Weekend Reading for Financial Planners (Dec 18-19)

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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Biden Tax Bill Pushed To 2022 (Laura Litvan and Erik Wasson, ThinkAdvisor) - When the Build Back Better Act (the ambitious package of climate and social spending legislation modeled on President Biden’s American Families Plan) passed the U.S. House of Representatives in November, it was widely assumed that the bill would be signed into law by the end of 2021. But as the focus has turned to the Senate, the differences between the Democratic Party’s progressive and centrist wings – all of whose votes are needed to pass the bill over Republican opposition – appear to be too great to reconcile before year’s end. As a result, it is being reported that a vote on the bill will not occur until at least the start of 2022. The most significant near-term consequence of the delay is that the expanded Child Tax Credit of $3,000 - $3,600 per child (which has been paid to most eligible recipients in monthly installments since this July) now risks lapsing instead of continuing into next year. But there is also uncertainty now over whether the bill will pass at all, and what shape it will take if so. Though many of the bill’s original tax provisions had already been stripped from the legislation, it was assumed that the final law would include both the prohibition on “backdoor Roth” contributions, and the increase in the cap on State and Local Tax Deductions that were included in the House’s version of the bill. Now that the bill is on hold, it is uncertain whether those provisions will be implemented in 2022 (as the bill currently stipulates), or even pushed back to 2023. In the meantime, the possible lapse of the Child Tax Credit, combined with the reinstatement of Federal student loan payments starting February 1, means that – unless Senate Democrats reconcile their disagreements soon – many middle-class households could find themselves with less money to spend (or save) in the election year ahead… which is only further amplifying pressure in Congress to get ‘something’ done in early 2022.

Cerulli Study Reveals Big Drop In Retail Broker-Dealers Since 2010 (Bruce Kelly, InvestmentNews) - Small-scale broker-dealer firms were once a staple of the financial services industry. In the days when buying a stock or mutual fund required picking up a phone and calling in an order, these types of Main Street firms were often where the public went to invest their savings (ordering them through a ‘local’ broker, who was paid on commission for the products they sold). But those days are long past, and the era of investing via online brokerage platforms in just a few mouse clicks has not been kind to small- and mid-sized broker-dealers, who lack the scale or funding to invest in technology and marketing as their larger competitors have, while struggling to retain the most planning- and advice-centric advisors (who have navigated this transition successfully, but are getting wooed away by larger broker-dealers with more resources for those top advisors). This is confirmed by new research from Cerulli, showing that the number of wealth management- or retail-focused broker-dealers declined by 28% between 2010 and 2020. Most of that decline has occurred among smaller-scale firms, many of which, according to Cerulli’s analysis, have consolidated with other broker-dealers to pursue scale and position themselves to compete with larger firms. Another factor that the report notes is the regulatory environment, which (following the implementation of the SEC’s Regulation Best Interest rule) imposes significant burdens on smaller firms that lack the resources to update and maintain their policies and procedures to comply with the higher standards of the regulations when it comes to standalone brokers. Of course, the reality is that in a more advice-centric future, it’s also not necessary to even be a broker-dealer to get paid for advice – in fact, an RIA structure is required to receive fees for advice – and accordingly, at least some broker-dealers appear to have simply moved to the advice model out of choice, as Cerulli shows a number of firms have dropped their broker-dealer registrations to operate as ‘pure’ RIAs, realizing that it can be easier to simply give advice as a fiduciary without the additional regulatory burden presented by the commission-based brokerage model (and its conflicts of interest and accompanying disclosures and more expensive oversight and mitigation policies).

New Study Finds Clients Using Financial Advisors Are Happier (Patrick Donachie, Wealth Management) - There are many potential reasons why people hire financial advisors, but it seems likely that one broad underlying reason is that they believe that, by helping them answer potentially complex questions about their financial future, hiring a financial advisor will ultimately make them happier. And according to a new study on consumer financial behaviors by consulting firm Herbers & Company, hiring a financial advisor actually is associated with being happier. By surveying 1,000 people with self-reported assets over $250,000, and assessing them on four broad predictors of overall happiness (fulfillment, intention, impactfulness, and gratefulness) along with other factors like relationship satisfaction, the study attempted to gauge the happiness of those who have hired a financial advisor against those who have not. The results of the study showed that respondents working with a financial advisor had higher (i.e., happier) scores across all four categories, as well as higher satisfaction in their personal relationships. Furthermore, while overall happiness levels were higher for clients of advisors across all levels of assets, the effect increased dramatically in individuals with household assets greater than $1.2 million – suggesting that above a certain level of wealth, the issues around money become so complex and time-consuming (not to mention impactful in sheer dollar terms) that not hiring a financial advisor can become a significant detriment to happiness. When advisors communicate the value that they can provide to prospective or current clients, then, it’s important not to overlook the idea of happiness – after all, for the client, the advice (and the money itself) is ultimately only a tool that is used for the larger project of becoming happier through greater financial security.

