Weekend Reading for Financial Planners (Dec 6-7)

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 6th/7th:

Tech Survey 2015: What's New Now? (Joel Bruckenstein, Financial Planning) - The annual technology survey from Financial Planning magazine has become one of the industry's most robust for evaluating advisor trends in technology utilization, and this year's survey shows a number of interesting new trends underway, with a pace of change that appears to be accelerating after years of advisor slow-adoption in technology. For instance, while FinaMetrica has been the only widely used third-party risk tolerance tool used by advisors for years (albeit with only a 13.8% market share), recent entrant Riskalyze is already up to 13.3%, and the even newer platform PocketRisk is already being used by 6% of advisors. The technology that was rated for the greatest ROI amongst most advisors was, not surprisingly, financial planning software itself, with MoneyGuidePro dominating advisor adoption at 36%, followed by eMoney Advisor at 18.6%, MoneyTree at 11.3%, NaviPro (which includes NaviPlan and Financial Profiles) at 9.8%, SunGuard at 7.6%, FinanceLogix at 3.4%, and WealthTec at 2.7% (with those still using their own homegrown spreadsheets down to just an estimated 5% or so). The next big ROI technology category was CRM, in a marketplace that is still very fragmented; the top two players, RedTail CRM and Salesforce, have only a 13.1% share each (with Redtail skewing towards dual-registered RIAs and smaller independent RIAs, while Salesforce is more widely adopted amongst larger RIAs and independent B/Ds), although Junxure is also a strong contender amongst independent RIAs. Notably, though, the biggest category for "CRM" software remains Outlook, which is down to about 20% of advisors, but still suggests ample room for more advisors to adopt real CRM tools. In the portfolio management category, almost 75% of advisors are using some technology, but the tools vary widely, with more than 20 competing products, along the leaders are Morningstar Office, Albridge, Advent's various products, and Schwab PortfolioCenter, with Orion Advisor Services as the fastest mover (up from 1.9% to 5.4% market share in just the past year). Other notable survey results: Windows 7 remains the dominant operating system, with Windows 8 a close second, but a concerning 12.4% of advisors still using (no-longer-supported) Windows XP, and the share of advisors using Apple actually declined slightly to 11% (from 14.6% last year); 66% of advisors use a tablet for business purposes, with most using an iPad, and Android tablets losing ground to (but still ahead of) Microsoft Surface tablets; 88% of advisors use smartphones, with about 2/3rds of use on an iPhone and most of the rest using Android; adoption of rebalancing software continues to rise, crossing the 50% threshold for the first time this year (and up sharply from 39.4% in 2013); and the top platforms for advisor satisfaction with technology included TD Ameritrade and then Schwab amongst custodians, and Metlife Securities (which oddly had the most highly satisfied and the most highly unsatisfied!) and Commonwealth Financial for broker-dealers.

After Betterment Deal, Fidelity Teams With LearnVest (Charles Paikert, Financial Planning) - Following on the heels of its announcement of a partnership with Betterment Institutional, this week Fidelity announced a second "robo" partnership, this time with digital-plus-humans financial planning platform LearnVest. Under the terms of the agreement, advisors who custody with Fidelity will have free access to LearnVest's online "financial wellness" content, and receive preferred pricing for clients who want to engage with LearnVest's digital financial planning program (i.e., refer "small" clients to LearnVest financial planners). The second Fidelity partnership is a notable contrast to the "robo" strategies of the other custodians; TD Ameritrade has opted for partnership agreements that will simply integrate external providers to their own Veo open access technology platform, while Charles Schwab announced that they are building their own platform, Schwab Intelligent Portfolios, from scratch with a debut scheduled for early 2015. Notably, though, a related article about the announcement quoted Fidelity Institutional president Michael Durbin as saying that Fidelity may ultimately "serve up these capabilities more natively" (i.e., build their own platform) in the future, suggesting that Fidelity may simply be using these partnerships as a testing ground to gain clarity on what exactly they might develop on their own down the road.

The Future Of Financial Planning - An Interview With Alex Murguia Of Instream (Raef Lee, SEI Practically Speaking Blog) - SEI is working on a white paper entitled "The Next Wage of Financial Planning", and as a part of their research, interviewed InStream financial planning software CEO Alex Murguia about how financial planning is changing. Some interesting highlights of the interview include: investment strategies and solutions have been effectively standardized, by the trend is just beginning in financial planning, though ultimately it will lead to "dashboards" where advisors can easily see and monitor how all of their clients are doing and which may need attention (just as can be done now with portfolios); innovation in financial planning software has been stuck for years but is starting to move again (e.g., planning tools are still cash-flow or goals-focused for retirement, yet don't integrate and illustrate widely adopted implementation strategies like "bucketing" or modeling safe withdrawal rates); clients need a portal for their software, but it's not clear which companies will drive those portals, so software vendors are migrating towards "widgetizing" their tools so they can be viewed via integration to any platform; financial planning software has been typically used as a giant calculator, but increasingly is shifting to become a tool used more dynamically and interactively/collaboratively; TurboTax democratized tax reporting but didn't eliminate CPAs, and the trend is likely similar with today's "robo-advisors", where some parts of the (investment) process may be commoditized, but that won't eliminate advisors, it will simply force them to evolve.

