situations the relief would not be available because the advisor typically has access to the agreements and the advisor "recommended, requested, or required [the] client's custodian" to be used. In addition, if the advisor has direct login access to client accounts, such that the advisor can change the address of record and disburse checks, custody may still be triggered. Accordingly, Giachetti suggests that the best way to handle the situation - to be safe - is to follow the SEC's guidance to draft a letter addressed to the custodian that deliberately limits the advisor's authority (notwithstanding the wording of the custodial agreement) and get the custodian's written acknowledgement to affirm the new (more limited and not-custody-triggering) arrangement.

Six Legal Risks That Will Zap You When Publishing Content (Sara Grillo, Advisor Perspectives) - When writing articles or newsletters for clients, or adding material to their website, advisors routinely share, reference, or use the content and graphics of other publications. Which isn't necessarily fatal, but Grillo points out that there are a number of legal traps that advisors should be aware of, including: 1) if you're not certain whether what you're using is 'original' and distinct from another source, just go ahead and cite the source to be safe (not merely for the risk of copyright violation, but also to avoid the adverse perception consequences of being caught plagiarizing... not to mention that those whose work are cited will be appreciative for being recognized); 2) when you do cite someone's work, be certain to use proper guidelines that includes all the relevant information (e.g., APA or MLA formats); 3) if you're going to cite a source, be certain you cite the original source (e.g., if a Forbes article cites an IRS table, you should cite the IRS directly for the original table, not the other publication that ran it, unless Forbes did something to change it and make it "Forbes'" table instead of the IRS's); 4) remember to cite all sources, including not just articles, but YouTube videos or social media posts, if that's really the original source; 5) don't swipe a copy of a chart without asking for permission of the creator, and/or affirming that the source/website gives permission for its graphics to be used; and 6) don't assume Google is a safe place to get images either, as while some images on Google are tagged as "Creative Commons zero license" (which means anyone can use it for any purpose), by default the graphics that come up in a Google search are not licensed that way (you must specifically set the Google search filters for Creative Commons if you wish to find legal images to use).

Where Will Advisor Regulation Be In 11 Years And Beyond? (Bob Veres, Financial Planning) - In the midst of the Department of Labor's fiduciary rule being vacated, and the SEC's advice rule (Regulation Best Interest) also avoiding a full-scale fiduciary duty for brokers giving investment advice, it's notable that the CFP Board itself did proceed with new Standards of Conduct that will require a full fiduciary duty for all CFP professionals at all times when providing financial advice. With the change taking effect in 2019, it will be a full 11 years since the last update to the CFP Board's standards from 2008, which had also put forth a fiduciary requirement, albeit one that was more lax towards practitioners who marketed as being CFP professionals but then claimed to not actually be doing financial planning or material elements of financial planning. In this context, broadening the CFP Board's fiduciary standard to capture all financial advice - which includes any/every product recommendation - represents significant progress over the span of 11 years in the industry. In this context, Veres raises the question of what might be coming over the next 11 years... suggesting that by then, broker-dealers will have figured out how to realign their business models to actually support best-interests fiduciary advice (which means not just being business-model-neutral in the regulations, but actually prescribing rules to mitigate or eliminate the most problematic compensation conflicts of interest, from commissions to back-office shelf-space agreements), that the debate over fee compensation structures (fee vs commission) will be over but there will be a much wider range of fee models (AUM, quarterly fees, hourly fees, etc.), and that perhaps CFP certification (or the PFS designation) will soon become a requirement to practice financial planning and the pressure on advisors to maintain higher standards continues to march inexorably forward.

