Weekend Reading For Financial Planners (August 5-6)

The Odd Logic To Fitch's U.S. Debt Downgrade

(Neil Irwin | Axios)

Unlike municipal or corporate bonds, U.S. Government debt (e.g., Treasury bills and bonds) is often considered to be the gold standard when it comes to minimizing default risk (i.e., the risk that the issuer will not be able to make timely payments on the debt). While Treasuries come with other risks (e.g., they are exposed to interest rate risk, which many have experienced in the rising rate environment), investors tend to assume that the government will honor its debt obligations in a timely manner. But a major credit ratings agency this week has called into question whether investors can count on the U.S. government to not default on its debts going forward.

Fitch Ratings on Tuesday downgraded its assessment of the U.S. government's creditworthiness, giving it an AA+ rating, down from AAA (the highest possible rating). Among the reasons cited for the downgrade, the firm cited expected fiscal deterioration over the next 3 years (with Fitch forecasting a general government deficit of 6.9% of GDP in 2025, up from 3.7% in 2022), the government's "high and growing" debt burden (as the debt-to-GDP ratio is over 2.5X higher than the median ratio of countries with AAA ratings), and an "erosion of governance" during the past 20 years related to peer countries (Fitch cited regular debt ceiling standoffs and a lack of progress addressing longer-term challenges such as rising Social Security and Medicare costs, among other concerns).

But Irwin suggests that the downgrade might not be cause for panic for investors in U.S. government securities. For instance, while the recent (and previous) debt ceiling debates have led the government to approach the brink of default, the eventual resolutions to the standoffs have signaled that legislators are more interested in using the deadline as a way to extract concessions rather than actually lead the government to default. Further, Irwin suggests that given the market for Treasuries is among the most scrutinized in the world, Fitch's downgrade does not reflect any "special insight", but rather reflects its experts' opinions of widely available and analyzed data.

Nonetheless, given the headlines generated by the downgrade, some advisory clients might be concerned that the portion of their fixed-income portfolios invested in Treasuries (typically viewed as the 'safer' portion of the portfolio) might be exposed to increased default risk than previously assumed. But given that many of the issues Fitch raised have been ongoing for years (e.g., regular debt limit increases) and that the broader market appears to continue to consider Treasuries to be among the 'safest' (if not the safest) debt instrument, advisors could offer clients some solace that, while it's possible a default could happen at some point in the future, the Fitch downgrade does not necessarily portend a major, imminent risk to their fixed income portfolios.   

RIA M&A Trends Down, But Far From Out

(Ali Hibbs | Wealth Management)

RIA Mergers and Acquisitions (M&A) activity had been brisk during the past few years, as heightened demand from acquirers (often larger firms, sometimes infused with Private Equity [PE] capital) drove up valuations, to the benefit of those selling their firms. For instance, 341 RIA M&A transactions were announced in 2022, an 11% increase over 2021 (which itself saw a nearly 50% increase in the number of deals compared to 2020, though the latter year's deal flow was likely impacted by the onset of the pandemic), according to data from investment bank Echelon Partners.

But data from a variety of firms tracking deals across the industry has found that the pace of dealmaking has begun to slow in 2023. Echelon Partners reported 65 deals in the second quarter, down 28.6% from 91 in the same quarter last year, while DeVoe & Company found a 14.9% decrease in activity (from 67 transactions to 57), MarshBerry recorded a drop from 77 to 61 deals and Fidelity Institutional found a decline from 60 to 48 deals. While the specific rate of decline varied (as the firms qualify and count RIA deals in different ways), they paint a consistent picture of a slower pace of deals compared to the same period in 2022. Looking at the full year, Echelon forecasted that the number of transactions will total 300 for 2023, which would be a 12.3% decline from the record-breaking totals seen last year.

