Weekend Reading for Financial Planners (Dec 11-12)

Authors:

Ben Henry-Moreland

Team Kitces

Ben Henry-Moreland is a Senior Financial Planning Nerd at Kitces.com, where he specializes in writing and speaking on financial planning topics including tax, practice management, and technology. He also co-authors the monthly Kitces #AdvisorTech column. Drawing from his experience as a financial planner and a solo advisory firm owner, Ben is passionate about fulfilling the site’s mission of making financial advicers better and more successful.

Read more of Ben’s articles here.

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Adam Van Deusen, CFP

Team Kitces

Adam is a Financial Planning Nerd at Kitces.com. He previously worked at a financial planning firm in Bethesda, Maryland, and as a journalist covering the banking and insurance industries. Outside of work, he serves as a volunteer financial planner and class instructor for local and national non-profits.

Read more of Adam’s articles here.

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Supreme Court Ponders Future Of ERISA Fee Litigation (Emile Hallez, InvestmentNews) - Under the Employee Retirement Income Security Act of 1974 (ERISA), administrators of employee retirement plans such as 401(k) or 403(b) plans are required to act as fiduciaries for those plans on behalf of their participants. One of the duties required of plan fiduciaries is to ensure that the fees paid by plan participants are reasonable (including both the fees paid for the investments within the plan, and the fees paid to the administrators, investment advisors, and recordkeepers who manage the plan). But the law is notoriously vague in defining what a “reasonable” fee might be, and how aggressively plan fiduciaries should act in seeking out the lowest possible fees for their participants. These issues are at the heart of Hughes v. Northwestern University, for which the U.S. Supreme Court heard oral arguments on Monday, December 6. In the lawsuit, the plaintiffs claim that participants in Northwestern’s 403(b) plan paid excessive fees by offering a large number of investment options and retaining multiple plan recordkeepers (as while “choice” is usually viewed as a positive, when the industry standard is a “sliding-scale” fee structure based on total assets under management, consolidating the plan’s assets into a smaller number of providers could have resulted in lower fees overall). But aside from the impact on Northwestern’s 403(b) participants, the case could have a broader impact for ERISA-governed plans and their fiduciaries, because if the Supreme Court decides to allow the case to go forward (after it was previously dismissed in a lower court), it could make it easier for similar cases to proceed against plan administrators… which could result in a new wave of lawsuits for breach of fiduciary duty for not obtaining the absolute lowest cost solution (and in turn force the Department of Labor to further evaluate the “reasonableness” of ERISA plan fees, and clarify what plan sponsors should do and just how far they really are expected to go in their quest for reducing costs to plan participants in order to stay in compliance).

Advisor Compensation Conflicts Are Likely SEC, DOL Target In 2022 (Tracey Longo, Financial Advisor) - In recent years, both the Securities and Exchange Commission (SEC) and the Department of Labor (DOL) introduced new rules defining the fiduciary obligations of people who give investment advice: the SEC’s Regulation Best Interest rule (which took effect on June 30, 2020) and the DOL’s Investment Advice rule (which will be enforced starting February 1, 2022). While both rules require those who give investment advice to act in the best interests of their clients (at least under certain conditions), they leave the door open for some advisors to receive forms of compensation that can incentivize conflicted advice (e.g., commissions and sales-related bonuses) that may run afoul of the best-interests standard. And while regulators cannot currently force advisors to eliminate these conflicts altogether (since they are allowed to exist under the SEC’s and DOL’s own regulations), they can scrutinize those firms’ policies and procedures to ensure they are adhering to the letter of the regulations. So it appears likely that, in the coming year, broker-dealers in particular could face more examinations focused on how those firms supervise their advisors’ investment recommendations to ensure they are eliminating or mitigating conflicts of interest. This seems especially likely in light of NASAA’s recent 2021 Reg BI Phase Two Report, which concluded that “too many Reg BI firms are still placing their financial interests ahead of their retail customers” by offering complex, costly, and risky products, offering sales contests and quotas, and failing to update their policies and procedures to supervise their employees. But it would also represent a “regulation-by-examination” approach of bringing firms into compliance one-by-one (in a manner where they often don’t discover they’re doing anything ‘wrong’ until the examination itself, when it’s too late to fix) rather than updating or clarifying industry-wide regulations. Of course, the SEC and DOL could simply revise their regulations to eliminate the majority of conflicted advice by reforming who may and may not call themselves an “advisor” in the first place, but after their long and unsuccessful battles to implement more stringent fiduciary standards, the agencies seem resigned to continue allowing investment product sales and advice to co-exist (while keeping a more watchful eye on the firms that mix them together).