Who Changes Their Financial Planner? (Martha Fulk & Kimberly Watkins & John Grable & Michelle Kruger, Journal of Financial Planning) - While there is a growing volume of research about what types of consumers tend to use a financial planner and why, there's remarkably little research about what leads a consumer to make a change to a new financial planner, from factors of dissatisfaction (e.g., lack of communication, poor performance, high fees, etc.) to life circumstances (e.g., death of a client). Accordingly, the researchers in this study actually surveyed consumers (via Mechanical Turk) and asked them whether they had ever fired their financial advisors, and about their own individual circumstances and demographics. The results showed that those who change advisors are more likely to have higher income and higher net worth (suggesting that consumers really do change advisors as their income and other financial circumstances change), are more likely to be older (perhaps having had more time to change and find new advisors), and were more likely to consider themselves "savvy investors" who knew how their investments were performing (i.e., were diligent in evaluating their advisors, the services being rendered, and the value being provided... or not). In addition, those who were remarried, widowed, or divorced, were also significantly more likely to have changed advisors. The significance of this research is not merely that "savvy" consumers are more likely to suss out bad advisors and make changes, and have done so more often as they're older (and have had more time to do so), but that changing financial and life circumstances - from increases in income and net worth, to changing in marital status through divorce, widowing, and remarriage - are predictors of changing advisors. Or stated more simply, consumers don't necessarily trust that an existing advisor who helped them with their "old"/prior problems will necessarily be skilled enough to help them with their new "more complex" problems as well (though the results aren't clear about whether the advisors really can't help their clients in their new more complex situations, or whether clients simply become anchored to an advisor's prior services and don't realize that the advisor can in fact do more).

The Profession Of Financial Planning: Past, Present, and the Next 45 Years (Lewis Walker, Journal of Financial Planning) - As a member of the third class from the College for Financial Planning (in 1975), and a past president of the ICFP, Walker has seen nearly 45 years of the evolution of the financial planning, and reflects on how that past has set the stage for the future and where the profession will likely go from here. Notably, the early roots of financial planning were in sales - where financial planning itself was effectively a sales tool - though, from its start, the shift from products to financial planning was about a shift away from just the products and the one-off sale and into a plan and providing more objective and holistic advice. Nonetheless, though, financial planners of the 1970s and 1980s subsisted largely from the compensation of selling products implemented pursuant to the plan (as Walker puts it, "you [still] had to be a damned good salesperson", selling both yourself, the idea of financial planning, and products, to survive). As financial planning proliferated, though, so did potential competitors, leading the famous financial planner P. Kemp Fain to call for "One Profession, One Designation", where the CFP certification might someday become the hallmark of a bona fide financial planning professional (akin to the CPA license in accounting). Eventually, the model began to shift away from products (in part as mutual fund commissions themselves began to decline), and towards the AUM model (which started with fees as high as 3% back in the early 1980s under E.F. Hutton), with NAPFA forming to support the fee-only advisor community in 1983. By the 2000s, financial planning was shifting again, both with respect to business models, and the impact of computers and the internet changing how financial plans were prepared and delivered. So where will financial planning evolve from here, over the next 45 years? Walker suggests a growing focus on how we train and develop financial planners - who are hired to start out as financial planners from day 1, not product salespeople who convert to advice later - and that financial planning will be an increasingly global profession as well.

The Value Of Financial Designations: A Consumer Perspective (Sterling Raskie & Jason Martin & Craig Lemoine, Journal of Financial Planning) - As income and wealth rise, so too does the desire to hire a financial planner to help with increasingly complex and high-stakes financial decisions, for which consumers then must decide which financial advisor to work with. In examining a nationally representative sample of consumers who work with a financial advisor, the researchers found that consumers do report that having a financial designation was important, and especially so for those at higher levels of income or investable assets. Although, notably, the researchers found that payments to financial advisors were actually highest amongst affluent young consumers (aged 18 to 39), declining for the middle aged and then rising (but only slightly) for retirees. In other words, it appears that younger consumers are the ones most likely to expect to pay a financial advisor, and at higher income and wealth levels (admittedly not common amongst those under age 40) tended to pay the most (relative to their income and wealth) and were the most likely to assign additional perceived value to the advisor's designations. The key point, though, is simply that from the consumer's perspective, bona fide financial designations do increase the perceived value of the advisor (and their willingness to pay the advisor), and the effects become even stronger for those with greater income and affluence.

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.