The rising interest rate environment is seen as a primary cause of the slowdown, as higher rates increase the financing costs of deals and some (for those buyers who qualify to access financing in the first place). Nevertheless, some industry observers suggest that because M&A drivers remain on both sides of transactions (e.g., acquirers looking to grow their client and talent bases or expand their services, and sellers looking to retire or offload some back-office activities) and given continued interest in the space among private equity firms (with M&A advisory firms finding that between 65% and 73% of transactions so far this year have involved private equity firms, either directly or indirectly as backers of an acquiring RIA), there will not necessarily be a shortage of deal opportunities through the rest of 2023, even if it is at a slower past than the past couple years.

Ultimately, the key point is that despite a variety of headwinds (from rising interest rates to the need for acquirers to 'digest' acquisitions announced in previous years), interested buyers and sellers continue to have opportunities to consummate deals, though perhaps not at the frenzied pace seen in the past couple years!

Firms Not Warming To Testimonials Despite Ad Rule, IAA Survey Finds

(Patrick Donachie | Wealth Management)

Almost 2 years after it was first announced, enforcement of the SEC's new marketing rule began in November of last year. The new marketing rule presents RIAs with the opportunity to greatly expand their marketing efforts with new options, from client testimonials to promoting the reviews they've received on third-party websites, to provide prospective clients with evidence of the quality of their service. Last September, the SEC issued a risk alert putting advisors on notice that examiners will be conducting a number of reviews to evaluate how firms are complying with the new rule since it was finalized nearly 2 years ago. More recently (perhaps as a result of these initial examinations), the SEC in June issued an additional risk alert highlighting areas of increased focus for its upcoming exams, including whether there is clear disclosure of whether the person giving the testimonial or endorsement is a client or investor, if the promoter has been paid, and if there are material conflicts of interest. Amid this backdrop, a recent survey suggests that given the SEC's enforcement posture, more investment advisers are playing 'defense' rather than 'offense' when it comes to the marketing rule.

According to the survey of 581 firms conducted by the Investment Adviser Association (IAA), despite the expanded opportunities presented by the marketing rule, only 5% of respondents said they have increased their use of testimonials and 4% reported increasing their use of endorsements, solicitors, and marketers. At the same time, 88% of firms reported changing their marketing materials to comply with the regulatory requirements mandated by the marketing rule, indicating that firms are more focused on working to ensure they are in compliance with the rule before a future SEC examination. Notably, 47% of respondents said they removed their previous marketing policies and procedures and adopted an entirely new one (and an additional 37% said they amended their existing policies). Perhaps unsurprisingly, advertising and marketing took the top spot among "hot topics" for firm compliance officers (cited by 70% of respondents), with cybersecurity coming in 2nd place at 52% and electronic communication surveillance in third at 35%.   

Altogether, the IAA survey suggests that advisory firms are largely taking a defensive posture toward the SEC's marketing rule for now. Though, given the potential opportunities it offers, it's possible that many firms are taking a 'wait and see' approach and will increase their use of client testimonials and endorsements once they have a better idea of how the SEC will enforce its marketing rule?  

Rookie Advisors: Who Are They And What Do They Want?

(Holly Deaton | RIAIntel)

Becoming a financial advisor is an attractive proposition for many individuals. From the ability to help clients achieve their financial goals to opportunities for schedule flexibility and healthy incomes, there are a variety of factors that lead advisors to report greater wellbeing than the broader population of workers. And while the image of a new advisor might be a fresh college graduate, a recent study suggests that career changers make up a significant portion of new advisor headcount.

According to a report from research and consulting firm Cerulli Associates, "rookie" advisors (i.e., those with 3 or fewer years of experience) have an average age of 37 and came to the industry with significant professional experience; in fact, only 15% of rookie advisors reported that financial advice was their first career. Among career changers, about 43% came from elsewhere in the financial services industry, with 28% previously working in sales and marketing, 19% working as an analyst, product specialist, or portfolio manager, and 16% came from client services, operations, and administration. 

