Weekend Reading for Financial Planners (Dec 5-6)

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 5th/6th:

The eAdvisor Cometh, is Your Firm Ready? (Joel Bruckenstein, Financial Planning) - This article covers the latest Annual Financial Advisor Tech Survey from Financial Planning magazine, one of the top independent surveys of advisor technology adoption trends. And the results show that a technology "renaissance" is underway for financial advisors, as more and more technology tools become available; while the survey found "only" 50% of advisors plan to increase their technology budgets last year (and almost 75% of advisors already spend 1% to 10% of revenues on technology and tech-related training), the rest plan to merely hold steady, and not one advisor of the 600+ surveyed indicated a plan to shrink their technology budget, as the tools become more and more essential. In addition, the Tech Survey affirms the trend of an emerging group of "eAdvisors" who are disproportionately heavy technology adopters, who are using everything from collaborative client portals powered by data aggregation to advisor CRM and its workflow-related functions. In terms of particular software categories: CRM leaders include Salesforce, Junxure, Redtail, Wealthbox, and ACT (although notably, "Microsoft Outlook" is still the #1 "CRM" even though it's not actually a CRM!); top financial planning software providers include MoneyGuidePro, eMoney Advisor, and Advicent's NaviPlan; the largest portfolio accounting solutions are PortfolioCenter, Morningstar Office, Advent, and Orion; in terms of digital advisor platforms to support interaction with clients (so-called "robo-advisor-for-advisors" platforms), top players included Wealth Access and Schwab's Institutional Intelligent Portfolios; with client portals, most advisors still "just" offer their broker-dealer or custodian's account access portal to clients, but services like eMoney Advisor, Morningstar, and Albridge are on the rise; rebalancing software continues to see rapid adoption, with Morningstar, tRx (now owned by Morningstar), iRebal, and Tamarac; and leading risk assessment tools include Riskalyze, FinaMetrica, and broker-dealer-provided tools (though a stunning 44% of advisors indicated they use no risk assessment software tools at all!). Notably, the results also showed that technology adoption, across virtually every category, is materially higher amongst younger advisors than more experienced ones, raising interesting questions about the competitive threat that younger advisors may pose as their firms grow built on the base of a more efficient technology stack.

Vanguard Whistleblower Could Get Billions in Tax Dodge Complaint (David Cay Johnston, Newsweek) - Momentum is building for former Vanguard tax-lawyer-turned-whistleblower David Danon, who two years ago filed formal complaints with the IRS and several state tax filing agencies claiming that Vanguard's low fees are a form of illegal tax dodge. The issue is that technically, Vanguard's mutual funds are owned by its investors, while "The Vanguard Group" is the investment manager that provides management services to the mutual funds; however, Vanguard (the investment company) is also owned by the Vanguard mutual funds, and as a result the investment company chooses not to (and has little incentive to) charge a going market rate for investment management to its underlying funds. Thus, Vanguard's mutual funds can price their costs lower than any other mutual fund competitor, because every other competitor works with an investment company that prices to make a profit (on which it must pay taxes). To manage this conflict of interest between related companies, the IRS normally requires that related businesses still assess costs to each other at market rates of return that would have been negotiated in an arms' length transaction; Danon alleges that Vanguard is failing to do so, and therefore is underpricing its services and avoiding taxes in the process. And tax authorities appear to be paying more attention now; just recently, Vanguard engaged in a multi-million-dollar settlement with Texas, but the estimates are that Vanguard could be on the hook for a whopping $750M to California, and a gargantuan $35B in taxes, interest, and penalties to the Federal government (for which Danon may be eligible for a 15%-30% whistleblower fee!). Building on top of the Texas precedent are a number of tax commentators also affirming that Danon's case looks valid. The long-term implication - Vanguard may be compelled to reprice its internal services, which would ultimately pass through to its investors, and could be material, as right now Vanguard's internal investment company pricing is barely 1/4th of the industry average. Alternatively, the question has also emerged as to whether Congress might get involved to actually carve out a clearer non-profit exemption for investment companies (for which Vanguard could become eligible), though notably competing mutual fund companies that struggle to compete with Vanguard's non-profit pricing would likely work to block any such legislation.

