Weekend Reading for Financial Planners (Dec 24-25)

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 24th/25th:

Fidelity Warns On The Fees RIAs Charge As Growth Falters (Janice Kirkel, RIABiz) - The latest Fidelity RIA Benchmarking Study is out, and the results affirm other recent benchmarking studies showing that RIAs are seeing multi-year lows for growth, though their AUM fee schedules remain relatively steady. Yet Fidelity suggests that the latter could at least in part be causing the former – in other words, that advisor growth rates may be slowing because of their pricing, suggesting that firms need to either re-evaluate their fees and their pricing structure altogether, or at a minimum come up with better ways to explain and differentiate (and justify the value of) their services. In fact, the study found that a whopping 73% of high-earning Millennials are interested in working with an advisor... if only their prices were lower. Advisory firms don't appear to be very worried at this point – likely due to the fact that profits and margins are still reasonably robust, thanks in large part to the ongoing bull market. Nonetheless, the implication is that when market growth actually slows, and advisory firms have to rely more on organic growth instead, it may be challenging to get the growth going again, until/unless firms either reform their pricing or better refine their value proposition, especially as competing services like Schwab Intelligent Advisory (their new hybrid CFP/technology offering) are coming in 2017 at a fee of just 28bps.

SEC Announces Examinations Of RIA Firms With Multiple Branch Offices (RIA In A Box) - Earlier this December, the SEC's Office of Compliance Inspections and Examinations (OCIE) issued a new regulatory risk alert regarding RIAs that operate from multiple office locations. Specifically, the SEC is concerned that advisory firms with multiple branch offices may not have fully developed appropriate supervisory and oversight policies and procedures to ensure that those outside the home office location are remaining complaint. The issue pertains to both advisory firms that have organically grown into multiple locations, as well as (or perhaps, especially) those that have expanded through recruiting or acquisitions in multiple geographic locations, where there may not be a supervisory structure in place to oversee the (new) branch location (and/or the supervisor at the branch doesn't have sufficient empowerment to engage in the necessary compliance oversight duties). Notably, the SEC has also indicated it will more deeply scrutinize the accuracy of the advisory firm's Form ADV filings regarding all of its locations, including branch offices, so advisory firms that are going through acquisitions in particular should be certain to keep Form ADV promptly updated. Though the greatest compliance concerns are still the most "common" ones, including proper calculation of advisory fees, compliance with the Custody Rule, review of advertising materials, and implementation of the firm's Code of Ethics (including monitoring personal security transactions) across all the firm's locations, as well as oversight of whether the investment recommendations being made to clients are actually appropriate.

Financial Advisors Face Share Class Confusion In Fund Selection (Chris Hall, Financial Advisor IQ) - With the DoL fiduciary rule implementation date approaching in April, and broker-dealers concerned that offering mutual funds with uneven commission payouts could run afoul of the Best Interests Contract Exemption, mutual fund companies are scrambling to try to develop a series of uniform mutual fund share classes to use. The problem, though, is that different broker-dealers each want their own payout structures, and some broker-dealers have changed their own policies more than once in the past few months as the details of the DoL fiduciary rule are digested, which means it's difficult to find consensus around whether to offer A-shares, C-shares, no-load shares, institutional class shares, or retirement class shares... which is a problem, given that getting new share classes approved takes 60-90 days, so time is truly running out. To resolve the dilemma, some are suggesting that broker-dealers could rely on an exemption in Section 22(d) of the Investment Advisors Act to force fund providers to set the right sales loads, while others are suggesting a new uniform share class (e.g., T-class shares) that would have a standardized modest upfront commission plus a trail (though there's still no consensus on what the upfront and trail payouts should be), and some are raising the question of whether the endpoint should simply be a "pure" mutual fund with no loads, trails, or even sub-TA fees, and just let broker-dealers add their own layers as they wish. Though in the near term, it seems likely that there will be a proliferation of even more share classes, as various fund companies acquiesce to large "price-maker" broker-dealers, with the field winnowing back down in a few years once the dust settles and a consensus emerges.