While career changers bring experience from previous jobs that could be useful in the advisor context (e.g., sales or client-facing skills), the study suggests that they are also seeking training from their new employers. For example, while 71% of new advisors reported that financial planning training was very important, only 47% reported being "very satisfied" with training they received from their firm. Other areas cited as important by rookie advisors included investment analysis training and support for the licensing process (71%), exposure to successful advisors (64%) and mentorship from established advisors (60%). With this in mind, Cerulli suggested that firms could consider structured training programs (e.g., letting new advisors manage small-balance accounts under the guidance of a senior advisor) to provide new advisors with training and mentorship opportunities while providing value to the firm.

Overall, the Cerulli report suggests that while pursuing a career change to become a financial advisor remains an attractive proposition for many professionals, the industry still has work to do when it comes to retaining talent (as the "rookie" failure rate was more than 72% in 2022, according to the study). And so, given this high attrition rate (particularly for advisors who have to develop their own book of business out of the gate), firms that focus on talent development (from developing an onboarding program to establishing career tracks) could have an edge when it comes to employee retention going forward!

Attracting Talent To Your Team

(Daniel Yerger | MY Wealth Planners)

Hiring a new team member can require a significant investment of advisory firm resources. Given the time needed to craft a position description, vet applications, and interview candidates, as well as the potential dollar cost of leveraging job search sites to attract applicants, firms will want to see a return on their investment in the form of a sufficient number of high-quality candidates that allows the firm to find the 'right' person for the job. 

Yerger's firm recently had a positive experience attracting candidates for a financial planner assistant position, receiving 109 applications in 6 days. First, he credits this to the time spent crafting a job posting that focused on the benefits to the potential applicant rather than bragging about the firm itself. For instance, his firm listed the compensation for the position as well as information on the company's benefits and career path. In addition, rather than including a long list of 'required' qualifications that are really 'nice to haves', the posting made it clear that the listed qualifications were nominal in an effort to attract a broader pool of candidates. The job listing also provided a timeline for the various steps in the hiring process in order to set expectations for candidates (and to assure them that they were not being ignored). In addition, Yerger's firm cast a wide net when it came to advertising position. The posting went out on both industry-specific job boards (e.g., CFP Board and NAPFA), as well as on more generic hiring platforms (e.g., LinkedIn, ZipRecruiter, and Indeed). Together, these efforts helped the firm not only attract a large number of applicants, but also a diverse pool as well. 

In sum, while some firms might be under the (possibly mistaken) assumption that applicants will flock to any position they advertise, being intentional about the hiring process can help them attract a larger number of qualified candidates. Which could ultimately be an investment that pays off in the form of a new hire that becomes a key part of the firm for years to come!

How RIAs' Non-Traditional Hiring Practices Are Creating A Diverse Talent Pool In Wealth Management

(Charles Paikert | Action! Magazine)

Recruiting talent is a major issue for many advisory firms, particularly given the current tight labor market and the expected number of advisor retirements in the coming years. But when it comes to hiring, some firms unintentionally limit the pool of applicants available to them, whether by primarily looking for candidates within the networks of the firm's employees or by mandating a level of financial planning experience that could exclude career changers with relevant skills.

Data show that the financial advisory industry has had a difficult time attracting a diverse population of advisors. For instance, about 75% of CFP professionals are men and 82% are white (while only 4% are Asian, 3% are Hispanic or Latino, and 2% are Black). This suggests that there is a significant untapped market of potential advisor talent that has yet to be reached (and could present a significant opportunity for firms that do pursue candidates in less-represented groups). Potential ways for firms to increase the diversity of their applicant pool include leveraging programs such as the BLX Internship program, which matches fee-only planning firms with qualified diverse candidates for summer internships, as well as by recruiting at a broader range of colleges and by implementing onboarding programs as well as creating mentorship opportunities and career tracks that provide candidates with a path to success at the firm.

