Weekend Reading for Financial Planners (Dec 28-29)

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 28th/29th:

Labor Secretary Lobbying Congress On Behalf Of Fiduciary-Duty Rule - There's a new player on the field in the efforts from the Department of Labor to advance their fiduciary proposals: Labor Secretary Tom Perez, who was sworn into office in July, and promised senators during his confirmation hearings that he would take bipartisan qualms about the regulation into account before the DOL proceeded, which accounts for why the re-proposed rule has now been delayed all the way out to next August, rather than a date in the spring. The primary concern stems from the Democratic side of the aisle, where lawmakers are concerned about the suggestions that brokers being subjected to a fiduciary duty could raise regulatory costs and drive them away from serving investors with modest retirement assets; accordingly, the DOL has stated that "it will be clear, when the re-proposal is published, that the department has been listening and taking seriously the comments it has received." Notably, legislative proposals have also been put forth that would force the DOL to wait until after the SEC proceeded - which could kill the DOL proposal altogether, since the SEC is not obligated to proceed at all - but thus far the legislation has had no momentum, and the Obama administration has issued a veto threat. As a result, it still seems likely that a DOL proposal will ultimately come forth, and the efforts from Secretary Perez suggests that the DOL is actually trying to build momentum for the rule; however, it remains to be seen exactly what the final proposal will include on key fiduciary issues.

Vanguard Raked In Almost Every Dollar That Went Into U.S. Equity Funds This Year - According to Morningstar, a total of $41.4B of net inflows went to Vanguard this year, while all other US equity stock funds combined only netted a total of $1.1B, which means that Vanguard has effectively netted 98% of all US equity flows this year. The bulk - about $36B - went to Vanguard's popular index funds, especially its $296.4B Vanguard Total Stock Market Fund (VITSX) which passed the PIMCO Total Return Fund (PTTAX) last month to become the world's largest mutual fund. Ironically, while many attribute Vanguard's success to its low costs, arguably low costs are most important in a low-return environment, while the S&P 500 index has been up more than 25% year-to-date, suggesting this "shouldn't" have been a year when investors were especially sensitive to costs. Of course, the good return environment is helping actively managed funds as well, which are also set to have their best year of inflows since 2005 - albeit still at a pace of "just" $10B of net outflows (after a crushing $130B of outflows in 2012)! On the other hand, Vanguard has been so popular that its own actively managed US Equity funds have seen inflows as well, and in fact the indexing giant "also" has more than $650B in actively managed funds in total. And Vanguard's good fortunes haven't been limited to US equities; its international equities and bond funds have also had $65B of inflows in the first 11 months, and the company is on track to win the annual flows crown for the third straight year. Vanguard is even winning in the ETF space now, as its $51B of ETF inflows in 2013 tops Blackrock iShares at "only" $37.7B for the year.

How Schwab Is Calling Out Wirehouses With Its 'Accountability' Blitz And What Collateral Effects Could Hit RIAs - The buzz continues after last week's announcement from Schwab that clients who are unhappy with its advisory services will be eligible for a refund of the last quarter's AUM fee. The offer is part of a big marketing blitz underway from Schwab that is viewed as an attempt to woo clients away from wirehouses by being more accountable, and will apply to its in-house advisory services, including Thomas Partners, Windhaven, and Schwab Private Client. Yet some have expressed concern that the new guarantee may put pressure on RIAs, especially those who custody at Schwab and may be confused why "their" RIA doesn't have the same money-back guarantee when their money is on the Schwab platform (especially if they're referred by Schwab as part of its Advisor Network). On the other hand, it's also not clear whether or how much the guarantee will really be utilized; Schwab has indicated they're putting aside little in reserves for it - suggesting they think few will make claims on it - and are perhaps counting on the fact that most clients will assume there's some fine print that will make it not worthwhile (though Schwab insists there are no conditions), or simply won't want to have the awkward conversation it takes to ask for a refund (and for very unhappy clients, the reality is that Schwab and others would often refund a fee on a case-by-case basis already). Yet some suggest that Pandora's box has been opened, and that guaranteeing fees in a world where clients may be unhappy with market performance the advisor can't control will come back to sting Schwab in the end.