Capabilities Decks: A Financial Advisor Marketing Necessity (Ray Sclafani, ClientWise) - Lots of industries use a "Pitch Book" during their sales process... a booklet typically stuffed with facts and figures, bios and service details, that are used to explain a company's solution to a prospective client. In practice, though, such an approach often does little more than throw a bunch of information at the prospect to see if something sticks. Nonetheless, Sclafani suggests that there can still be value to producing such a document... but in the context of financial advisors, it needs to be more client-oriented towards what really matters to the client – which is all about not just what you can do, but why you do it, who you serve (and who you don't), and how you're differentiated and unique from other advisors. Specifically, Sclafani suggests creating a "Capabilities" Deck that explains these details to prospects, covering 8 core questions: 1) Why you do what you do; 2) Who your firm is built to service; 3) Demonstrated knowledge of common client needs; 4) Identifying other needs that clients may not be aware of; 5) Solutions (not just products and services) that you provide; 6) Your unique wealth management process; 7) Your team of trusted professionals; and 8) The process of becoming a client and what kinds of service(s) clients can expect. And if you serve multiple different types of clients, you may have a separate Capabilities Deck for each, to ensure that when you're talking with a prospect, you're staying on target to what's relevant for that prospect.

How To Turn Around A Bad Prospect Meeting (Dan Solin, Advisor Perspectives) - Sometimes, a new meeting with a prospective client just doesn't go well... there's no good connection made between the prospect and the advisor. The starting point is to at least try to get the prospect to talk about themselves and their concerns by posing open-ended questions. In some cases, though, prospects just won't engage, instead delivering short responses that don't move the conversation forward. Solin suggests one way to break the logjam is to ask the prospect "What would you find most helpful to discuss at this meeting?" As that helps the prospect share what it is they're looking for in the conversation – to share their own agenda, rather than let the advisor's agenda (to close the prospect) to unwittingly guide the conversation. In one example, Solin notes how an advisor engaging with such a 'disconnected' prospect wrapped up with an approach meeting, to which the prospect said "I need to think about it, I'll get back to you" – the classic brush-off – but was surprised to find the prospect still wanted to meet again, implying that there was something else causing a blocking point. As Solin notes, sometimes the problem can simply be that the prospect is an introvert, and simply isn't comfortable opening up in a meeting with a relative stranger; to ease the transition, Solin suggests asking "Is there anything unspoken between us" as a way to prompt the prospect about deepening the relationship... and has found the technique can be very effective if the prospect is in fact simply an introvert who needs more time to adjust to the advisor relationship.

The Who, What, And Why Of Hiring A Business Coach (Meg Bartelt, XY Planning Network) - For some financial advisors, the goal of the practice is simply to generate enough income to support a certain lifestyle. For a few, though, it's about achieving a bigger and broader mission – a Big Hairy Audacious Goal (BHAG) – which can quickly become so complex, making it necessary to find a business coach to get some help and advice on how best to grow the business the right way. In this article, Bartelt shares her own process of searching for a business coach, which ironically parallels the challenge that many consumers face in finding a financial advisor, including: no clear marker for who constitutes a professional (the way an "M.D." does for finding a doctor); no training or education necessary to refer to yourself as a business coach; so rarely used, that few understand what the experience should even be; no minimum set of competencies to judge a professional; and no easy way to evaluate success. Accordingly, Bartelt started by soliciting recommendations from advisor peers and her Mastermind group, getting an initial list of 10 suggestions and culling it down to 5... and then "interviewed the heck out of them". Bartelt notes that it's critical to ask the "hard questions" that will really allow you to understand how the coach may help you, such as: Here's my goal/problem – do you help people with that? How would you help me accomplish my goal? What would it look like for us to work together? How do you hold me accountable? How can you serve me better than other business coaches? Ultimately, Bartelt chose a coach who specializes in the advisory industry, and she found amongst the financial advisor business coaches some variability, from twice-a-month meetings at 45 minutes each, to a starter kit of three meetings in the first 3 months and then some email support, to a choice of 1-3 meetings per month at 90 minutes each. Pricing is typically $250-$350/hour of face time.