In addition to gender and ethnic diversity, career changers can also bring a diverse array of experiences and ideas from their previous professions. For instance, a journalist might have significant experience building trust with others and asking probing questions, skills that could translate well to client-facing advisory work. Or consider an operations manager at a factory, who might not have a background in financial planning but would bring experience with logistics and managing complex systems that could be applied to managing an advisory business. Firms that might be worried that these career changers might not be committed to a career in financial advice could consider prioritizing candidates who have started (or completed) the CFP education or exam requirements, which could signal that the candidates already have 'skin in the game' when it comes to a career in planning.

Ultimately, the key point is that advisory firms can benefit in a variety of ways by seeking out a more diverse group of candidates for internships and full-time positions. From gaining access to a larger number of qualified candidates to attracting applicants with unique experiences and talents, broadening the pool of advisor talent can not only benefit job-seekers and firms that are hiring, but also the planning industry as a whole (as it looks to reach more clients and transitions from an industry into a profession)! 

The Problems With Monte Carlo Are In Your Mind

(David Blanchett | Advisor Perspectives)

Monte Carlo projections have become a common way for financial advisors to demonstrate the uncertainty associated with planning projections and accomplishing financial goals and represents a significant improvement over 'straight line' projections that (unrealistically) assume a constant investment return across a single 'trial'. Nonetheless, advisors (and clients) sometimes are frustrated with the presumed limitations of Monte Carlo analysis in providing a more nuanced view of a client's situation.

However, Blanchett argues that many of the complaints about Monte Carlo simulations are not with the concept in general, but with the software tools available to financial advisors that incorporate Monte Carlo functionality. For instance, the output of many Monte Carlo tools is a probability of success expressed as a percentage (often to multiple decimal places). But because individuals do not experience binary outcomes (i.e., pass or fail), being able to understand the magnitude of failure can provide more insight into the efficacy of a given strategy. For instance, a client with a 0% probability of success who could cover 95% of their spending needs through 'guaranteed' income sources (e.g., Social Security benefits or an annuity) if their portfolio went to $0 might be better off than a client with a 90% success rate who would only be able to meet 15% of their spending needs if their portfolio were depleted. 

Blanchett suggests that advisors could move away from precise success levels (e.g., 85.23%) to more general guidance on the likelihood of achieving a certain goal (e.g., off-track versus on-track) to communicate the results of Monte Carlo analysis more effectively in these situations. An alternative approach is to focus on outcome percentiles instead of success rates (e.g., tell the client what their expected income would be in the bottom quintile of trials and ask how that makes them feel). Other alternate options for using Monte Carlo analysis include reducing the target success rate (which can allow for increased income early in retirement while leaving the door open for spending adjustments later on) or by factoring a spending cut into retirement (i.e., incorporating the "spending smile", Blanchett's finding that spending tends to decline in real terms during retirement) to better track real-world spending patterns.

In the end, Monte Carlo analysis is a flexible tool that advisors can use to model uncertain futures. And whether advisors are using more basic Monte Carlo software tools or those that allow for more advanced calculations, it is not just the results of the analysis that add value, but also how they are communicated to the client to give them a better idea of their planning options and the chances they will achieve their financial goals!

You Are Underestimating Longevity And How Uncertain It Is

(Massimo Young and Erik Pickett | Advisor Perspectives)

One of the common ways financial advisors add value is by helping clients plan for a financially sustainable retirement. However, this is no simple task, as there is inherent uncertainty in many factors that can affect whether a client will have sufficient assets to meet their needs throughout the rest of their life, from the sequence of portfolio returns to their longevity.

When it comes to longevity, advisors sometimes try to err on the conservative side. For example, while the 2021 life expectancy in the United States was 76.1 years, an advisor might model their clients' life expectancies to age 90. But Young and Pickett argue that projecting life expectancy out to age 90 might not be conservative enough. For instance, if clients are part of a couple, there is a greater chance that at least one of the partners will reach a more advanced age (e.g., the Social Security Administration [SSA] estimates that there is a 25% chance that at least one member of a male-female couple who reaches age 65 will live to age 93). In addition, a client's net worth can influence longevity, as wealthier individuals tend to live longer than others. Further, future medical advances could extend Americans' lifespans beyond what is typically seen today. Putting all of these factors together, the authors estimated that for healthy, wealthy 65-year-old male-female couples, there is an approximately 75% chance that one member of the couple will live beyond age 90. 