When Employees Leave: What to Do Now - It's an unfortunate reality that even as more advisory firms grow larger and hire employees, they also have to deal with the challenge that from time to time, advisors leave as well. At the same time, one of the defining characteristics of a great firm is how it prepares for and reacts to the announcement of a departing employee. Some tips from Gen Y advisor Dave Grant - who himself has been on the leaving end of more than one firm - include: 1) don't get emotional (or you may change an overall positive experience of working for the company into a burnt bridge, and remember the departing employee may be emotional as well); 2) have replacements ready (make sure staff members are cross-trained on the essential tasks of others); 3) have an exit policy (Grant states he's not a fan of exit interviews, and instead suggests having the employee and employer write a letter to each other, listing both what they appreciate and a few constructive suggestions for improvement); 4) re-evaluate your team (the disruption of a departing staff member may be a good excuse to re-examine the balance of employees in the firm, current workloads, and whether to restructure); and 5) stay in touch (as former employees can actually still be referral sources, or a reference for new hire).

Time To Hire A Professional Manager? - This article looks at the emerging trend of growing financial advisory firms hiring full-time dedicated managers for the business... and not just by grooming talent internally, but hiring outside the firm and the industry altogether. In fact, a recent TD Ameritrade Institutional survey found that firms with more than $500,000 in gross annual revenue that have dedicated professional management can point to 161% more total revenue than firms without dedicated management. The key seems to be not only the value of hiring someone dedicated to the role of business management, but the acknowledgement that most firm founders are entrepreneurs and advisors and business developers and relationship managers - not necessarily the best skillsets for an internal business management role. Of course, dedicated management also has a significant cost (median total compensation of $156,238 and upper quartile firms pay nearly $200,000, and equity up front or down the line is often involved as well), so industry consultants suggest that dedicated professional managers are probably not a good fit until the firm approaches $1.5 million in revenue, may be especially good at helping a firm through a critical growth phase from $250M to $500M of AUM, and are absolutely critical by the time the firm manages $1B of AUM. Key skillsets for professional managers should be around project management, effectively building teams, and ideally a track record for business building and managing complex business systems. On the other hand, it's also notable that transitioning to a professional business manager represents a loss of control for the owner... which means at a minimum, be certain to hire someone who has an appropriate consultative approach to keep connections and buy-in from partners as they try to relinquish some of that control, and recognize that the new hire must be comfortable with the firm's culture as well or the match may be doomed to failure.

The Rise of Super Ensembles - In this article, practice management expert (and Pershing Advisor Solutions CEO) Mark Tibergien looks back at the history of advisor benchmarking studies, which he started doing in the early 1990s for FPA-predecessor the International Association for Financial Planning (IAFP). At the time, most firms were tiny, and very few even had $100M of AUM or multiple partners and staff; by contrast, in the latest Investment News/Moss Adams Advisor survey, the median participating firm is generating over $2M in revenue with more than $200M in AUM, and that's just the median! Even back in "just" 2002, the first Moss Adams study showed an average participating firm with just $350,000 of revenue and $25M of AUM. But most notable in the latest study was a subgroup of 57 participating firms with revenue over $5M, which have been dubbed the "super ensembles" of the industry (with average revenue of $11.8M and AUM of $1.5B). These firms are notably different; they have far more revenue per staff member than solo practices (more than double), yet 30% fewer clients per staff, resulting in almost double the income per owner of solo practitioners. What are the top firms doing so right? Tibergien suggests a few key areas, including: they develop a clear value proposition and a clear idea of who their optimal client is (and get very effective at communicating it); they create organizational structures that allow them to leverage workflow, technology, and staff; they effectively leverage support staff, with almost two dollars of non-partner compensation for every dollar of partner compensation; their organizational structure makes it easier to focus on growth, which allows them to have a stronger market presence, which in turn begets even more growth (and also helps them to attract larger clients); they pay a premium price to recruit premium talent (but also offer challenging work, recognition, responsibility, and opportunities for growth); and they actively manage to profitability targets with more discipline around pricing, client acceptance, and managing workflow. To say the least, we've come a long way from the world where independent advisors were once dismissed as "failed brokers" - in fact, Tibergien suggests that soon many will be equal in size to a number of today's mid-sized broker-dealers!

2013's Best Tech for Advisors - In Morningstar Advisor, advisor tech guru Bill Winterberg highlights his choices for the best technology providers in 2013, in the "Best Back-Office Technology", "Best Client-Facing Technology", and "Innovation of the Year" categories. Winterberg actually starts out by noting that 2013 was a rather tepid year for advisor technology overall, with a lot more small incremental updates but few big splashes, though the pipeline seems full for the coming year. Nonetheless, there were a few standouts in 2013. First up were the best back-office technology winners, an award that is shared by LPL Financial and Fidelity for their introduction of mobile check deposit solutions for their affiliated advisors; while the technology may not seem that significant at first, it has some huge efficiency benefits for advisors (no more overnight envelopes, photocopying checks, delays impacting fund availability, etc.) as advisors can now process deposits directly from mobile devices while visiting clients. For the best client-facing technology, Winterberg selected Riskalyze, a combined risk-assessment-and-portfolio-construction tool that guides clients through a dozen "tradeoff" questions (which would rather have a certain financial outcome of X or a 50/50 chance of a nominal loss or sizable gain instead) to get a 1-to-100 "risk number" and then compares the client's actual portfolio to the risk result. In the "Innovation of the Year" category, Winterberg chose rising investment custodian TradePMR and their Fusion Advisor Workstation tools, which have been called "the most impressive custodial interface" by fellow advisor tech columnist Joel Bruckenstein; built around the Windows 8 "live tiles" approach, touch-responsive charts and reports can be fully customized for advisors and their clients with real-time updates of prices and position information. Honorable mentions for the 2013 awards included the workflow CRM integrations from Fox Financial Planning Network, and digital content marketing platform Vestorly.