10 Ways to Maximize Social Security Benefits Under New Law (Emily Zulz, ThinkAdvisor) - With the recent changes to Social Security under the Bipartisan Budget Act of 2015, advisors and clients are still scrambling to get up to speed on the new strategies to maximize Social Security, particularly for the roughly 1.5 million baby boomers who only have about 5 more months to engage in a "file-and-suspend" claim and be grandfathered under the "old" rules. Key strategies include: Delaying benefits as long as possible (at least for one member of a couple) is still ideal for most; for single-earner couples, it may not be appealing for the earner to delay past full retirement age, as it may cause the couple to lose out on several years of spousal benefits; divorcees who were married at least 10 years, are still unmarried, and were born prior to 1954, will still file a restricted application for spousal benefits based on an ex-spouse at full retirement age, and switch back to their own full benefit (if higher) at age 70; it's still possible to do a voluntary suspension of benefits at full retirement age (even after the new effective date), for scenarios where someone has simply changed their mind and wants to stop benefits and earn the 8%/year delayed retirement credits; the new rules have no impact for widows (including divorcee widows), who can still choose independently when to start widow(er)'s benefits and when to start their own individual retirement benefits; and the new rules now create scenarios where it may be appealing (at least, mathematically!) for long-term married couples to voluntarily get divorced, so that each can claim a spousal benefit at full retirement age as an ex-spouse (which isn't possible when they're currently married, as one must file-and-get benefits for the other to claim spousal once the file-and-suspend rules are gone). Notably, this article contains the highlights of a full Social Security presentation that Kotlikoff did for the Financial Experts Network; the full version of the presentation handout materials can be viewed here.

Rule Changes on Money-Market Funds: What Investors Need to Know (Robert Powell, Wall Street Journal) - Effective October 14th of 2016, the SEC is putting in place new rules that will require certain money market funds to abandon their stable $1-a-share value, and allow some funds to temporarily suspend redemptions or impose liquidity fees on investors withdrawing assets during volatile periods. The distinctions for which rules apply to which money market funds is based on two defining characteristics: whether the money market fund is for institutional investors versus retail investors, and whether it invests in a wide range of short-term debt or exclusively in government debt. The safe harbor across the board is for money market funds that invest exclusively in government debt; in that case, the fund cannot suspend redemptions, cannot impose a redemption fee, and the NAV will remain fixed at $1. For money market funds that invest in other "prime" debt (high-quality short-term bonds), the fund's board of directors can impose a temporary halt on redemptions, and if the money market funds' weekly liquid assets falls below 30% of total assets it can also impose a redemption fee up to 2%. In addition, prime money market funds for institutional (but not retail) investors will be required to accept a floating NAV, which means the money market funds' share prices could deviate (though still not likely more than a penny or few) from a $1 NAV. Notably, money market funds within employer 401(k) plans will fall into the "institutional" category (even though it's ultimately owned by retail investors), and some experts suggest that 401(k) plans may soon begin to replace their money funds with stable-value funds, guaranteed investment contracts, certificates of deposit, or just outright offer a short-duration (and also-not-stable-NAV) bond fund. On the other hand, the reality is that for long-term investors who don't intend to move money in and out of their money market funds anyway - now or in times of market stress - the potential of a temporary halt on redemptions or a possible redemption fee is a moot point anyway.

