Weekend Reading for Financial Planners (Dec 14-15)

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.

Weekend reading for December 14th/15th:

NAPFA, FPA Waiting On CFP Board To Have Fee-Only Talk - It's been four months since the controversies began over the CFP Board's definition of "fee-only" and how advisors should characterize their compensation, yet formal talks amongst NAPFA, FPA, and the CFP Board about how to resolve the matter still have not yet even begun. While both NAPFA chief executive Geoffrey Brown and FPA incoming President Janet Stanzak acknowledge there is a lack of clarity and needs to be a constructive dialogue, both state they are deferring to the CFP Board to take the lead and start the dialogue. In the meantime, disparities remain; the FPA website continues to have advisors in its search tool who declare themselves as fee-only yet work for a broker dealer (a violation of the current CFP Board rules, as they should declare themselves commission and fee, though notably CFP Board requires such disclosures even though there's no proof that any of those advisors actually receive any form of commission compensation). Similarly, NAPFA estimates that as many as 5% of its members comply with its own rules but are in violation of the CFP Board's "fee only" definition as well, and confusingly states that while it requires members to have the CFP marks, they will not remove members who violate the CFP Board's fee-only rules. At this point, it remains unclear what will break the stalemate, as FPA and NAPFA continue to wait but the CFP Board shows no outward momentum at all towards reforming the rules, even though historically NAPFA has been at the forefront of pushing the definition of fee-only forward.

46% of Planners Have No Retirement Plan, FPA Finds - The FPA completed a recent inaugural study for its Research and Practice Institute, polling 2,400 of its members and finding that a whopping 46% of them have no retirement plan for themselves; another half don't have a written business plan, and 75% have no succession plan for their firm (even amongst advisors age 65 and older, only 41% said they have a succession plan!). Of course, the study results acknowledge that advisors are busy and may struggle with the time to do this planning, and finds that younger advisors (under age 40) are more likely to at least have a written business plan; nonetheless, in an environment where planners deliver these services to clients, the FPA research suggests planners may be neglecting themselves. The study also found that advisors are shifting their branding towards calling themselves wealth managers (whether they were already financial planners, or previously money managers). The study also found that planners are struggling to grow, yet still don't have target clientele clearly defined; only 25% of advisors have a formal definition of their ideal client, and only 38% of those say that 3/4ths of their current clients actually fit the definition. In addition, the study found that only 43% of advisors had an asset minimum. The bottom line: while a lot of planners may be succeeding, there's clearly a lot of room for many to get their business and personal affairs in better order!

Consumer, Investment Adviser Groups Push Lawmakers To Support Bill To Boost Adviser Exams - Last week, seven interest groups - including the CFP Board, FPA, and NAPFA, as well as AARP, the Consumer Federation of America, the Investment Adviser Association, and NASAA - sent a letter to each member of Congress, seeking to expand support for legislation from Rep. Maxine Waters (D-Calif.) that would boost the SEC's funding to examine investment advisers by establishing user fees on RIAs. (The solution is viewed as an alternative to shifting investment adviser oversight to FINRA or another SRO.) The groups are trying to build more momentum for the legislation, following a Nov 22nd unanimous (with one recusal) vote by the SEC Investor Advisory Committee that recommended the commission support the measure. Notwithstanding the push, the legislation still faces significant uphill battle in the Republican-controlled House, and may not get a hearing in the House Financial Services Committee, as many in the GOP view user fees as taxes and do not support the measure.

U.S. Regulator Intensifies Scrutiny Of Fee-Based Accounts - The SEC has announced that in 2014, it will be stepping up its scrutiny of "reverse churning" where brokerage firms charge ongoing fixed/AUM fees for 'unlimited' trading but then in practice trade them rarely, resulting in a significantly higher cost than what the investor would have paid by just paying trading fees for each individual transaction. As brokerage firms continue to migrate from commission-based to AUM-based models, the problem appears to be getting worse, as assets in fee-based managed accounts at US brokerage firms are up to $2.8 trillion in 2012 (increasing 18.5% from 2011 alone), and the trend is expected to continue as consumers shift, firms find the stable revenue more appealing, and wirehouse brokers receive increasing incentives to shift clients towards fee-based accounts. The SEC has acknowledged that sometimes additional value-add services - such as financial planning - may be attached for an AUM fee, making it more reasonable, but the regulator remains concerned nonetheless about how much larger many AUM fees are than what the investor may pay by just relying sticking with commission-based trades; ironically, the distinction is especially notable as fee-based businesses are increasingly fiduciary, and it may be difficult to justify the ongoing (higher) AUM fee compared to lower cost commission transactions. Of course, the regulators note that "reverse churning" is much harder to detect than an inappropriate level of active trading, especially since sometimes the right decision really is to buy and hold, or to keep a large chunk of cash flexible; nonetheless, as long as the cost of many AUM fees is significantly higher than what commission-based transactions would cost for similar activity levels, there may be pressure to rethink some fee arrangements.