Combining SPIAs and Smoothing To Improve Retirement Outcomes (Joe Tomlinson, Advisor Perspectives) - Prior research has found benefits to both the use of a Single Premium Immediate Annuity (SPIA) and withdrawal-smoothing strategies for retirement income; in this article, Tomlinson explores the benefits of combining the two. The starting point is simply to recognize that relatively simple "smoothing" strategies – such as basing annual withdrawals not just on the current portfolio value, but a multi-year average of the past several years –  can go a long way to cutting the volatility of spending (though in a severe market downturn, may be too slow to adapt if spending was already too high, producing a more severe shortfall). On the other hand, using a SPIA can reduce the extent of the downside exposure, given that by definition it's a guaranteed income stream that cannot be outlived (ideally used to cover "essential" expenses). The combination of the two – where the SPIA guarantees essential expenses, and the portfolio spending is then adjusted for annual market changes with a smoothing factor – does little to change consumption on average, but Tomlinson finds it can help to increase the average size of the portfolio's bequest value while dampening down on the volatility of the spending. Though when testing different types of smoothing factors, Tomlinson finds that just limiting the magnitude of the spending change from one year to the next – a "guardrail" style approach – can actually do a better job of preserving wealth, in part by avoiding the risk that spending ratchets up too quickly (which then might not reduce rapidly enough in the other direction in a market downturn).

3 Reasons To Own An ETN (Cinthia Murphy, ETF.com) - While often grouped together with the label of "ETFs", in reality there are actually two different types of "exchange-traded products": an actual Exchange-Traded Fund (ETF), and an Exchange-Traded Note (ETN). The difference is that an ETF actually holds the underlying assets, while an ETN is ultimately a debt note issued by a bank, where the bank promises to pay as its "interest" a certain pattern of returns, such as "the return of a particular commodities index" or "the return of VIX short-term futures". The key distinction is that, ultimately, the investor doesn't actually own the underlying investments that generate the return; instead, the bank simply promises to pay it as a condition of the bond. On the one hand, this means that an ETN has credit risk and counterparty risk, as either the bank or the counterparty paying the ETN's return, could falter. On the other hand, not owning the underlying investment can actually be a benefit from a tax perspective, as many of the more esoteric investments require a partnership structure that distributes a K-1 and has to mark-to-market annually, while an ETN simply only pays taxes at redemption/sale and avoids the K-1. In addition, many ETNs simply open up market opportunities that wouldn't otherwise be feasible for most, as few investors actually want to open a futures trading account to get direct access to commodities and currencies anyway (but can do so via a normal brokerage account by buying an ETN that tracks those investments). However, be wary that most ETNs have only had limited adoption; as a result, a whopping 107 of the 188 currently trading in the marketplace are at a high risk of closure due to low AUM and/or a problematically low NAV, which could trigger tax consequences at an undesired time, or even additional losses given that many ETNs are not very liquid for those who want to sell in advance of a forced liquidation.

Morningstar Dispels Myth Of SRI Underperformance (Karen Demasters, Financial Advisor) - In its latest Manager Research report, Morningstar evaluated a wide range of in-depth studies on sustainable investing, and found that despite the popular myth, sustainable investing is not necessarily a recipe for underperformance. Notably, the studies don't necessarily find any conclusive evidence of higher returns, either, but for those who want to pursue sustainable investing strategies, it's still important to recognize that doing so does not necessarily entail sacrificing returns. And in point of fact, sustainable investing is becoming more mainstream already; over 1,000 asset managers have signed the Principles of Responsible Investment, backed by the United Nations, which commits them to including sustainable standards in their investment process. Though the nature of what constitutes "sustainable investing" is evolving as well; originally, it was primarily about avoiding or excluding "undesirable" companies, though now it is increasingly oriented towards proactively identifying companies that have active programs to improve the environment, pursue social causes, or support effective governance (with some research now suggesting the former has a slight lag in returns, but the latter can actually improve results). Unfortunately, the reality is that barely 2% of the fund marketplace is currently dedicated to sustainable investing, which can make it hard to establish a diversified sustainable investing portfolio, although with Morningstar's new Sustainability Ratings it's feasible to find "conventional" funds that happen to still align well to a sustainable investing portfolio, even if not part of the fund's explicit investment mandate.