Retirement Planning and Life Insurance: Some Traps - In the Journal of Financial Planning, attorney Jon Gallo looks at the latest environment for Irrevocable Life Insurance Trusts (ILITs), which are often being evaluated as wealthy clients transition into retirement and existing life insurance becomes less about income replacement and more about estate planning (possibly with some new/additional coverage as well). Setting up an ILIT for existing policies has become somewhat more complex over the past two decades, as there is an increasing amount of ambiguity about how to properly value such gratuitous transfers (i.e., gifts) of life insurance. Treasury Regulation 25.2512-6 stipulates that term insurance is valued based on the unused portion of the annual premium, and cash value life insurance is valued based on the interpolated terminal reserve of the policy (plus unused last premiums and dividend accumulations, minus any outstanding loans). The problem, though, is that Treas. Reg. 25.2512-6 is more than 50 years old, and was written at a time when the only types of life insurance were annual renewable term, and whole life; the former was always easy to value, and the latter was too, as whole life policies had clear reserving requirements to meet the contractual guarantees. In today's world, with universal life (variable and fixed and indexed), guaranteed no-lapse UL, and 10-30 year level term, the situation is messier, as the policies are "current assumption" products - which means mortality experience and investment performance are passed through to the policyowner - so there is no known "terminal reserve" until the end is actually reached, which means there's nothing to "interpolate" towards; in addition, there are now several different types of reserve calculations as well. As a result, valuations can vary tremendously from one carrier to the next, which means if a valuation is requested, at a minimum be sure to ask for documentation about how it was done and what reserve methodology was used, in case there's a challenge in the future, and consider whether it's worthwhile to also get an independent third-party valuation, or in the extreme even exchange to another carrier with a more favorable formula. The article also discusses some important complications that can arise with Crummey powers.

What Do Lifetime Income Projections Achieve? - A recent rulemaking proposal from the Department of Labor may soon mandate that defined contribution plan workers receive a simple monthly income projection of what their account with growth could buy at retirement, in addition to just showing the account balance itself, in recognition that most people don't necessarily know how to intuitively convert a large account balance (especially a distant future one) into a relevant and appropriate amount of lifetime income. As Texas Tech professor Michael Finke points out, this approach has both some benefits and potential pitfalls. On the plus side, it may give a more realistic perspective about how much is really needed for retirement, as many people seem to misjudge how large of an account balance it takes - especially in today's low-yield environment - to really fund a prospective 30-year retirement; while large account balances may seem alluring, it's harder to dodge the reality with a statement that clearly shows a six-figure account balance may still only provide a three-figure monthly payment in retirement, and the proposed rule would require that works also be shown ow much more lifetime income could be saved if they saved a little more each month. So will it work? A recent study tested the approach amongst 17,000 employees at the University of Minnesota, and found that this kind of "information policy" does work, but not for everyone and the aggregate impact isn't huge; nonetheless, the outcomes were better than approaches like workplace retirement education. Interestingly, the lifetime income projection seemed to work best for those who were already the most motivated to save, especially if they were already future oriented; in other words, information doesn't help less informed workers make better retirement decisions, but it does help informed and motivated workers to save even more for retirement. Another challenge of the approach is that there is still much debate over the "proper" assumptions to make for the lifetime income projections; Finke suggests that using inflation-adjusted TIPS returns for growth and an inflation-protected annuity at retirement would be best, but these extremely conservative assumptions (especially at today's rates) place tremendous and daunting savings demands on most. The DOL is considering projections with a 3.9% real return, which is notably less than the historical record for a 60/40 portfolio (about 5.6% real), but arguably may be unrealistically high in today's environment (and in general, it's difficult to come up with one return assumption given the wide range of aggressiveness in how pre-retirees invest). Notwithstanding the issues, Finke suggests that ultimately something will probably be done in this regard, as it's difficult to oppose a policy that's proven to increase 401(k) assets, but employees may well end out getting a lifetime income projection that they won't like to see... and hopefully it will stir at least some of them to action!

