Weekend Reading for Financial Planners (Dec 3-4)

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 3rd/4th:

Kansas Judge Denies Effort To Block DOL Fiduciary Rule (Mark Schoeff, Investment News) - This week, Kansas Federal judge Daniel Crabtree ruled in the second of the six lawsuits against the Department of Labor's fiduciary rule (this time filed by indexed annuity provider/distributor Market Synergy Group) and once again the court ruled in a 63-page decision that the DoL had not exceeded its authority or been capricious in its treatment of fixed indexed annuities, and that the fiduciary rule would not cause irreparable harm to the insurance model. In fact, the judge specifically declared that at this point, delaying the rule would cause more consumer confusion than allowing it to proceed. Commentators suggest that the judge in this case was likely swayed by the prior judge that ruled in favor of the DoL two weeks ago, as that judge – Randolph Moss – is a recognized expert in the Administrative Procedure Act, which is the exact law upon which most of the DoL fiduciary lawsuits rely. Notably, even two court rulings in favor of the DoL doesn't ensure that the remaining lawsuits will automatically go that direction; nonetheless, the more lawsuits the DoL wins, the more pressure there will be on subsequent judges to rule in line with the existing precedent being set, unless one of the subsequent cases can establish an entirely novel reason for why the Department of Labor rule should still be delayed or blocked. In the meantime, as with the prior NAFA decision in favor of the DoL, Market Synergy is expected to appeal as well.

Should I... Hire Another Planner? (Ingrid Case, Financial Planning) - The evaluation of whether to hire another financial planner or not is a major crossroad decision for any financial advisor. On the one hand, there's the growth potential of finding the right person, who can help with client servicing, expand the capacity of the firm, and even serve as a natural succession/exit plan. On the other hand, not everyone wants to be a "boss" that has the responsibility to hire, train, and manage a professional staff member. Of course, even for those who decide they do want to here, there's still the non-trivial challenge of finding the "right" hire, who is a good fit for the firm and its clients. Hiring across channels (e.g., hiring someone from a broker-dealer if you're an RIA) can sometimes be challenging due to the culture differences, though some hiring risk is virtually always necessary. Accordingly, some hire from their personal network, while others look to recruit locally, and some work with external recruiting firms for advisors. Though even with outside help, recognize that it still falls to the advisor to train and develop their new staff member, which means while there may be a favorable payoff in the long run, it can still take a year, or even several, to earn the near-term return on the staff investment.

Compensation Shouldn't Be Crisis Management (Yvonne Kanner, Financial Planning) - As the end of 2016 arrives, so too does the time to do employee reviews and set compensation for 2017. For many firms, though, there is no compensation strategy in place; instead, compensation is only reformulated when an employee leaves, or at least threatens to leave. The starting point to setting an actual compensation plan, though, is really to define the anticipated growth trajectory of the firm, and then fit appropriate career tracks into it. Key strategies include: formulate some strategic plan for the overall business over 3, 5, and 10 year time frames (to consider the opportunities that might be available in the future); consider what is needed to fill the company's org chart as it grows, and what kind of personal growth or formal training current employees may need to fit into those future roles; consider who the star employees/performers are, as well as the new ones you want to attract, and consider how they need to be compensated/incentivized to be attracted and stay (as the most entrepreneurial employees must have an opportunity to participate in the wealth creation, or they'll leave to create their own); and create compensation tracks that align to the career paths (e.g., service advisors may have a different compensation/career track that business developers). In the meantime, Kanner cautions to be wary of relying too much on compensation studies (which are fine as a baseline, but be cognizant that different firms have different job descriptions and responsibilities for similar-sounding titles), and be cognizant that incentivize compensation is powerful for top performers, but should still be achievable (as out-of-reach targets can just be even more demotivating!).

