Weekend Reading for Financial Planners (Dec 20-21)

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 20th/21st:

Disciplinary Chief Exits CFP Board (Ann Marsh, Financial Planning) - This week, the CFP Board confirmed the departure of Managing Director of Professional Standards and Legal, Michael Shaw, the chief of the CFP Board's "embattled" disciplinary division that has faced ongoing criticism regarding its enforcement of advisor compensation disclosures over the past year. Shaw's departure is being viewed as a positive by outsiders, who suggest it's an opportunity for the CFP Board to restore confidence in the organization by addressing some of its recent enforcement controversies, from uneven treatment of advisors after the amnesty it provided to wirehouse brokers last year which it later called a "mistake", to recent public discussions with advisor Rick Kahler, and the CFP Board's ongoing lawsuit with the Camardas. In separate but related news, the CFP Board also confirmed that it hired John Loesch earlier this fall as a new Director of Investigations; Loesch comes to the CFP Board after an 11-year tenure with the SEC (including as branch chief in the Division of Enforcement). There has been no announcement at this time regarding a replacement for Shaw's position.

CFP Board Calls First Computer-Based Exams a ‘Success’ (Melanie Waddell, ThinkAdvisor) - The results are out for the first computer-based CFP exam in its new, shorter format, and the pass rate was 66%, which is only slightly higher than the exam's historical pass rate (which has fluctuated as low as 50% and as high as 64.5% for the last physical-paper exam this past summer), suggesting that the shorter computer exam was not necessarily (materially) easier than the longer paper-based format. On the other hand, the number of exam-takers jumped up to 2,147 (who were able to test at a whopping 265 testing sites), the highest in the past two years, implying that the CFP Board's goal of making the exam seem less daunting (so that more prospective CFP certificants will be willing to sit for the exam) was a success. Nonetheless, all eyes will remain on the number of CFP exam test takers in 2015, as well as the pass rates, to see if the November exam results were an aberration or the sign of a positive new trend. The next CFP exam window will be March 24-28.

Landmark Military Suicide Prevention Study Approved By Congress (Ann Marsh, Financial Planning) - Included in this week's $1.1T spending package approved by Congress was a provision authorizing $1M for a study of whether financial stress has been a main precipitating factor fro the recent epidemic of military suicides; the measure was sponsored by Representative Rush Holt of New Jersey, and was proposed after this spring's Financial Planning magazine cover story regarding the challenges financial planners face in serving military families in dire financial situations (where advisors can actually be fired for helping soldiers beyond the limited scope of their contracts). The hope is that the study will validate the issue - as while most Americans believe military suicide is driven by lingering combat trauma, Financial Planning's investigation found that more than 80% of suicides were among soldiers who did not see combat (with more than 50% of 2012 suicides from soldiers who were never even deployed), and that the military's government-paid $500,000 life insurance policy may be an inadvertent "incentive" as well. If the study can provide the financial-stress/military suicide link, the results can then be used to push for the Department of Defense to allocate resources to address is, although realistically it may still take years for the study's impact to be felt, even if the results do affirm a connection.

Cerulli's New Numbers Buttress The RIAs-Supplant-Brokers Theorem With 40% Market Share Jump Seen By 2018 (Lisa Shidler, RIABiz) - The latest industry trends report from Cerulli suggests that RIAs will continue to pick up material market share in the coming years, having risen from 16% market share in 2007 to 20% by the end of 2013, and now accelerating to 28% market share in 2018. Pure RIAs are projected to grow at 12% annually, with hybrid RIAs (which are somewhat fuzzy to define and count) accounting for the rest of the growth, and Cerulli projects that most of their growing market share is being taken directly from wirehouses, which were at approximately 41% market share in 2007 and have now "stabilized" around 36%. Yet competing analysts from Aite Group suggests that RIAs gaining so much more market share so quickly is too bold of a prediction, and that wirehouses have been responding with their own programs, from bulking up fee-based offerings like Merrill Lynch One, to circling the wagons around their high-net-worth core clientele, which means ongoing wirehouse losses may be more of a slow erosion than any kind of mass exodus. Nonetheless, as wirehouse advisors see more and more RIA breakaway success stories, there are more willing to consider their own breakaway effort in the future, and the RIA movement appears to be more successful in courting younger clients in particular, which suggests that as ongoing consumer demographics shift towards millenials the RIA industry may enjoy an even more sustained tailwind.