RIA Custodians Charge Steep New ETF-Related Fees - On RIABiz, this article looks at the rise of new "trade away" fees that Schwab, Fidelity, TD Ameritrade, and Pershing Advisor Solutions are now charging for the execution of ETFs on other platforms that are subsequently housed/custodied at the primary custodian; with costs varying from $8 to $25 per account per trade, the fees may seem nominal, but for an RIA with hundreds of clients can quickly add up to $10,000 or more. The issue centers around the fact that some RIAs are not happy with the price execution they're receiving from their existing custodians, and are finding the bid/ask spreads can be navigated more effectively by looking outside; however, because the trades have to be settled in a more laborious and potentially manual process, the custodians have higher costs to hold traded-away securities and are passing the expenses through to the RIAs. In practice, though, the fees are high enough that some RIAs state that it's becoming cost-prohibitive to seek out best-execution prices for clients. Accordingly, some suggest that the custodians are limiting their ability to operate in the best interests of their clients, while others simply suggest that the custodians need to do a better job providing best execution to eliminate any incentive/desire to trade away in the first place. For the time being, though, advisors must balance between the two, which may make trading away ineffective for many actively traded ETFs with narrow bid/ask spreads, but still potentially appealing for thinly-traded low-volume ETFs that may still have wider spreads. On the other hand, as ETFs get more efficient and widely used, the problem may largely resolve itself.

Brightscope Lets Advisors Get Basic Entry To Its Advisor Pages For Free - This week, BrightScope announced that advisors can now set up their Advisor Pages and perform core modifications and updates for free, a significant turnaround from the $1,200 annual fee is used to charge for any changes advisors wanted to make to their pages. The "Basic" free membership level will allow advisors to add a picture, participate in the site's Q&A, and update essential information about their firm; a $25/month "Plus" level allows advisors to highlight additional information about the firm and contact consumers who make inquiries, while a $95/month "Pro" subscription gives advisors more visibility on the site, allows them to be features in advertisements, highlight their specialties, and gain further data about who's visiting their profile. Competitor Jack Waymire of Paladin Registry raises the question of whether BrightScope can truly vet all 600,000 advisors on its site, but BrightScope's primary goal is to broaden transparency regarding all advisors, not just provide a vetting service like Paladin, and the BrightScope CEO notes that core regulatory data (e.g., regulatory infractions) cannot be changed to ensure consumer transparency. On the other hand, not all advisors necessarily want transparency - especially those with problematic history - and BrightScope acknowledges that it will still be limited in its ability to prevent advisors who engage in outright fraud and dishonesty. Nonetheless, the platform reports that there are advisors already winning clients through its transparency, and ultimately BrightScope wants to do more to highlight good advisors, including the potential of rolling out a rating system for advisors in the future (if it can be done without running afoul of compliance rules). For the time being, advisors can access BrightScope "badges" to invite consumers to verify them and to highlight their clean regulatory record (if applicable).