Best New Compensation Plans For Advisers (Michelle Zhou, Financial Planning) - Employee compensation is the single biggest line item expense for virtually all advisory firms, yet few have a clearly designed compensation structure. To the extent firms evaluate compensation at all, it is usually just to compare it to industry averages using available industry benchmarking surveys, but often those studies just show total compensation, and not the components of it, or how it was determined; for instance, there's a huge difference between top-tier advisors getting paid $200,000 in salary, versus $200,000 comprised primarily of variable compensation bonuses that they only hit with growth (even if the total dollar amount is the same). More generally, it's important to recognize that advisor compensation really falls into five broad categories: base salary, performance-based bonuses, bonuses for originating new business, compensation for servicing clients, and equity compensation. And different job roles and tiers might participate differently – for instance, administrative staff might receive primarily salary, performance bonuses, and perhaps new business bonuses, but key operational staff might also get equity compensation; similarly, servicing advisors might also get a servicing fee for clients, but not equity participation, which is reserved for only the most senior advisors. And ultimately, the targets to earn and participate in those various compensation types should be specific to the firm and its growth path. More broadly, though, it's important to recognize that one of the biggest drivers of long-term retention for employees is not just whether they're paid reasonably well, but whether they feel like they have a continued path forward – which means in many cases, providing a clear career track on how to reach higher compensation in the future can be just as important as simply giving reasonable compensation today.

Brain Drain: How RIAs Can Hang Onto Employees (Kelli Cruz, Financial Planning) - One of the biggest keys to retaining top talent is that it's not only necessary to compensate them appropriately, but also to define career paths for them that help to keep them engaged and committed to the firm's long-term success. In essence, a career path is simply a track or defined plan for progress over an employee's tenure at the firm – which means it should cover not only the upside compensation potential, but also the skills and capabilities that the employee must acquire in order to progress. Which is actually a plus, not only for developing employees, but because for many, the opportunity to gain in-depth knowledge and experience is itself very intrinsically rewarding and motivating for them! Of course, the reality is that for solo firms or those with just a few employees, there may not be enough depth in the organization to really define a long-term career track (which is why the firm doesn't offer one), but Cruz suggests that once a firm hits about $170M of AUM and has around 7 staff members, there's usually enough team depth to begin defining a career track. For instance, advisor roles might get fleshed out into Support, Service, and Lead advisors (each of which has its own requisite skills for success), while operations roles may become administrative assistants, client service administrators, operations managers, and then a Chief Operating Officer, and the investment roles could include trading administration, portfolio manager, senior portfolio manager, and Chief Investment Officer. Creating the career track itself would then entail establishing a job description for each tier, defining the skills necessary to reach that tier and move up to the next one, and the compensation available at each tier; from there, employees at least know the path before them, and as the firm owner you can reward the ones that step up accordingly!

Help Clients Avoid Capital Gains Distributions (Sheryl Rowling, Investment News) - As we approach the end of the year, we approach the season of end-of-year capital gains distributions from mutual funds, where capital gains that have been generated inside a mutual fund get distributed to shareholders... along with the tax consequences. Already, firms are beginning to publish preliminary estimates of distributions, and while most won't be very material, some will, especially in a year where many actively managed mutual funds have experienced large outflows (which can force fund managers to sell long-term appreciated securities, triggering gains, in order to meet the redemption requests). In fact, there are a few funds that are already estimating distributions in excess of 20% of their entire net asset value. So what can be done? The most straightforward option is simply to sell the investment before the distribution is made – either switching permanently to another investment, or at least switching for a limited period of time, and then switching back after the distribution has been made. Of course, liquidating now means recognizing any capital gain that the investor has on the fund itself, which for a long-term investment could be equal to or larger than the gain about to be distributed, so these switching strategies won't always make sense. Nonethleess, at a minimum Rowling suggests researching all the mutual fund holdings you currently have for clients, checking to see which might be making material distributions, and if there are some, evaluate all the clients who have them and whether it would be a smaller gain to switch out before the distribution date (and if so, find the alternative security you're going to hold while waiting for the distribution to occur!). Rowling suggests CapGainsValet as an easy service to look up and monitor which funds will be making distributions. (Michael's Note: Nerd's Eye View readers can get $10 off the "Pro" version of CapGainsValet with the Kitces10 discount code!)