Wealthy Millennials Embrace Both DIY Platforms And Professional Advice (Michael Fischer, ThinkAdvisor) - The number of financial technology solutions for consumers has exploded over the past decade, giving them a wide range of options not only for where to invest their money, but also how to get advice. And while consumer-focused robo-advisors have not replaced human advisors as some observers feared, younger generations, in particular, are heavy users of digital financial management tools, including the robos. However, according to a survey by advisor matching platform Wealthramp, Millennials with investible assets of at least $250,000 were actually more likely to hire human advisors to manage their investment portfolios than those in Generation X and Baby Boomers. At the same time, though, more than half of Millennials reported that digital trading apps like Robinhood and Coinbase give them the freedom and flexibility to invest the way they want. In fact, 83% of Millennials surveyed said that better coordination between digital tools, robo-advisors, and their financial advisors would be an important aspect of receiving financial advice in the future. Other important factors were frictionless integration of digital currencies into portfolios (more than half of the respondents said they own cryptocurrencies, though only 8% said they did so at the recommendation of their financial advisor), and access to socially responsible investment products. These results suggest that advisors who incorporate the range of AdvisorTech tools available, including in particular client-facing digital tools, can not only improve internal efficiency, but also attract younger clients who are looking for better integration between their human advisor and digital tools (and cryptocurrencies!). But the key point is simply that while robo-advisors might not have overtaken their human counterparts, advisors who embrace the advantages digital tools offer are likely to have more success, particularly with younger generations as they build wealth and seek advice!

NAPFA Finds More Than A Third Of Consumers Get Financial Advice Online (Financial Advisor) - Americans are experienced in looking for information and recommendations online, whether it’s browsing restaurant reviews on Yelp or looking for medical guidance on WebMD. The amount of financial advice content has grown significantly as well, and consumers are embracing a wider world of digital financial information and advice content. According to a survey of 2,007 U.S. adults ages 18-64 commissioned by the National Association of Personal Financial Advisors (NAPFA), 39% said they receive financial advice online or from social media, while only 21% said they get most of their advice from a financial advisor. Many of those who found financial advice online or through social media acted on this advice as well, with 60% of all respondents doing so, including 67% of Millennials and 48% of Baby Boomers. Of individuals who get financial advice from social media, 64% said they use YouTube, and 57% said they get financial advice from Facebook. Other popular sources of advice were Instagram (39%), and TikTok (35%), with blogs only used by 17% of respondents. Because the quality of this online advice can vary widely, though, advisors who engage in these communities can not only offer sound information to consumers, but also market themselves as a particularly trusted source of expert financial advice. For advisors who are used to marketing in a largely analog world, expanding into the digital environment can allow them to better reach the wide range of individuals looking for financial advice online, though the results suggest that platforms where the advisor can actually be seen – e.g., YouTube and Instagram and TikTok – connect particularly well with the consumers they may be trying to reach!

How Consumers’ Choices Differ When Selecting A Financial Advisor (Philip Palaveev, The Ensemble Practice) - As financial planning has evolved over the years, so too has the range of clients and their preferences. Working with clients across a range of incomes, ages, and professions can require different tools for both marketing and client service. A recent survey of consumers with more than $100,000 in income conducted by advisory consulting firm The Ensemble Practice has put numbers to the preferences and actions of a range of clients, showing that one size definitely does not fit all. Older respondents were more likely to work with an advisor, but younger consumers with more than $1 million in net worth behaved more similarly to older consumers with similar wealth than their less-wealthy peers (i.e., affluent Millennials behaved more like the affluent than Millennials). In searching for an advisor, respondents with more than $1 million in net worth are more likely than less wealthy individuals to rely on the opinions of other advisors (e.g., CPAs and attorneys), rather than the recommendations of friends. Wealthier individuals are also more likely to interview more than one advisor before making their choice, and are more likely to rely on their impression of the advisor in particular, rather than the firm’s brand (compared to how individuals with less wealth weigh advisor personality vs firm brand). Business owners are more impressed by the advisor’s presentation than other consumers, and are also more likely to make referrals than non-business owners. Female consumers are less likely than males to have an advisor, though those who are looking for one trust their friends and family more than men do when choosing an advisor. Taken together, the range of preferences across demographic characteristics suggests that advisors could face significant hurdles trying to attract individuals in all of these categories, because they focus on different information when evaluating advisors, which means for those advisors willing to do so, pursuing a client niche that consistently seeks out advisors in a particular way can lead to better efficiency, productivity, and income!