Senators See Finish Line For Secure Act 2.0 (Kenneth Corbin, Barron’s) - In May of this year, the House Ways and Means Committee introduced the “Securing a Strong Retirement Act of 2021”, better known as “Secure 2.0” after its 2019 predecessor. At the time, there was a strong sense of optimism that the bill would become law, on account of its rare bipartisan support in Congress. But over seven months later, with the end of the year fast approaching, Secure 2.0 still has yet to pass the full House. Meanwhile, on the other side of the Capitol, the Senate’s version of Secure 2.0 remains in the Senate Finance Committee, while the full chamber is mired in partisan (and intra-party) disputes over the Build Back Better Act. So while there is still time to pass the bill in the final weeks of the year, its status seems much less (ahem) secure than at the time it was introduced. Yet there could be reasons to be optimistic about Secure 2.0’s chances of passing this year. It still has bipartisan support for its many provisions (including an increase in the RMD age from 72 to 75, increased “catch-up” contribution limits, requirements for new 401(k) plans to auto-enroll participants, and expanded incentives for small businesses to set up and contribute to retirement plans, among many others). Additionally, the House and Senate versions of the bill, while containing some differences, largely agree on the most important items, making reconciliation between the two versions achievable in relatively short order. And finally, to envision how Secure 2.0 could still be passed this year, it’s possible to look back at its predecessor. The original Secure Act was introduced on March 29, 2019, and passed the House on May 23, but then faltered in the Senate. A last-minute push brought the bill back to life, however, and it was signed into law on December 20, 2019. So with only a few weeks left in the year, it’s possible that there will be two pieces of legislation with major tax and retirement implications – Secure 2.0, and Build Back Better (with its increase in the State and Local Tax deduction and elimination of the backdoor Roth) – and that financial advisors will have only a few weeks (or days) to sort out the impact on their clients before the new laws take effect. Though at the least, it still seems likely that Secure 2.0 will get passed some time in 2022, if it doesn’t make it through the end-of-year legislative process.

Ritholtz, WisdomTree Launch Crypto Index Separate Account (Jeff Benjamin, InvestmentNews) - Individuals looking to gain exposure to Bitcoin and other cryptocurrencies currently have several options, including purchasing them directly on a cryptocurrency exchange, buying a Bitcoin trust, or a Bitcoin Futures Exchange-Traded Fund (ETF). However, the impracticality for most clients to hold cryptocurrency in individual wallets, along with the lack of an ETF or similar vehicle that holds cryptocurrencies directly (and therefore better reflect the spot price of the cryptocurrency), has made it difficult for financial advisors to give clients direct exposure to these assets. Yet while a U.S.-based crypto ETF (that actually holds the underlying cryptocurrencies themselves) remains in regulatory limbo, RIA Ritholtz Wealth Management has teamed up with index provider WisdomTree, crypto custodian Gemini, and crypto platform provider Onramp to offer access to a diversified cryptocurrency index through a separately managed account format that financial advisors will be able to use with their clients. The index offers direct exposure to a blend of 13 currencies, with a 36% weighting in Bitcoin, a 20% weighting in Ethereum, and 4% weightings in 11 other crypto assets. The index is currently available through Ritholtz advisors, but the creators hope to roll it out to other advisors in early 2022, and potentially directly to individual investors in the future. In terms of fees for the product, an Onramp executive said they should be ‘less than 2%’, which would put it below the expense ratio of the popular Grayscale Bitcoin Trust, but potentially above the sub-1% expense ratios for the Bitcoin Futures ETFs. So while financial advisors wait for a U.S.-based ETF option that directly invests in crypto (i.e., one that could easily be purchased in client brokerage accounts), the new crypto index in a separately managed account format could still serve as an entry point for clients who are interested in exposure to crypto (and for advisors who would prefer they invest into a wider range of cryptocurrencies in an index-style format, instead of putting all of their chips in one cryptocurrency alone).