HSAs Gain (Serious) Traction In Retirement Planning (John Sullivan, 401k Specialist) - The total amount of assets in Health Savings Accounts (HSAs) was up a whopping 16.7% year over year, rising to a total of more than $30B, and projected to cross $50B by 2018. Notably, though, the data shows that HSAs are being opened disproportionately by those at or nearing retirement, with savers over age 55 accounting for 34% of HSA assets on the Ascensus platform – which suggests that much of the growth in HSAs may be less about using them "just" to cover near-term medical expenses, and more about using the HSA as a form of supplemental retirement savings vehicle (and in fact, the highest average HSA balances are for those who are over age 65!). The driver in recent HSA growth appears to be attributable to not only the shift towards high-deductible health plans in general, but the rising use of automatic enrollment into HSA plans, done almost entirely online, which is materially boosting participation rates further.

Helping Clients Weigh The NUA Distribution Decision (Robert Westley, Journal of Financial Planning) - The "Net Unrealized Appreciation" (NUA) rules allow workers who have appreciated employer stock inside of an employer retirement plan to withdraw the stock in-kind (and transfer it to a taxable brokerage account), pay ordinary income taxes on just the cost basis (plus the 10% early withdrawal penalty, if applicable), and then sell the shares at favorable long-term capital gains tax rates. The strategy is often more appealing than the alternative, which is to simply sell the shares inside the plan and incur no current tax consequence, but face ordinary income treatment when the value is ultimately distributed out of the retirement account in the future. In essence, the NUA strategy converts the appreciated value of the shares inside the plan from ordinary income into long-term capital gains. Accordingly, the bigger the gap between an individual's long-term capital gains rates and ordinary income rates, the more appealing the NUA strategy will be; for those in the 25% tax bracket (and subject to the 15% capital gains rate) it generates some tax savings, though it's even greater for those in the 39.6% ordinary bracket who would pay only 20% in long-term capital gains (as notably, the 3.8% Medicare surtax does not apply to the NUA gain). On the other hand, because ordinary income taxes must be paid immediately (for the year of distribution) on the cost basis, whereas if the shares stayed in the retirement account those taxes could have been deferred for years (or even decades), the NUA strategy is best when the cost basis of the NUA shares is very low (e.g., pennies on the dollar). Other NUA factors to consider include: the time horizon (as the sooner the money would have been withdrawn from the retirement account anyway, the better the NUA distribution), the need for diversification (which can accelerate the desire to do the NUA distribution), needs for creditor protection (which are similar but not the same between IRAs and employer retirement plans), and any charitable and estate planning strategies (bearing in mind that the NUA gain is not eligible for a step-up in basis at death).

Income Annuities In A Low-Rate Environment? You Bet! (Scott Stolz, Research Magazine) - Despite at least some consumer interest in guaranteed lifetime income, many financial advisors and retirement experts have cautioned against purchasing any form of immediate annuity in today's environment, given low interest rates. However, Stolz points out that because ultimately, the payment from an immediate annuity is comprised of a combination of interest, principal, and mortality credits, the reality is that lower interest rates haven't necessarily dragged down immediate annuity payments all that much in the first place; for instance, from the beginning of 2011 to the end of 2015, the 10-year Treasury yield fell by 33%, but New York Life's payout on a life-with-10-year-certain immediate annuity for a 75-year-old male only fell 4% during the same time period. And in fact, the New York Life annuity would pay out dramatically more for an equivalent dollar amount invested; a $100,000 premium would give about $658/month at today's rates (or about $7,892/year), while a bond paying 2% would give barely 1/4th that amount. Of course, the reality is that the higher payout is driven primarily by the fact that the annuity isn't just paying interest, but also principal and mortality credits, as noted earlier; on the other hand, that's also the whole point, as the economic value of the immediate annuity is going to be driven primarily by how long the client lives and receives those payments, not the interest rate component of the payout factor itself. And in fact, for those who live a long time, the internal rate of return for an immediate annuity can be drastically higher than a bond over similar time horizons (thanks again to the mortality credits), which means for the long-lived, interest rates would have to rise, quite materially, just to make up for not buying the immediate annuity now!