Too Many Choices: How to Help Clients Decide - From Investment Advisor magazine, this article looks at some of the research on choice, and the challenging phenomenon that sometimes having more choices actually makes it harder for us to choose to buy something. One of the lead researchers in this space is Dr. Sheena Iyengar, who has now published a book called "The Art Of Choosing" around her research on choice. As Dr. Iyengar and others find, these challenges around choice are becoming more and more prominent as technology and the internet provides us with an ever-widening array of choices, 24 hours a day; while this range of choice can be helpful in a domain where we already know a lot, it becomes disabling when complex choices come in an area with which we're not already familiar and comfortable. In fact, when faced with too many choices, our brains can actually become depleted of energy, further reducing our ability to make decisions (or resist temptations). So does that mean the alternative of "less is more" may actually be better, even if it narrows the number of choices available in the process? The research suggests yes; after all, comparing two choices requires one comparison, while comparing three has two sets of differences, and four has six sets of differences to compare, which makes the problem exponentially more difficult to choose which is best or eliminate what's worst as the number increases. Notably, the research also finds that while we like to think we always make rational decisions between choices, the driver of the decision is often emotional. Fortunately, coming technology and automation may simplify some of these choices and efforts - think self-driving cars that free up our minds to focus elsewhere. Ultimately, all these challenges around choice also suggest that an advisor's greatest value may not be focusing on things like investments, but helping clients to clarify their wants and needs and navigate their choices more effectively. Similarly, the article notes that in a world where information is not scarce but so abundant it can be overwhelming, the value of an advisor is being trained to know what information to focus on that's most important, and what's less relevant and can be ignored.

Here’s The Surprising Truth About Why Your Financial Planning Customers Love It When You Double Your Income - This article from Dutch financial planner Ronald Sier focuses on some research cited in the book "Made To Stick" by the Heath Brothers about how people are more likely to contribute money when they receive a personal and emotional plea than an analytical/statistical one; for instance, telling the story of a poor starving 7-year-old girl from Africa draws twice the donations than just sharing statistics about the millions of children starving in Africa. In other words, appealing to the heart trumps the abstract cause, no matter how well it is articulated technically. In fact, the researchers even found that if someone is "primed" by being asked to think about analytics and numbers and then given an emotional statement, the emotional impact is blunted; in other words, once we put on our analytical hat, it's a lot harder to make an emotional appeal. In the context of financial planners, these concepts are powerful - given that planners often market and communicate their services with highly analytical terms, talking about achieving financial goals, maximizing tax efficiency, etc., the implication is that we may be making our services less interesting and compelling by encouraging prospective clients to put on their analytical hats when evaluating our services. So what's the alternative? Use words/language and imagery that communicates your services and tells the story of yourself and what you do in a manner that makes clients emotionally feel, not just analytically think.

Ric Edelman Tells How He Succeeds In Advice's Death Valley -- Online Investing - On RIABiz, this article provides a fascinating look at the advisory business of Ric Edelman, which now boasts a whopping $12B of AUM and 22,000 clients (which notably comes out to an average household of 'only' about $545k, making Edelman's firm a massive player in the "mass affluent" marketplace while most larger RIAs have pursued the ultra-wealthy). Notwithstanding its tremendous size, Edelman's firm is focused on significant growth from here; private equity firm Lee Equity Partners bought the firm last year and has been supporting investment into Edelman's infrastructure, including technology, advisors, and offices across the country (already up to 34 offices in 15 geographic markets), to support an even higher pace of new clientele.  Also notable was Edelman's recent launch of Edelman Online last year, its pure-online-only service that now has 500 clients and $25M of AUM, and notably has the same pricing schedule and offers the same full services (i.e., clients who want planning assistance can still get it), a significant difference from competitors like Wealthfront and Betterment who Edelman predicts will not be able to generate the revenues to support their infrastructure unless they pivot to work with advisors or be more like them (offering a real human being to interact with). The firm is also managing the challenges of becoming less dependent on Ric himself; last year over 500 marketing seminars were conducted, but primarily by 6 other speakers (Edelman himself did only seminars himself), and Edelman is trying to reduce the firm's dependency on him in other ways as well, including co-hosts for his radio show and writing support, even while acknowledging it is still a personality-based firm. Overall, Edelman is still upbeat about serving the mass affluent marketplace, though he acknowledges it's difficult and takes more effort and investment because of the volume that's required for the business to be profitable.

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, including his "FPPad Bits And Bytes" weekly advisor technology update!

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!