Fidelity Launches Bitcoin ETF…In Canada (Lisa Shidler, RIABiz) - Many investors cheered the introduction of Bitcoin Futures ETFs in October as a way to gain exposure to the cryptocurrency in the relatively low cost, secure, and liquid ETF wrapper. The downside to these ETFs was that they invest in Bitcoin Futures, rather than hold the cryptocurrency directly, creating the potential for deviations between the price of the ETF and the spot price of Bitcoin. Several ETF providers have filed with the Securities and Exchange Commission (SEC) to create a spot Bitcoin ETF, but the regulator has yet to approve one of these funds. In the absence of regulatory movement in the U.S., Fidelity has looked to Canada, and on December 3 its Canadian subsidiary launched the Fidelity Advantage Bitcoin ETF. The ETF will invest in ‘physical’ spot Bitcoin, as well as Bitcoin derivatives, and has an expense ratio of just 0.40%. While Canadian investors and advisors might cheer the development, there are significant hurdles for U.S. investors (and their advisors) to use the ETF. Notably, it is possible for U.S.-based advisors on the Fidelity platform to implement the Canadian Bitcoin ETF, but they will have to set up international trading capabilities on each client account that will purchase the ETF (as it would have to be purchased via the Canadian exchange), and will have to be prepared for the impact of currency fluctuations by buying a Canadian ETF priced in Canadian dollars. So while U.S. advisors and investors wait for a U.S.-based ETF alternative that allows for direct ownership of cryptocurrencies, purchasing Bitcoin directly on crypto exchanges, via a Bitcoin trust, or using the Bitcoin Futures ETFs remain available (if not advisor-friendly) as options for clients.

DAOs Are Gaining Steam [Or At Least Awareness] (Steve Larsen, Advisor Perspectives) - While cryptocurrencies are the most-discussed blockchain-related innovation, this year has seen others gain in popularity. For example, Non-Fungible Tokens (NFTs), a form of digital token that can be publicly tracked and attached to a particular digital image or sound file, have allowed artists to benefit from the demand for ownership over digital artifacts. In addition, Decentralized Finance (DeFi) networks can potentially offer trustworthy, transparent, and fast transactions for activity ranging from trading on exchanges to issuing loans and taking deposits using ‘smart contracts’. Another innovation, Decentralized Autonomous Organizations (DAOs), gained significant media attention in November when a DAO attempted to buy a copy of the U.S. Constitution. At its core, DAOs are member-owned communities that operate without centralized leadership. Instead, the policies and governance of the DAO are programmed in the blockchain on incorruptible contracts, and decisions are made directly by DAO members. Those with the highest stake in the DAO (through ownership of tokens) can have more influence in votes on DAO matters, but all token owners have a say in decision-making for the DAO. The upside for DAOs includes a lack of management bureaucracy and less friction in decision-making. Larsen himself has entered the DAO landscape with PlannerDAO, a self-described cryptocurrency education community for financial planners that operates in a DAO structure. Whether DAOs become prevalent across a range of industries (including financial planning?) as an alternative to ‘traditional’ membership associations remains to be seen, but the number of blockchain-related applications beyond simply tracking cryptocurrencies appears to be expanding going into 2022.

The Secret Is Out On 7.12% Series I Savings Bonds (Brian Chappatta, ThinkAdvisor) - In May and November of each year, the U.S. Treasury resets the interest rates that will be paid for the next six months on its Series I Savings Bonds. The rates are indexed to inflation based on the CPI-U index, and with inflation spiking this year due to a surge in consumer demand combined with issues in supply chains, this November’s annualized composite rate shot up to 7.12% – over twice the previous rate, and the highest composite rate since May 2000. As a result, interest in Series I bonds has sharply risen (helped along by news articles comparing the government-backed bonds’ returns with those of riskier assets like Gamestop stock and cryptocurrency), and according to the Treasury Department, $1.31 billion in Series I bonds were issued in November – its highest monthly total in at least eight years. While the Treasury does not release data on the total number of individuals purchasing Series I bonds, the math shows that, given the $10,000 annual limit on individual purchases, hundreds of thousands – and more likely millions – of individuals have purchased the bonds since November’s rate adjustment (on top of those who had already purchased Series I bonds earlier in the year). But with the Federal Reserve signaling that it will act soon to tamp down the inflation that has persisted longer than anticipated, the current eye-popping rates of Series I bonds may not last beyond the next rate adjustment in May 2022… though until then, the bonds are likely to remain popular with investors as a higher-yield (and government-guaranteed) alternative to alternative to traditional bonds or CDs, and those who wish to maximize their investments up to the $10,000 limit may wish to purchase before the end of the year and then again in 2022 (and even split the purchases across multiple children or family members to dip repeatedly up to the $10,000 limit?).