How To Invest Your Money When Inflation Is High (Nick Maggiulli, Of Dollars And Data) - Before this year, the specter of high inflation had not been on the front pages for decades. But with inflation for November coming in at 6.8% on a year-over-year basis, many investors are considering how best to adjust their portfolios to the current environment to ensure that their assets are not eaten up by inflation. Gold has long been thought of as a hedge against inflation, but when looking at the years since 1976 when inflation exceeded 4%, gold actually had a negative median real return! Asset classes that performed better included Real Estate Investment Trusts (REITs) at a 6.0% real return, international stocks (2.0%), the S&P 500 (1.0%). This makes intuitive sense, as owners of real estate can raise rents and corporations can increase prices in response to inflation, potentially preserving their profitability. On the other hand, assets where investors receive fixed payments over time (e.g., individual corporate bonds) tend to perform poorly, because the payments do not increase to match the rise in inflation. Of course, inflation is not bad news for all types of bonds, as I-Bonds, whose yield takes into account the inflation rate, can be a valuable part of a portfolio in inflationary periods. Ultimately, though, the fact that domestic and international stocks, plus REITs, tend to perform well in inflation environments, suggests that investors with diversified portfolios are likely to already hold a significant percentage of assets that perform well during inflationary periods (but might not know it!?). And so advisors can not only reassure these clients that their portfolios are positioned to weather inflationary periods, but if desired may also wish to take additional inflation-protection measures (such as purchasing I-Bonds or TIPS) to further insulate client assets from inflation risk!

Will Cryptocurrency Protect Against Inflation? (John Rekenthaler, Morningstar) - In previous periods of high inflation, investors had a variety of investments to choose from to try to hedge against the increase in prices, including equities and real estate. In addition to these traditional assets, investors today have a new option: Bitcoin and other cryptocurrencies. Proponents of cryptocurrencies often tout the potential for the digital coins to serve as an inflation hedge. They note that, unlike the variable supply of U.S. dollars, many cryptocurrencies have either fixed their number of coins, or at least capped their potential circulation growth, making it more akin to gold (which similarly has a ‘limited’ supply and has traditionally been viewed as an inflation hedge). However, because cryptocurrencies have only been around for the past decade or so, a period of relatively tame inflation, it is hard to judge whether they will actually perform well in an inflationary environment. Taking into account changes in inflation, and the direction of interest rates since 2017, Rekenthaler found no discernable pattern between the price of Bitcoin and the other variables. Bitcoin performed well during certain periods of both rising inflation (2017) and disinflation (2019), but also struggled in 2018, when inflation was rising. Given the small changes to inflation since cryptocurrencies first appeared, the rapid increase in inflation seen in 2021 should serve as a better test for cryptocurrencies as an inflation hedge – with results remaining to be determined. In the meantime, though, advisors have other tools with more historical data backing them—such as I-Bonds, TIPS, and plain old equities and REITs—available for clients that want to hedge against inflation.

Inflation-Adjusted College Tuition Is Finally Falling (Timothy Lee, Full Stack Economics) - While the overall inflation rate has been relatively tame since the early 1980s, the price of higher education has seen dramatic increases. In fact, inflation-adjusted tuition at public four-year universities rose four-fold between the 1980-1981 and 2019-2020 school years, from $2,610 to $10,980 (an annualized 3.66% growth above inflation), and tuition at private colleges rose three-fold, from $11,810 to $38,780 (an annualized 3% growth above inflation). And while many students do not pay the sticker price for tuition, these increases almost certainly have contributed to an increase in student loan debt, and concern among parents who want to contribute to their children’s educations (but increasingly fear whether they can afford to do so). However, this rapid rise could be coming to an end, as inflation-adjusted tuition was flat for public schools, and declined slightly for private schools, during the 2020-2021 school year. And for the current academic year, inflation-adjusted tuition at public schools fell 2%, and declined 1.6% at private colleges, according to a report by the College Board. A variety of reasons could explain this shift, including a declining number of students attending college, and changes in the college experience caused by the COVID-19 pandemic. And even greater declines in the inflation-adjusted cost of college could occur if the broader inflation rate remains high (as the implication is that colleges are already struggling to maintain pricing power in the current environment). That said, if the pandemic abates and more students decide to attend college, tuition prices could start to increase again. In either case, college tuition is likely to remain an important part of the financial planning process, and advisors have many tools to use when working with parents and grandparents of students attending college in the near future as well those who are many years away. In addition, advisors who have used projected tuition growth rates well above the broader inflation rate in their planning might want to reconsider this assumption if tuition prices continue to stagnate!