In sum, while longevity is inherently uncertain, taking each client's circumstances into account (from their marital status to their health) when estimating longevity could lead to more accurate planning analyses than using a 'one size fits all' approach, even if it assumed to be conservative! 

Will You Claim Social Security Early Or Hold Out As Long As Possible?

(Mark Hulbert | MarketWatch)

One of the most important decisions retirees make is when to begin claiming Social Security benefits. While some might need to claim benefits early (i.e., at age 62, or at least before their full retirement age) because the income is needed to support their lifestyle, others have the option to delay taking benefits until later (and reap the benefits of a higher monthly benefit for the remainder of their lives). Yet many individuals in this latter group still choose to claim benefits early.

Researchers from Cornell University and Duke University explored this phenomenon in a 2022 study and found 2 psychological factors that can influence the decision to claim benefits early. One element is a sense of "psychological ownership" (i.e., the feeling that something is 'mine') of the Social Security benefits one is slated to receive. For instance, the researchers found that survey respondents who agreed with statements such as "I feel that I have earned these retirement benefits" and "The Social Security benefits that I will receive come from the money that I contributed" were more likely to say that they were to claim benefits early. 

The researchers also found that a greater sense of loss aversion (i.e., the tendency of individuals to fear losses more than they desire gains) was correlated with being an early claimer. They showed individuals a table with the increased lifetime benefits they could receive by delaying claiming in an attempt to show them, in real numbers, how much they could gain by waiting to take Social Security benefits, but this actually had the opposite effect and made the participants want to claim early, possibly because the table showed them how much they stood to 'lose' if they waited to claim and died before the breakeven point of claiming early versus later.  

Ultimately, the key point is that this research suggests that the decision of whether to claim Social Security benefits early is not just a mathematical question, but a psychological one as well. Which means that advisors might not be able to rely on data alone when it comes to discussing Social Security claiming strategies with certain clients, but potentially also addressing their psychological 'ownership' of their benefits and degree of loss aversion (which might be known ahead of time based on their investment risk tolerance?) in the conversation as well! 

Give More Feedback – Others Want It More Than You Think

(Nicole Abi-Esber and Juliana Schroeder | Behavioral Scientist)

Individuals have the opportunity to give feedback throughout the day, whether it is regarding how a colleague performed in a client meeting or how well a spouse did at making dinner. And the recipients often appreciate the feedback, particularly if it is positive ("Dinner was delicious!") or constructive ("You spoke at a fast pace and I'm not sure the client understood everything you said."). Nevertheless, researchers have found that individuals tend to underestimate recipients' desire to receive feedback and, as a result, provide it less often than would be ideal.

In a paper by Abi-Esber, Schroeder, and 2 co-authors, the researchers conducted a variety of experiments to explore whether this gap persisted across different scenarios. In the experiments (which ranged from testing whether individuals would tell a researcher whether they had a chocolate stain on their face to having friends and couples provide actual feedback to each other), the researchers found that advice givers consistently underestimated the recipients' desire to receive the feedback. Sometimes the gap was small (e.g., when telling someone they have a rip in their pants), but other times it was larger (e.g., when telling someone they are interrupting colleagues), suggesting that individual's willingness to give feedback varies depending on the circumstances. 

Given the potential benefits of providing more feedback, the researchers tested different ways to encourage individuals to actually provide it. For instance, they asked participants to imagine that someone else would give the feedback before predicting how much the recipient would want to receive it. While this was effective at boosting the feedback givers' predictions of how much the recipients would want the feedback, an even more effective intervention was to ask participants to put themselves in the shoes of the potential feedback recipient before predicting how much they would want to receive it.  