How Much Can Clients Spend in Retirement? A Test of the Two Most Prominent Approaches - In this Advisor Perspectives article, retirement researcher Wade Pfau compares and contrasts two variable safe withdrawal rate strategies: the Guyton decision rules, where spending increases for inflation only if the portfolio experienced a positive total return in the prior year, and spending is further adjusted up or down using he "capital preservation" and "prosperity" rules that provide 10% increases or cuts in spending if the withdrawal rate materially deviates from its starting point; and the Blanchett approach, where a "simple" formula is used to update the target safe withdrawal rate spending each year based on changing client time horizon, target probability of success, positive or negative alpha, and asset allocation. Since the Blanchett approach recalculates based on the account balance each year, while the Guyton approach generally only makes spending adjustments if certain conditions are met, the Blanchett strategy potentially produces more volatile client spending. Pfau tests the efficacy of each using either historical returns or the reduced forward-return assumptions recommended by Harold Evensky in the MoneyGuidePro software, and finds that in a low return environment Guyton spending is more stable but is highly likely to trend downwards in later years, while Blanchett spending starts a bit lower but has more potential upside for those in their 80s and 90s (which in turn means that expected final wealth drops more precipitously in the later years with the Blanchett approach than the Guyton approach). Using historical market returns, the Guyton spending is even more stable, though it still declines in some adverse scenarios, the Blanchett approach again starts lower in the early years and peaks higher in the later years (though the crossover is in the client's 70s rather than their 80s); the Guyton approach is also significantly more likely to leave a substantial legacy in the later years. Overall, Pfau concludes that the Guyton spending approach, with its greater stability, may be preferable for many advisors and clients, but suggests that the target levels for initial spending and spending adjustments might be refined further to produce spending paths somewhat less likely to decline as much in later years, and notes that it is unclear how advisors should apply the Guyton rules if they wish to adjust based on their own capital market assumptions. On the other hand, the Blanchett approach may do a better job modeling dynamic life expectancy changes over a retiree's time horizon, and may still be appropriate for those who have more flexibility with their spending.

A Step Back for Reverse Mortgages - The U.S. Department of Housing and Urban Development (HUD) recently implemented a number of changes to reverse mortgages, generally aimed to encourage their use more as a long-term financial planning tool than as a last-resort disaster-recovery kind of approach. Yet despite some growing acknowledgement from financial planning researchers that reverse mortgages may have their place, consumer surveys suggest that only about 2% of older homeowners have a reverse mortgage and only 10% more have even considered them. And while the recent changes are designed to make reverse mortgages less of a tool of last resort, these changes were accomplished in part by making reverse mortgages higher cost with smaller lending limits, and the introduction of a new 'financial assessment' that will look to the credit quality of borrowers for the first time (those with weaker credit may be required to use the reverse mortgage to fund their property taxes and homeowners insurance, which does provide some household cash flow savings but crowds out the reverse mortgage loan limits for other goals). Notably, even with the new loan limits and somewhat higher costs, much of the prior financial planning research supporting strategies like a standby reverse mortgage line of credit is still valid, but the greater upfront costs may still dissuade clients from the long-term strategy in lieu of lower cost alternatives (like simply using a Home Equity Line Of Credit {HELOC} instead).

Will Older Advisers Pay More Than Younger Colleagues For Health Care Coverage? - This article highlights that under the Affordable Care Act, health insurance for small groups will be priced based on the ages (and family size and geography and tobacco use) of their plan participants, in contrast to the past where everyone in a small group paid premiums based on the average age of the group. In an environment like financial planning firms, where advisors are typically older than their average staff member, transitioning health insurance to actual-age pricing may result in a relative premium increase for advisors (and decline for their other, younger staff members). The Small Business Health Options (SHOP) exchange where small businesses will purchase coverage in the future was largely delayed this year (though firms can still purchase plans directly from an insurance agent), but should be rolled out in full force next year, and most advisors will notice the premium changes then (if not already). On the other hand, it's also notable that many advisory firms may be eligible for the small business health insurance premium tax credit - available to those who purchase coverage through the exchange - as the up-to-50%-of-premiums credit applies for firms that have fewer than 25 employees with average wages below $50,000; since the owner's/partner's compensation is not included in the wage calculation, many advisory firms may find they are eligible going forward.