Six Ways To Spend Less Time On Finances (White Coat Investor) - Research finds that one of the ways that money actually does increase happiness is when we use it to free up time... which, ironically, can be challenging precisely because having more money can take more time to tend and oversee it. Accordingly, White Coat Investor notes that as he transitions into "financial independence", it's a plus to him to find ways to not need to spend as much time overseeing his finances, and suggests the following tips: 1) Spend less in the first place (because if your spending is more prudent and frugal in the first place, it's actually not as crucial to sweat finding the best deal or monitoring your account balances, because you already know you'll have more than enough!); 2) Keep more in cash (i.e., if you always keep more than enough in your checking account, you never need to worry about checking on it when making a bigger purchase, and if you're already financially independent the "cash drag" is still modest); 3) Automate and simplify investments (from automatic transfers, to lumping deposits together so it's once-and-done each year, and consolidate accounts so there are fewer to monitor); 4) Quit watching your investments (as it takes time, and doesn't contribute to the bottom line anyway!); 5) Put all your spending on one card (it may be fun to optimize the return on every last dollar of spending through credit card points, but at some point you're sacrificing your time to squeeze out an ROI that doesn't actually matter to your financial future, anyway!); and 6) Set it and forget it (the more you automate key parts of your life, the less time you have to spend monitoring and worrying). Notably, White Coat Investor points out that another option is to hire a professional to delegate some of these tasks (i.e., a financial advisor), but frets that the time to hire them, meet with them, and oversee them can still be time-consuming – a good reminder to advisors that offering "top" clients more meeting time may be the exact opposite of what they actually want when they choose to delegate to you in the first place!

Personal Finance Lessons From The Ultrawealthy (Veronica Dagher, Wall Street Journal) - The Tiger 21 group is a peer network of the ultrawealthy (those with more than $10M of investible assets) who do an annual "portfolio defense" where they share their personal balance sheet, portfolio, and financial goals with group peers. Key takeaways from one recent "portfolio defense" session of the Tiger 21 participants include: 1) Consolidate accounts to the extent you can, as it helps to both simplify, makes it easier to monitor, and may even help get breakpoints on investment costs; 2) Keep cash handy, not only to handle emergencies, but to deploy tactically when unique investment opportunities come along (as notably, the group averages a 12%-of-net-worth cash holding); 3) Get feedback about the gaps you may be missing in your financial plan (from your peers, or a financial planner); and 4) remember that it's never too late to accumulate wealth (as some group members note that the bulk of their wealth actually came when they were already in their 50s and 60s, not just by striking it big when they were young!).

20 Rules Of Personal Finance (Ben Carlson, A Wealth Of Common Sense) - Carlson shares his personal list of 20 personal finance rules, and although few are novel or noteworthy, it's a remarkably good reminder of the key steps in financial due diligence for any client, including: 1) it's not about what you make, but what you save, that let's you accumulate wealth; don't just live within your means, but below your means; avoid credit card debt like the plague ('nuff said), but take the time to bolster your credit rating (so you can get a mortgage, car loan, or student loan, as necessary in the future); look at where your money goes each month to understand what you're prioritizing (and consider whether it needs to be changed!); automate everything; get the big purchases right (i.e., automobiles and houses) and most of the rest takes care of itself; use insurance for what you can't afford to lose; always get the 401(k) match (it's free money!); save a little more each year (out of your raise), to help minimize lifestyle creep; recognize that material purchases won't make you happier in the long run; the easiest way to get wealthier is often to try to make more money (and save it), not just figure out how to spend less; and recognize that the real goal shouldn't be "retirement", but simply "financial independence" to choose your own path. Good reminders for everyone!

I hope you enjoy the reading! Please let me know what you think in the comments below, and if there are any articles you think I missed that I should highlight in a future column!

In the meantime, you may be interested in this video as well, on the topic of "Wealth Prejudice", and how those who inherit substantial wealth actually face significant social challenges, as they are effectively "born into" a form of social minority that has a number of unfavorable stigmas associated with it!