The Three Stages Of Business Transformation (Julie Littlechild, Absolute Engagement) - A lot of advisors will struggle at various points in their career about "feeling stuck", and trying to make a breakthrough. As Littlechild studies advisors who are trying to find better engagement in their firms, though, a pattern is beginning to emerge, about what actually allows a breakthrough to happen. The first step is some fleeting glimpse that there could be something more/better than the current status quo; simply put, we first have to overtly recognize that we're not entirely happy with the way things are now, and have at least some momentary vision of how it might be better. Once the fleeting glimpse occurs, the next stage is for that discontent to crystallize, as we really begin to consider the question "what do I really want to create"; in practice, it often feels like an epiphany moment where we make a conscious decision that a change must occur, even though in reality it could be the culmination of months or even years of ruminations since the first fleeting glimpse. From there, though, it's still necessary to figure out exactly what the change should be – in other words, a vision of the better future has to be created, and it's that prospective vision of the future that ultimately drives us to make a transformation for the better. Notably, Littlechild points out that a lot of us reach the first step, and a few reach the second, but the real key to an actual transformation is figuring out the vision of the third step, as that's what eventually drives at least a small number of us to actually take action for the better.

One Behavior Separates The Successful From The Average (Benjamin Hardy, Medium) - Most people will do what they are reasonably asked, but generally no more than the minimum requirement. But those who become most successful are typically far more engaged, proactively initiating an effort to get a better outcome. As an example, Hardy tells an anecdote of a farmer who is choosing which of his two sons should inherit the family farm; when they're in need of more cows, one son goes to the neighboring farm and finds out there are 6 cows for sale, while the other goes and finds out that there are 6 cows for sale, what they cost, the deal for buying them all at once, other alternatives if they're willing to wait for better cows, and the delivery options if they want to get the cows immediately. While both did the basic task – find out if there are cows for sale – one exhibited drastically more initiative, and it's that initiative to go deeper that ultimately defines success (or in this case, the son that will inherit the farm). Of course, initiating can also entail risk – it means putting yourself out there to determine an opportunity that might not pan out, while not initiating and simply doing what you're told might feel like playing it safe. But in the end, as with any risk/reward trade-off, those who don't initiate and take at least some of the risk, won't enjoy (m)any of the rewards, either.

Silence Those Voices In Your Head (Stephanie Bogan, Investment News) - Everyone has some kind of internal dialogue that runs through their heads. One study from the National Science Foundation estimated the average person has 12,000 to 60,000 thoughts per day... and notably, it further estimated that about 95% of those thoughts were repetitive, and a whopping 80% were negative. Which means, simply put, that most of us are continuously on a mostly-negative auto-loop of thoughts. Accordingly, this means that the beliefs we have – about what we can and cannot accomplish – are incredibly powerful, because they set up much of that auto-looping feedback, and whether or how much of it is positive versus negative. For instance, Bogan notes that a lot of the beliefs that formulated around her during a challenging childhood turned into very limiting beliefs as an adult – challenges of feeling "not good enough" when young turned into a constant striving to be successful as an adult, to the point that it did drive her to create a successful business, but notably didn't make her any happier in the process. More broadly, the key point is simply to recognize that our beliefs inform and guide the thoughts in our head, which in turn can drive, or severely limit, our success and the happiness we derive from it. Which in turn means that breaking through to the next level of success is often a matter of first addressing the beliefs we have about ourselves... in an effort to silence, or at least address, those voices in our heads.

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, 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!