Fidelity Finds RIAs Seriously Lag in Marketing, Business Development (Michael Fischer, ThinkAdvisor) - A white paper based on the 2014 Fidelity RIA Benchmark Study is out this week, and finds that most advisory firms continue to struggle with marketing and business development, with only 5% of RIAs claiming their firms are "advanced" in these areas, and a whopping 70% not having a plan in place to guide them towards better business results despite the fact that three-fourths of firms see improving their marketing and business development as a top strategic initiative. In comparing the subset of high-performing firms to the rest in the study, the results revealed that the best firms: 1) are effective at telling a consistent story about the firm, with all client- and prospect-facing associates describing the firm and its key differentiators in the same way; 2) have clearly defined target client profiles to help generate the right referrals (and which can be effectively communicated to existing clients and centers of influence); 3) have an "advanced" referral process, especially in leveraging center-of-influence referrals, with a process to review their centers of influence to evaluate potential referrers, manage referral relationships, and reciprocate referrals where appropriate; and 4) are focused on talent-management plans, including changing firm compensation as necessary, to incentivize growth. Notably, the successful firms found their marketing so effective, and had so few issues with internal sales and marketing capabilities, they were actually less likely to be hiring business development officers to support their growth.

Buying High, Selling Low: Are You Ready for the Next Downturn? (Angie Herbers, Investment Advisor) - The market has had an astonishing ride over the past 5 years, up a whopping 81.5% since the fall of 2009 (and up even more since the market low earlier that year), and the rising tide of the market has lifted the assets and revenues of most advisors. But Herbers warns, having already seen the impact of two prior bear markets as an advisor business consultant, that the market cycles come and go, advisory firm owners tend to unfortunately do exactly what their clients do: buy high, and sell low. In other words, the firms tend to add clients, staff, and overhead during the good times in a pedal-to-the-metal growth mode, and then when the downturn comes, the firms struggle just to keep their doors open until the market recovers enough to bail them out of their prior over-indulgences. And Herbers notes that such a strategy is not only risky, but often leaves the firm terribly positioned for one of the best potential growth environments: the aftermath of a market crash and the early recovery stage. But firm owners don't have to follow such a feast-and-famine business path; Herbers suggests instead that during good times, advisors start "cocooning", building up reserves and capacity and stockpiling resources to be ready for when it's time to spread the wings again. Of course, most don't know when the market turn will come, so it's difficult to perfect time the cocooning moment, but Herbers still notes that after such a longer and massive market run-up, we're likely closer to the end than the beginning, so it may be time to start. Initial strategies include: shift focus away from growth and over to operational efficiency and the bottom line, to ensure that cash flow and profitability are robust (and to build up reserves); don't push too hard to keep adding a high volume of (resource-intensive) new clients, and instead take steps to improve client service (since not losing clients during a downturn is crucial); beware of adding staff; and have a plan for the recovery, including a marketing system in place that can help put the business back into growth mode again when the time comes!

You (Sometimes) Get What You Pay For (Mark Tibergien, Investment Advisor) - As year-end approaches, it's time to talk about compensation in advisory firms (as an employee, or as an owner addressing the issue with employees), but Tibergien suggests that it's not enough to just pay someone enough in total and hope/expect they will perform; the structure of the compensation and the incentives matter too, and Tibergien believes that in the end compensation is not necessarily a motivation factor at all but merely a means to recognize motivated people who do their jobs well. Distortions to income and incentives, though, can clearly have a perverse negative effect. For instance, in the broker-dealer environment, the shift from upfront commissions to recurring fee-based revenue has led a lot of advisors to slowing growth rates, as the recurring revenue becomes comfortable and the desire to push for more growth wanes; Tibergien suggests the same is often true in RIAs as well, which often pride themselves on not having a sales agenda, but in truth still often pay advisor employees variable compensation for the business they bring in or manage, with the same problem that once compensation reaches a certain level the hunger for more growth begins to wane. While variable compensation for new business development is reasonable, Tibergien implies the real culprit is variable compensation tied to revenue (e.g., to the advisor's AUM) for assets and clients that are "just" being managed, where rising income for merely managing clients reduces the meaning and significance of variable compensation for new clients. Instead, Tibergien suggests that compensation for service and management should be mostly fixed, with bonuses tied only to growth and exceeding expectations. It's also notable that while variable compensation structures can be crucial for businesses getting started, and a buffer for flat or declining growth, they also eliminate the firm's ability to expand profits and gain financial leverage when times are good. The bottom line: as you consider reviewing employee compensation (or your own) at the end of the year, pause for a moment to give thought to the compensation theory that's backing it, and whether it's really incentivizing the behaviors and creating the long-term business value that's intended.