Structured Notes Are Attracting Interest – And Controversy (David Sterman, Barron’s) - In recent years, as traditional bonds and bond funds have offered low or negative real yields (effectively acting as a drag on portfolio returns during the last decade of equity bull markets), advisors have felt pressure to seek out higher-yielding alternatives to bonds that can still serve to protect portfolios from the downside risk of market volatility. One of the alternatives that has gained popularity is the “structured note”, a type of debt instrument that is combined with an equity derivative such as an S&P 500 index option to achieve some downside protection while retaining the potential to at least partially benefit from bull markets. And while structured notes were traditionally only accessible to high-net-worth and institutional investors (owing to their cost and complexity, and their primary distribution through wirehouses), structured notes have become increasingly available to a greater number of investors as technology platforms like Envestnet, Simon, and Halo Investing have developed offerings aimed at distributing alternative investments like structured notes to financial advisors and their clients. For those platforms, the potential upside is obvious: Not only is a company like Envestnet able to offer and distribute structured notes; it is also able to effectively market the products by integrating them into its Tamarac portfolio management software and its MoneyGuidePro financial planning platform. But the increased access to structured notes does not necessarily translate to them always being the best assets to include in clients’ portfolios. For one thing, their fees still tend to be higher than traditional bonds and bond funds, averaging over 2%. And though they are often marketed on their ability to provide downside protection to a portfolio, the risk characteristics of structured notes can be more complicated than what is implied by the initial marketing pitch. With some types of notes, a steep downturn in the equity index linked to the product can lead to missed coupon payments and loss of principal, and in general, understanding how the product will behave in specific market environments requires a deep understanding of both the note itself, and the derivatives it is linked to. Notably, despite the recent interest, structured notes still represent a very small portion of overall portfolio assets; nonetheless, as technology and distribution methods continue to improve, structured notes will likely be more and more front-and-center in investment options that financial advisors at least have to consider and vet as potential solutions for client portfolios.

The Pros And Cons Of Direct Indexing (Neal Templin, Wall Street Journal) - In recent years, technological improvements coupled with a decline in (or elimination altogether of) transaction costs have led to great interest in the potential of “direct indexing”, i.e., holding all (or most) of the stocks of a particular index such as the S&P 500 individually rather than via an index mutual fund or ETF. In theory, direct indexing offers many potential benefits. First and foremost for many investors, it allows for individual stocks to be sold at a loss to capture tax losses or offset gains, leading to greater possibilities for creating value via tax management: according to one study, the excess returns that can be achieved through tax-loss harvesting alone by holding stocks in the S&P 500 directly versus through an index fund exceed 1% per year, which by itself could more than make up for many advisors’ portfolio management fees. The underlying stocks can also be tailored to an individual investor’s needs: for instance, they can be adjusted from the reference index to account for the investor’s Environmental, Social, and Governance (ESG) preferences (e.g., removing certain oil or tobacco company stocks from the portfolio), or they can be adjusted to account for the investor’s existing holdings (such as a highly appreciated legacy position or company stock holdings). Seizing on this potential, many large brokerages like Schwab, Fidelity, Vanguard, and Franklin Templeton have created or acquired direct indexing platforms, in anticipation of a large-scale pivot from mutual fund and ETF portfolio models to direct indexing. But despite all the money being poured into direct indexing by large institutions, it still has yet to see wide adoption among financial advisors and their clients. And it remains to be seen whether direct indexing technology can improve to the point where advisors – many of whom transitioned away from managing individual stock holdings to model portfolios in the first place in order to focus more on financial planning than investment management – will be truly convinced that its benefits will be worth the large-scale change in strategy (or at least implementation of that strategy) that it represents.