Medicare Changes Coming Up (Mark Miller, Rep Magazine) - For the past several years, health care inflation has actually been negligible, but in 2015 health care inflation suddenly re-emerged, and is expected to continue in the coming years. In turn, the impact of inflation on actual health care costs for retirees is showing up in several areas, including: Medicare Part B premiums, which had been flat at $104.90 for the past 3 years, but are now projected to rise at 6%/year in the coming years (but for most, not until 2017 thanks to the so-called "Hold Harmless" provisions that limit Medicare premiums from rising when the Social Security COLA is 0%); a 16% spike in Medicare Part B premiums next year (in 2016) up to $120.70 (plus a $3/month surcharge for the next decade or so) for those not eligible for Hold Harmless next year (which includes those who delayed their Social Security benefits, and those who are impacted by the high-income Medicare premium surcharges); Medicare Part D prescription drug plans, which are projected for 8% premium increases in the coming years (driven mainly by rising use and cost of specialized drugs designed to fight catastrophic illnesses); new rules for the high-income Medicare bracket surcharges that kick in beginning in 2018, and will increase the premium surcharges for individuals earning between $133,000 and $214,000 (and couples earning $267,000 to $428,000); and beginning in 2020, supplemental Medigap plans will no longer cover the annual Medicare Part B deductible for new enrollees (intended to give seniors more "skin in the game" and make them most cost-conscious in utilizing services, though a recent new study questions whether people make better cost decisions about health care with higher deductibles or simply get less care).

Harness the Power of the Swap (Martin Shenkman, Financial Planning) - Clients adopt irrevocable trusts for a wide range of reasons, from lawsuit asset protection to various estate planning objectives. In most cases, these trusts are specifically structured to be outside of the grantor's estate for estate tax purposes, but are often designed to still be treated as a "grantor" trust for income tax purposes; while the "bad" news is that including trust income on the grantor's tax return triggers a bigger tax bill for the individual, the "good" news is that it's taxed at the grantor's income tax rates (which may be more appealing than trust tax rates), and furthermore than the grantor can actually pay the trust's income tax bill without having it treated as an additional gift to the trust (essentially turbo-charging the trust to grow its own assets free of any tax drag inside the trust itself). In practice, triggering grantor trust treatment was often accomplished by giving the settlor of the trust a "swap power" to substitute (or "swap") personal assets for trust assets of equal value (which does not trigger a tax event, as it's a 'transaction' between the grantor and the trust that is also treated as the grantor's for income tax purposes). However, while the swap power's primary purpose was simply to trigger grantor trust rules (to allow for the tax strategy of paying the trust's tax bills with outside dollars), swap powers actually offer another estate planning opportunity - to swap cash assets outside the trust for highly appreciated assets inside the trust, giving the grantor the opportunity to get highly appreciated assets into his/her own name before death to achieve a step-up in basis! While this is a moot point for younger and healthy clients, it can be an appealing opportunity for those who are older or in poor health - but only if advisors are watching for the availability of swap powers, and then get an attorney involved to handle the process properly (with the added complexity that loans or lines of credit may be necessary, as the settlor/grantor may not actually have sufficient cash available!).

Broker-Dealer Technology (Joel Bruckenstein, Financial Advisor) - In the rapidly-evolving space of technology for advisors, Bruckenstein reviews a number of the leading broker-dealers and their recent technology initiatives. Highlights include: Cambridge Investment Research launched its new "Retirement Center", intended to be a centralized and comprehensive resource for its advisors working in the qualified plan space, pulling in data feeds from 50 different record-keepers to monitor employer plan trends, search capabilities to find potential plans with which the advisor might do business, and a dashboard of current client retirement plans and supporting data analytics; Commonwealth Financial Network recently launched its own proprietary CRM solution (replacing a prior Microsoft Dynamics CRM that Commonwealth thought was "too slow, too clunky, and not integrated enough"), along with native mobile apps for its advisors, and is looking next year to launch a new streamlined account opening process (with a single master agreement for all account openings, rather than individual ones for each account) that can be done fully digitally; Lincoln Financial Network is working on its new "Advice Next" platform, built in partnership with Fidelity (one of its clearing firms) and intended for launch in the second half of 2016, with a focus on integration (to Salesforce, Redtail, and Ebix CRM systems), third-party marketing databases, and enhanced managed account platform capabilities (along with Lincoln's proprietary "Design It" financial planning application); LPL Financial has been focusing heavily on rebuilding its internal infrastructure over the past year behind the scenes, and is now beginning to roll out features of "ClientWorks", its integrated cloud solution for advisors (to replace the old BranchNet system) with a new interface, mobile-friendly design, dramatically enhanced trading capabilities (e.g., block trading across multiple accounts), upgraded rebalancing tools (from FolioDynamics), and a bidirectional data integration to Redtail CRM; and Wells Fargo Advisors is focusing primarily on upgrades to its user experience, including new usability/design changes to SmartStation (its integrated advisor workstation), and plans to roll out a new tablet-friendly supplement called SmartToGo.