Heavy Lifting: How To Move A Billion-Dollar Book Of Business (Andrew Welsch, On Wall Street) - For advisors in charge of a large team practice at a broker-dealer, the process of breaking away to become an RIA or transitioning to another broker-dealer is complex and intensive, often taking months or even years of research, due diligence, and preparation before a move happens (which itself is usually precipitated by growing unhappiness with a current firm's pricing, discount policy, staffing, marketing or some other factor, often driven by one final aggravation that is a catalyzing event). When it's actually time for the move, keeping all the team members on board is crucial, as if not all the advisor team members move, the clients may not all come along either (though in some cases, a partnership splitting may be inevitable if the partners have different goals, stay or go). For wirehouse advisors that do more than "just" portfolios, it's also important to recognize that other solutions implemented for the client, from mortgages to corporate business loans to real estate and certain illiquid investments, may not be able to transfer - and in some cases, the clients may even stick with the old firm just for its banking services, if a transition plan is not established. Remember as well that once the breakaway decision is announced, other advisors at the old firm may be directly encouraged and incentivized to pursue them, so proactive communication to retain clients is essential - even flying out to distant clients to meet with them and explain the situation in person. Ultimately, recruiters interviewed note that even in good transitions, only about 75%-80% of the client assets tend to make the transition.

4 Questions To Avoid Buying Baloney (Mark Hurley, Financial Advisor) - Advisors willing to sell their wealth management firms today will find no lack of prospective buyers, but Hurley cautions that many are offering stock-swap deals that sound great but are really just "baloney" and that it's crucial to look carefully to separate the good from the bad. Key issues to consider include: stock-in-trade deals often promise appealing cash flows, but if the amount to be paid out is not contractually determined and formulaic (Hurley suggests tying it directly to the buyer's gross profitability), there's a risk that the buyer can control/manipulate where funds go resulting in a lower-than-expected cash flow for the seller; the buyer's stock itself may not be liquid, so be cautious not to count too much on a sale down the road, especially if the deal offers little in ongoing cash flows and is entirely contingent on a very vague and uncertain future liquidity event (contractually demanding liquidity is an option, but buyers tend to strongly dislike such an obligation because it requires the buyer to keep capital set aside to fund the commitment, although the best buyers should have firms strong enough to access such capital if needed); recognize that if the acquirer's own capital structure involves a significant amount of debt (e.g., from funding growth and other acquisitions), receiving stock-in-trade is more like getting an out-of-the-money stock option than real equity (despite what the buyer's valuation expert suggests); and beware buyers that have the power to alter the capital structure after the deal, placing future acquisition needs ahead of your own and "cramming you down" the claims structure (which could be catastrophic if the buyer later hits a financial rough patch). The bottom line: Hurley suggests that in the end, if you want to sell your business, in many or even most cases it's best to simply ind an all-cash buyer who has the capital (or access to it) to fund the deal, rather than swapping stock and hoping it works out later.

Why I Happily Pay $7,900 A Year For Strategic Coach (Jeff Rose, Good Financial Cents) - Financial advisor Jeff Rose had never pursued a business coach for most of his advisor career, until a few years ago when he realized that while his business was financially successful, he was spending more time than he wanted each day on a lot of things he absolutely dreaded doing, and started looking at options for a business coach. An initial exploration led to some "sticker shock" - recommended to Dan Sullivan's Strategic Coach program (which has reached over 16,000 entrepreneurs from 60 different industries in the past 20 years), the program would cost Rose $6,900/year (the price adjusts based on the business owner's income and was lower then) and consisted of (just) four days of in-person meetings, which seemed like a lot of money when Rose was already a very motivated self-starter (having built the business to the point he had). Yet after taking the plunge anyway, Rose notes that the ROI from the program has been so high in his experience (boosting his income in 3 years from $250,000 in 2011 to over $650,000 in 2014), he doesn't think twice about writing the $7,900 check now (plus some incidental travel costs). On an ongoing basis, the Strategic Coach includes not only the four full-day workshops with a small group of other entrepreneurs (and taught by entrepreneur-coaches who have also succeeded themselves as entrepreneurs using the Strategic Coach program), but also quarterly focus calls with your program advisor, weekly booster calls (optional to use if you want), lots of online tools and resources, and the opportunity to connect with other entrepreneurs (Rose notes that even when entrepreneurs are in other industries, the personal challenges are remarkably similar). Some immediate takeaways for Rose included: better understanding his personality and work style by taking the Kolbe Index (which helps him focus his energy, and understand where he needs help); identifying his "unique ability" (something you enjoy doing so much you lose track of the time in doing it, but you're still getting paid for it); and managing time by dividing into focus days, buffer days, and free days (focus days you spend the majority of your time working in your unique ability, buffer days are a blend of focus and putting out fires, and free days are where you do nothing work-related for 24 hours); more defined processes to make the free days possible (which expanded to include a 5-day vacation with his wife and another 2-week trip with his three children); and the launch of multiple businesses that are now fueling his income even higher.