Adapt Or Die: 5 Ways Advisers Must Embrace Change - Just under 10 years ago, Blockbuster had 60,000 employees and 9,000 stores worldwide, while today the company is bankrupt and in the midst of closing its last few remaining stores; the world had changed, but the company failed to embrace shifting consumer preferences and move along with them. In a similar manner, advisor consultant Robert Sofia suggests 5 major trends underway that will impact financial advisors in the coming years, which may be a significant threat to advisors that fail to change and adapt. The first trend is consolidation, as shrinking profit margins driven by higher operational costs (especially tied to regulation) are pushing small firms to merge into larger ones or risk perishing; the survivors will be those who create a clear growth strategy towards profitable niches and/or really figure out how to scale key areas of the business. The second trend is the generational shift, as most advisory firms are basing their revenue models on serving the baby boomer generation via assets under management, which in the near term may grow more slowly as boomers begin withdrawals and ultimately may result in faster attrition if advisors can't create connections to their next generation of clients (an estimated 86% of younger investors don't plan to use their parents' advisors). The third trend is automation through technology, as tech-savvy investors potentially replace some advisors with low-cost platforms and demand more from their advisors; the solutions are to focus on value-added services that online competitors can't offer, and/or providing these technology tools themselves (for instance, Edelman Financial Group offers Edelman Online for automated investment management services for young investors). The fourth key trend is increasing regulation, especially as the focus from regulators shifts to smaller firms that some believe have not been receiving sufficient oversight; the more you're acting like a true fiduciary now, the less disruptive this is likely to be. The fifth trend is compensation, as competition drives down available revenue (broker-dealers are struggling terribly with the commoditization and "race to the bottom" of pricing for services like implementing trades); some advisors will face this by trying to make current clients more profitable, while others will need to figure out how to generate greater client volume to survive.

Introducing Vanguard’s New AlphaBet ETFs - This article is not actually an announcement of a new Vanguard ETF product, but a very clever satire that highlights the hazards of investment offerings that are built almost entirely on backtested results. Vanguard parodies the rollout of a series of 26 new ETFs - the "AlphaBet" series - where, for each letter of the alphabet, there will be an containing equal-weighted components of all the securities in the S&P 500 that start with that letter. Yes, you read that right; so the "A" fund will have all stocks that start with the letter "A", the "B" fund will all start with "B"s, etc. Imagine the fun - you can craft portfolios based on any letters or words you want, as the ultimate portfolio building blocks! Sure, it sounds ridiculous... until you see the performance, where each of the 26 hypothetical AlphaBet ETFs outperformed the S&P 500  over the past 20 years (you could have also outperformed the S&P 500 by simply building portfolios based on the words SMART, ALPHA, BETA, or even "JOEL" after the author's name!)! Of course, since this is a parody, Vanguard acknowledges that in truth, the outperformance is a result of both the equal-weighting methodology (which tilts the portfolio more towards smaller cap S&P 500 securities that outperformed over the time horizon) and also a significant hindsight bias (since it's built based on current S&P 500 securities, the AlphaBet ETFs automatically avoided every stock for the past 20 years that failed and fell out of the S&P 500. Yet it's a disturbing illustration of how ridiculously simple it can be to build a hypothetical backtested portfolio full of biases that has great historical performance yet no reasonable expectation that it would possibly be sustained in the future.

Britain’s Ministry of Nudges - From the NY Times, this article looks at the workings of the British Behavioral Insights Team in Great Britain, a small band of psychologists and economists that are working to transform British policymaking by looking at how small tweaks to bureaucratic processes to better suit human nature can bring about significant change to benefit society at a small cost. That's a tall order, but the team has had early successes, enough that after three years the team first established by Prime Minister David Cameron has doubled in size and is about to announce a joint venture with an external partner. The basic concept of the group is to help people by implementing a "Nudge" - after the concepts set forth in the book of the same name by Richard Thaler and Cass Sunstein (which has been reviewed previously on this blog as well). For instance, one big success of the unit was to modify tax collection letters to either include sentences telling recipients that a majority of people in their community had already paid their taxes, and another said that most people who owe a similar amount of tax had paid; over the past year, the letters brought forward £210 million of revenue that otherwise would have had to be chasing in costly court procedures. Another initiative was to help people at job centers by having them go through expressive writing exercises and a test to identify their strengths to help reinforce their commitment to finding work; after just 13 weeks, 60% of the 1,000 workers who had gotten the 'nudge' were back in a job, compared with only 51% who hadn't. Yet another initiative got people to help insulate their attics by simply offering a supplemental service that would help clear out people's lofts (often full of junk); the low-cost solution had a 4.8-fold increase in utilization than expensive tax subsidies the government had been offering. Notably, the initiatives have had some controversy as well; while Thaler dubs the approach "Libertarian Paternalism" some have suggested it amounts to little more than government coercing its citizens, and/or inappropriately experimenting upon them. Nonetheless, the British nudge unit has a waiting list of government agencies who want to work with them, and the concepts are being expanded to other countries as well as "evidence-based" public policy, including potentially here in the US in the coming years.

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. You can see below his new Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!

I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!