Hire Help for Your RIA with Interns and Paraplanners (Alan Moore, XY Planning Network) - As a startup advisory firm grows, it eventually reaches one of the biggest "good problems" of growth: that there's no longer time to do everything that needs to be done. Classically, the challenge for advisors was that once at capacity, it was necessary to hire a usually-full-time staff member - a huge investment, as it "doubles" the size of the firm (from 1 to 2)! In today's environment, though, there are an increasing number of options to hire on a part-time basis, particularly for what is usually the most labor-intensive part of a financial planning firm - the "paraplanner" work of doing financial planning data input and plan construction and analysis. Thus, while many advisors do hire a full-time associate planner, the leading trend is actually to hire a "virtual" part-time paraplanner, which might be a company specialized in doing outsourced part-time paraplanner work, or even hire a younger/newer planner who has started their own firm but doesn't have enough clients to occupy all their time, such that they're looking for "side hustle" work to support another advisor's capacity. The benefit of the approach is that if the firm really "only" needs 5-10 hours/week of support, it's possible to hire for just 5-10 hours/week (at costs as "low" as $25-$35/hour for some), rather than hiring a full-time person with more hours than are needed, and have them sit around with nothing to do with the excess time. In addition, outsourced virtual paraplanners typically will need little-or-no training, as it's possible to get a more experienced person, or a company who is responsible for training (rather than the advisor themselves); at the same time, the introduction of an external provider may actually force - in a good way - the advisory firm to adopt more structure and process to what they do (though be certain to have a non-disclosure agreement in place to protect client privacy, along with ensuring client data is protected with appropriate anti-virus and firewall software). Moore notes that the opportunity for part-time support is also feasible with an intern (virtual or in-person). And if you're not sure of what to delegate to the paraplanner, try installing an app like RescueTime to help you track where you're spending your hours... and then see what you really shouldn't be doing yourself anymore!

RIAs and the Pricing Paradox (Angie Herbers, Investment Advisor) - As financial planning has grown from the small "Mom and Pop" shops of the 70s and 80s into growing bona fide businesses over the past 20 years, the landscape has become increasingly competitive for independent advisors, with large Wall Street firms increasingly adopting advisor-style business models (e.g., AUM), robo-advisors competing for retail business, and a growing flood of breakaway brokers going into the independent channels to compete head-to-head as well. Notably, Herbers suggests this isn't a bad thing in the long run... but it does mean that as investment management alone becomes a commodity and the focus shifts to financial planning and other services, advisors will have to get a lot better at differentiating themselves and articulating their value. And so far, it doesn't appear they're doing a good job at it yet, as Herbers notes that their data shows while retention remains good (top firms are losing just 2% of their client base per year), client referral rates are falling (from 36% down to 23% per year), and closing ratios on prospective new clients are falling as well (down from 70% to 50%). Herbers suggests these dynamics imply advisors are competing too aggressively on price, a battle they're losing for prospective/new clients (in part because they're priced "so low" they're undermining their own perceived value?), while at the same time causing an 'unnaturally' high retention rate that implies clients aren't being charged enough (as there should be some unhappy clients every year or the firm is underpriced!). So what's the alternative? Herbers suggests that just trying to add on new services ad hoc, or cut prices to compete, will only compound the problem. Instead, advisory firms need to take a step back and re-create the business with a clearer vision of what they truly want the firm to be - which is a tough transition since most advisory firms only indirectly evolved to where they are today (from selling tax shelters, annuities, insurance, mutual funds, etc.). Nonetheless, the basic points are relatively straightforward - the firm should be able to craft a simple and direct business plan, covering four key areas: whom will you service, what are the needs of that target client, what services do you really want to offer, and how will you meet them?