Policy-Based Financial Planning as Decision Architecture (Dave Yeske & Elissa Buie, Journal of Financial Planning) - As most advisors know in practice, helping clients to make and actually implement effective financial decisions is difficult, due to a wide range of cognitive and behavioral biases that impact the decision-making process in not-always-favorable ways; in fact, the emerging framework of "choice architecture" focuses on altering the ways that choices are even presented to clients, in an effort to "nudge" them towards certain (healthy or positive) outcomes. Yeske and Buie make the case that in the financial planning context, this can be achieved through an approach of "policy-based" financial planning, where clients work with advisors to create "policies" - essentially, a series of decision-rules - that can help frame (positive) choices to tackle difficult situations as the future unfolds. The point is not simply about getting the client to state beliefs and observations, or goals and action items, but instead to create a framework that provides action items in light of the client's beliefs, observations, and goals, that can adapt to changing circumstances. For instance, a cash flow policy might be to save 10% of every paycheck, build emergency savings to 3 months' of living expenses first, then contribute to an employer retirement plan to the available limits, then add remaining savings to an after-tax opportunity fund, with windfalls allocated 10% to a "fun" fund and 90% to the preceding rules; notably, such an approach means that, whatever income and expenses are from year to year, the unknown future cash flows themselves can still be easily allocated when the time comes. A similar example would be the use of Guyton's "Withdrawal Policy Statement" approach and decision-rules for retirement, where spending is maintained, increased, or decreased, depending on whether certain policy-based targets are reached. Ultimately, the goal is to do enough in figuring out policies with clients up front during the planning process, that when the inevitable bumps in the road and challenges come, there is an easily-executable policy already in place to guide the next step, so clients don't need to make difficult and complex decisions in the midst of emotional and stressful events.

Is The CFP Board Losing Its Focus (Dan Moisand, Financial Advisor) - The CFP Board has made a significant transportation since the arrival of Kevin Keller, which former FPA National board member Dan Moisand cites as being "substantial and positive", with initiatives from the Financial Planning Coalition, the public awareness campaign, the recent Women's and academic initiatives, and the newly launched Career Center... especially remarkable progress, compared to the pre-Keller leadership at the organization, when the CFP Board tended to be more disengaged from the profession (including when the FPA engaged in its successful advocacy lawsuit against the SEC over its proposed fiduciary exemption for broker-dealers offering fee-based accounts) under the auspices that it is a 501(c)(3) organization to benefit the public, while the FPA is a 501(c)(6) membership association, and the two have substantively different purposes and reasons for being. Yet notwithstanding all this progress, Moisand raises concerns about the CFP Board's current disciplinary process - something with which he has intimate knowledge, as he was the Chair of the Disciplinary and Ethics Commission (DEC) in 2008 and was involved in formulating some of the current rules. While noting that the details in the public media often feel different than what it's like actually hearing cases appearing before the DEC, Moisand notes that the Goldfarb case in particular appears to have meted out a punishment far in excess of the crime, possibly the result of Goldfarb's hearing occurring before a specially convened (and potentially less experienced) panel than the usual DEC (which ironically was done to avoid any conflicts of interest given Goldfarb's own history and relationships with members of the DEC) - and the situation is worse because the Goldfarb matter became public as a result of his (rumored-to-be-pressured) resignation before the case could even be tried. And beyond Goldfarb, the CFP Board is also under fire from a lawsuit with Jeff and Kim Camarda, who also dispute whether their public-sanction punishment fit the "crime" of which they were accused. The key is that while Moisand notes in the end, all the other recent initiatives from the CFP Board are great, upholding the integrity of the marks with effective enforcement is absolutely crucial and is the core function of the CFP Board... and Moisand raises the question of whether all these other activities and initiatives are distracting the CFP Board from straightening out its core purpose first.

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!

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 latest Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!