Always Ask For What You Want: A Lesson In Asymmetric Risk (Chris Guillebeau) - As individuals, we take risks every day, but we do not always stop to think about the tradeoff of risk to reward in a given situation. Sometimes a decision involves symmetrical risk, where the rewards are roughly equal to the risk (a simple example would be a wager on a coin flip). Other risks are asymmetrical, though, where the risk and reward are unequal, and sometimes dramatically so. Walking through traffic on a busy street is an example of a negative asymmetric risk, as the benefit of getting to the other side quicker is far outweighed by the risk of getting hit by a car. But not all asymmetric risks are negative, and individuals often hesitate to take a risk even if the potential reward greatly outweighs the risk taken (i.e., a positive asymmetrical risk). For example, Guillebeau once asked the airline gate staff to be considered for an upgrade from economy class to business class on a transatlantic flight, was lucky enough to get it, and enjoyed many hours of free champagne. Another potential positive asymmetric risk is asking for a raise, where the best-case scenario is a significant pay boost, and the likely worst-case scenario is merely that the manager says “no”. Financial advisors often have the chance to take a positive asymmetric risk, from marketing their services to clients who might be hesitant (where the upside is getting a new client with significant lifetime value and the downside is the prospect saying "no") to taking the leap and starting one’s own independent RIA (where the upside is a profitable firm that fits the advisor’s desired lifestyle, and the downside is simply a return back to working as an employee advisor). The key point is that taking positive asymmetric risks can result in significant benefits in both an individual’s personal and professional lives, and that it’s important not to overweight the risk relative to the (sometimes very sizable) potential upside of taking a small chance!

Striving For Perfection, Rather Than Excellence, Can Kill Creativity (Emily Reynolds, The British Psychological Society Research Digest) - Many individuals would describe themselves as perfectionists, always striving to complete tasks perfectly and being the best. This can lead to academic and professional accomplishments… but also increased stress and burnout that could affect performance. With this in mind, researchers in Canada sought to find out whether striving for excellence instead (i.e., striving to perform well, rather than perfectly) led to higher creativity and increased openness to experience. In two studies of undergraduate students, the researchers found that participants who strove for excellence performed better on tasks measuring their creativity, openness, and originality than those who were identified as perfectionists. The results also suggested that perfectionism can inhibit flexibility, which can also be useful in creative thinking. A second study looked at both creativity and self-efficacy among undergraduate students. It also found that perfectionists performed worse on creative tasks than those who sought excellence, but that there was no difference in reported self-efficacy, suggesting that perfectionists might not recognize they are inhibiting their own creativity. Similarly, financial advisors can often find themselves working with clients who have perfectionist, or maximizer, tendencies. These clients tend to think all of their goals are high priorities, but advisors can intervene to help clients discover what really matters to them, and help them rank their priorities accordingly. The studies also suggest that advisors can also consider their own tendencies, as striving for perfectionism could be limiting their creativity in everything from creating financial plans to their marketing activity, and perhaps even limiting their own career!

If You’re Not Skipping Some Tasks, You’re Making Life Harder (Darius Foroux) - When working toward a goal, momentum can be a crucial factor for success. As various items are checked off, it can seem easier to finish upcoming tasks and reach the finish line. Of course, sometimes a task will come up that cannot be completed easily, which can lead to stalled momentum, and potentially not reaching the desired goal. People who strive for perfection can be susceptible to this, as they do not want to skip steps along the way. However, just like skipping a question on a challenging test to make sure the other questions are answered, it can be helpful to put aside a difficult task (at least temporarily) in order to maintain momentum. For financial advisors, momentum can be crucial to a firm’s success. With only a limited amount of time and energy available for each individual, maintaining momentum and being focused on the next task at hand, rather than spreading one’s energy out in different directions, can lead to major goals being achieved. Firms can have momentum as well, and systems are available to help organizations maintain positive momentum toward achieving their goals. So whether it’s an individual with a goal of exercising every day, or a financial advisory firm seeking to expand its client base, maintaining momentum (and not getting bogged down in the challenges that arise along the way by trying to force yourself to check every item on the to-do list) is a valuable and often underappreciated practice!

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, as well as Gavin Spitzner's "Wealth Management Weekly" blog.