Altogether, this research suggests while individuals might be hesitant to give feedback in certain circumstances (perhaps not wanting to be rude or assuming the other person would not want to receive it), potential feedback recipients are in fact much more open to receiving it than one might guess. Further, the study suggests that the next time you are reluctant to give feedback, you can consider putting yourself in the recipients' shoes and thinking about whether you would want to receive it; if the answer is yes, it might be a sign that you should go ahead and give it (and this research indicates that the recipient will likely be glad that you did!). 

What's Your Work Style Preference?

(Anna Oakes and Claire Hughes-Johnson | Quartz)

Thinking about people you have worked with over the course of your career (or yourself), you can likely identify individuals with different sets of skills and preferences. For instance, some might have preferred to work collaboratively with coworkers, while others enjoyed drilling down into a task themselves. And so, because each individual has different work style preferences, identifying them and ensuring that their job duties are a good fit can help individuals and firms improve their performance.

One method of identifying work styles is to plot an individual on a continuum from individual to extroverted and from task-oriented to people-oriented. Together, this creates 4 quadrants that describe different work style preferences, which Hughes-Johnson dubs Analyzers, Directors, Promoters, and Collaborators. Analyzers are those who are more introverted and task-oriented, meaning that they tend to be deliberate about decisions and constantly seek data to inform their actions. Directors are extroverted and task-oriented, and often have a bias toward rapid action and strong opinions about the 'right' answer in a given situation. Promoters are extroverted and people-oriented, typically having a lot of ideas and the ability to articulate an inspiring narrative. Finally, Collaborators are introverted and people-oriented and tend to care a lot about 'customers', whether they are external clients or other employees at the company with whom they collaborate.     

Importantly, no work style preference is inherently 'better' than the others; rather, the key is to ensure a team has the right combination of work style preferences to handle different tasks that come its way. For instance, a team full of Analyzers might be good at getting things done but might not be able to set a larger vision for the team, while a team of Promoters might come up with an inspiring plan but not actually be able to execute on it. Further, by knowing your work style preference, you can seek out positions that most closely match it (e.g., a "Promoter" might not want to take on a data-heavy assignment that doesn't involve interaction with others). And so, whether you are building a team or are considering your own career path, awareness of work style preferences can help promote both job satisfaction as well as firm performance! 

How Your Physical Surroundings Shape Your Work Life

(Brianna Barker Caza, Alyson Meister, Blake Ashforth | Harvard Business Review)

In the digital age, knowledge workers have more options than ever for where they complete their work. From traditional offices to home offices to coffee shops, there are a variety of physical workspaces from which to choose. And while some companies and individuals might default into one type of work environment, the authors suggest that taking a more considered and flexible approach could boost productivity and wellbeing.

Workplaces are comprised of several elements that can promote (or detract from) the ability of employees to get work done, interact with others, and simply function effectively. These include functional elements (i.e., the physical attributes that facilitate work), sensory elements (i.e., lighting, sounds, and views), social elements (i.e., opportunities for interaction), and temporal elements (i.e., markers of past accomplishments or future aspirations). Notably, employees are likely to have different preferences across these dimensions. For instance, some workers might like the 'buzz' and opportunities for interaction that an open-plan office offers, while others might prefer to work in peace with fewer potential distractions. Further, these preferences can change depending on what task is being performed; for example, an employee who gets inspiration from being around nature (e.g., working outside when possible) might want a distraction-free space (perhaps an office away from windows) when drilling into a key time-sensitive assignment. Altogether, this framework suggests that companies that offer more workplace flexibility, not only in terms of where they work but what that physical location looks, sounds, and feels like could find that their employees are more productive and satisfied with their surroundings.

Ultimately, the key point is that a workplace is not just a desk where work gets done, but rather an environment that can inspire creative ideas, interactions, and moments of meaning (e.g., think back to where you were when you signed on your first client). With this in mind, individuals and companies that take more intentional (and flexible) approaches to designing their workplaces could find that they not only boost productivity, but also overall wellbeing!

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

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