Old-Fashioned Exams (Diana Britton, Wealth Management) - For most advisors today, the FINRA Series 7 exam was/is the gateway to becoming a financial advisor, with a whopping 98% of advisors at national broker-dealer firms holding the license. Yet its 250 multiple-choice questions cover topics like account openings, order entry, delivery obligations and settlement procedures for trade execution, and the legal rules in seeking business for (i.e., trying to sell the products of) the broker-dealer... most of which has little relevance to the competency needs of today's financial advisors. Accordingly, questions are beginning to stir about whether it's time to revamp the Series 7 exam. Although significant debate exists about what the best course of action should be. Some - including yours truly - advocate in the article that the Series 7 sets the bar too low, and that it tests too little regarding competency to actually deliver personal financial advice; yet others raise the question of whether the 6-hour exam is too daunting, and may be inhibiting the industry's ability to attract new young talent, such that FINRA is now proposing a new "general knowledge" exam, similar in content to the Series 7 but shorter and less rigorous (and without requirement of a member firm to sponsor). And some note that the Series 7 has already evolved to some extent, with new material being added periodically (e.g., on today's limited partnership investments) to stay current. Still, it seems increasingly likely that the Series exams will be adapted in some manner, though in the meantime national brokerage firms are starting to add additional voluntary programs and certifications in place - Merrill Lynch, for instance, has a training track for new recruits that looks for people who either have CFP certification or will by the end of the program.

Mark Zuckerberg Tests New Philanthropic Model (Richard Rubin & Laura Saunders & Deepa Seetharaman, Wall Street Journal) - The big news this week was the announcement by Facebook CEO Mark Zuckerberg that he plans to give away about 99% of his Facebook fortune, or a whopping $45B, to advance social causes he and his wife Priscilla Chan want to support. Yet notably, unlike most other charitably-inclined large donors, the new "Chan Zuckerberg Initiative" will not be a private foundation; instead, the couple are creating a (for-profit) Limited Liability Company (LLC) which in turn will invest into the various initiatives they want to support. The effort highlights an emerging model of philanthropy beyond "just" grant-making foundations, into a fusion of corporate and philanthropic goals - which also allow the "charitable" endeavor more latitude in what the dollars go to support (and what public disclosure rules may be required, or not). In particular, the use of the LLC allows the new Chan Zuckerberg Initiative to invest into other for-profit companies (in addition to donating to other non-profit organizations), that also happen to be pursuing meaningful endeavors the couple wants to support. It also allows them more latitude to engage in public policy and advocacy debates. Of course, the caveat to the strategy from a tax perspective is that now, when the Facebook shares contributed to the LLC are sold, Zuckerberg and Chan will still have to pay capital gains taxes on the appreciation; on the other hand, given the sheer amount of dollars involved, the couple would have likely been severely limited on their charitable tax deduction benefits anyway (especially since Zuckerberg only takes a $1 salary and Facebook pays no dividends!), making the LLC structure even more appealing given greater flexibility and 'limited' foregone tax benefits anyway. In the meantime, the question now arises as to whether others who prioritize the flexibility of their philanthropic efforts over the tax benefits alone might adopt a similar strategy in the future.

The Real Value Of A Home (Jason Zweig, Wall Street Journal) - With the proportion of people who own a home at its lowest level in three decades, Americans aren't as interested in buying a home as they used to be, likely impacted by both the general preference of younger workers to rent in today's marketplace, and the scars of real estate losses after the 2008 financial crisis that have made "investing" in a home for appreciation purposes less appealing. Yet Zweig emphasizes that ultimately, it's the non-financial value of a home that matters most - a reflection he makes after helping to move his 87-year-old mother out of the house she's lived in for more than half a century. The family purchased the property (along with 96 surrounding acres) in 1961 for $13,000, nestled on a 20-acre lake, in a small hamlet with fewer than 100 people. Over the years, the house became a museum of the entire family, including pictures and memorabilia going back to the 1950s, and still contains memories of the family growing up over the span of more than 50 years. Ultimately, the property will no doubt be sold for more than it was originally purchased (though research by Shiller suggests that most houses in the long run appreciated by little more than just the rate of underlying inflation), but Zweig's fundamental point is that the real value of the home is that it helps to shape who we are and where we come from,

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!

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!