Vanguard Steps Up Push Into Financial Advice (Michael Mackenzie and Chris Flood, Financial Times) - In 2015, Vanguard launched its Personal Advisor Services, marking an evolution from its roots as a provider of low-cost mutual funds and ETFs into growing an “insourced” financial planning service with the scale to provide financial planning and portfolio management at a 0.3% annual AUM fee. Though the foray into advice has not been without growing pains – it has often come under criticism for glitchy technology and long wait times to talk to its advisors – the initial rollout has been an unqualified success, amassing over $200 billion in assets in just over six years. But Vanguard clearly sees an opportunity to go even further beyond its initial success and shape the future of the financial advice industry (as it once did with the mutual fund industry). Its next step is to open a new office, which will house its growing advice business, in Plano, TX outside of Dallas – and notably nearby to the headquarters of its rival Charles Schwab in Fort Worth, where the two megafirms will undoubtedly compete for CFP professionals to serve their respective advisory clients. But as was true in 2015, Vanguard’s expansion of its advice business (which is centered and marketed around the idea of a human advisor on the other end of the call) is also a validation of the value of “human” financial advice over purely-digital automated solutions. And the experience of the Personal Advisor Services – which, while popular, has yet to upend the advice industry for independent financial planners – has shown that, at least for existing clients of RIAs, even the scale and reach of one of the world’s largest asset managers has not overcome the depth of expertise and relationship-building that many successful independent advisors build their businesses on. But Vanguard’s continuing investment into its advice business shows that its sights are on growing its own share of the advice industry, meaning that future clients and growth may be where independent advisors eventually feel the pressure to prove their value over the “Index” advisor baseline that Vanguard has set.

The (Vanguard) Mutual Fund That Ate Wall Street (Randall Smith, Wall Street Journal) - Vanguard’s first (and still likely its best-known) index fund was its Vanguard 500 Index Fund, which launched in 1976 and started a revolution of low-cost investing based on simply replicating the performance of the widely tracked S&P 500 Index. And while the Vanguard 500 is still massively popular today (with net assets totaling $827 billion), Vanguard’s biggest fund – which is also the biggest mutual fund in the world by asset size – is its Total Stock Market Index Fund (totaling $1.3 trillion in net assets), which tracks a much less commonly known index: the CRSP U.S. Total Market Index. Because the fund’s original index (the Wilshire 5000) proved ill-suited to manage index funds around (once the sheer size of the Total Stock Market Index Fund began to influence the performance of the index itself), Vanguard commissioned (and funded) CRSP index specifically to drive its massive index fund. But despite being purpose-built for index fund management, CRSP still runs into issues with “front-running”, and the market impact of additions to and subtractions from its index. So as the Total Stock Market Index Fund – whose mutual fund and ETF versions form a core component of many asset managers’ portfolios – continues to grow in size, the impact it will have on the index will become even greater. And the effect of an index fund that is large enough to influence the index it is tracking (not to mention an index that was paid for by the index fund manager that is tracking it) is that, compared to Vanguard’s history of offering funds that “passively” track an existing market index, the future of index investing may be the exact opposite: where megafunds like the Total Market Index Fund have much more influence on the index they are tracking than the other way around.

Has Vanguard Lost Its Way? (John Rekenthaler, Morningstar) - For a long time, Vanguard was known for doing the same thing over and over again, and doing it well: providing mutual funds (and eventually ETFs) at as low of a cost to investors as possible, while aggressively managing its own expenses in order to make the business model work. This was largely the model overseen by John C. Bogle, who founded Vanguard and led the firm as CEO until 1996 (and remained on as chairman until 1999). But just as Vanguard undercut its competitors’ fees again and again over the decades, it now faces its own pressure from rivals who have (at least in part) adopted its approach of low-cost investing and slashed their own fees (in some cases, all the way to zero), making today’s business landscape far different from the one that Bogle upended in the last century. Rekenthaler points to two signs that Vanguard’s old recipe for success may no longer be viable: first, a (largely anecdotal) decline in customer service (suggesting that Vanguard’s famous cost-cutting was starting to infringe on the company’s operations in ways that really matter to its customers); and second, the eyebrow-raising announcements that it would begin bringing private equity and actively-managed funds to its Personal Advisor Services portfolios. But while some hardcore Bogle aficionados may take these developments as a sign that Vanguard has strayed from its original mission, another argument is that Vanguard has simply realized the same thing that its competitors did: that different investors are often interested in different products, and offering a mix of low- and high-margin investment solutions (or more broadly, a mix of indexing and more actively-managed investment solutions) can allow the firm to serve a broader range of clients while investing in the technology and client service support it needs to compete with the likes of Fidelity and Schwab, and still staying true to its low-cost positioning (at least on a relative basis to competitors). After all, one could argue that, if a person wants to invest in private equity, it is better to do so within a Vanguard wrapper than at a private bank or wealth manager, since both products would be complex and illiquid, but Vanguard’s would be likely to be far less costly as Vanguard stays true to its roots?

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.