How An Under-The-Radar UHNW Performance Reporting Firm Is Taking On Addepar And Advent In A Bid For RIA Bucks (Lisa Shidler, RIABiz) - Although relatively unknown in the RIA marketplace, portfolio reporting and accounting software WealthTouch monitors a whopping $200B of wealth for just 300 ultra-high-net-worth clients, and was recently sold to another technology firm (Archway Technology Partners) that is aiming to invest into the platform in an attempt to bring it "downstream" to the wider mass of RIAs (a similar approach to another ultra-HNW reporting platform, Addepar, which WealthTouch sees as their primary competition). The acquisition is intended to broaden WealthTouch's scope, so that it's not just a high-end supplement for ultra-HNW clients while an RIA also uses a platform like Advent for the rest of their clients; WealthTouch hopes to make themselves a single point solution across the board. Notably, though, WealthTouch still intends to be primarily focused on its core ultra-HNW marketplace, where it has clients with at least $30M and an average account balance of $230M, while also expanding and 'simplifying' their complex solution for clients as "low" as $5M.

How An Annuity Is Like A Hedge Fund (Bob Seawright, Research Magazine) - The big news in the institutional investment world this fall was the decision by Calpers, the massive (and influential) California public employee pension agency, to discontinue the use of hedge funds in its portfolio, given poor returns for many, and the challenges even amongst those with decent returns regarding their complexity, cost, and their lack of scalability (at Calpers' size). The cost, in particular, appears to be the biggest culprit of hedge fund woes, and according to one book their infamous "two and 20" (a 2% AUM fee plus 20% of earnings) has led the asset-weighted returns of hedge funds to be less than half that of U.S. Treasury bills! Of course, many hedge fund supporters will point out that the whole point of "hedge" fund is that they are hedging and managing risk, and aren't necessarily designed to outperform traditional investments head-to-head; in other words, the point (at least in the early years) was not better nominal returns (which can be done by simply buying stocks with leverage), but superior risk-adjusted returns. However, the risk-adjusted return promise hasn't held up well in recent years either; institutional leader Yale lost 24.6% in its hedge funds in fiscal year 2009 (compared to a 26% decline in the S&P 500 over the same time period), and the hedge fund returns were highly correlated to traditional equities throughout the crisis, rather than being the hedge they were intended. Seawright notes that in reality, some large institutions probably don't even need such "hedging" vehicles anyway, given the long-term nature of their portfolios, and in the context of individual retirees - who perhaps do need some short-term hedging to manage sequence of return risk - might be better served by edging the longevity risk that can be effectively hedged (with an annuity), rather than trying to hedge the portfolio itself with a hedge fund whose cost can't be justified by the results.

Maximizing The Retirement Paycheck (Michael Finke, Research Magazine) - Maximizing retirement income is about making good choices with available resources, though unfortunately many retirees do not, often overwhelmed by the sheer complexity of the rules and decisions that lay before them. Yet as Finke points out, some decisions really do have a clear "bias" that favors one strategy over another; for instance, the mere fact that a client can afford a financial planner - which implies something about their assets/income/net worth - actually means that the client should probably be delaying Social Security past age 62, for the simple reason that there is a significant (and growing) longevity gap between the top half of income earners and the bottom half. For instance, in 1912 the top earning half of workers lived about a year longer than the bottom half, for workers born in 1937 (today's 67 year olds) the gap had widened to a 5-year difference in life expectancy, and current annuity company mortality tables reflect a 43% chance that one spouse of a 65-year-old married couple will live to age 95 (while it's only a 20% chance according to Social Security mortality tables); this means those who have more wealth have a materially longer life expectancy than the averages implied in the Social Security mortality tables, leading to a natural bias in favor of delaying Social Security to age 70 (unless specific individual health circumstances dictate otherwise). Beyond maximizing Social Security, Finke notes that the next decision is to consider whether or how much to annuitize. Just as with delaying Social Security, the decision to annuitize also has a natural "bias" in favor of clients who fear living past their life expectancy and not having enough money to afford the long retirement; because annuitization "pools" longevity risk, its payouts are based on spending down money over average life expectancy (and those who live longer still receive ongoing payments thanks to mortality credits), while an individual trying to avoid outliving money has to assume an artificially long time horizon and then may end out being restricted from spending very much due to that extremely long assumed time horizon. Even for those who don't want to annuitize, Finke suggests that getting a quote for a lifetime single premium inflation-adjusting annuity can still help for setting expectations and evaluating tradeoffs, which right now will pay about $3,000/month for every million dollars of premiums at age 65. The retiree who wants to spend more than this would at least need to acknowledge the potential spending, inflation, or market risk that must be embraced as a trade-off to pursue a higher spending amount.

Why The Risk-Reduction Benefits of Bond Ladders Have Been Overstated (Joe Tomlinson, Advisor Perspectives) - The concept of a bond ladder is relatively straightforward - to match (individuals) bonds with specific maturities to the timing of future cash flow obligations that can be satisfied by the maturing bond payments. The structure is popular with institutions as a way to invest towards specific liabilities (e.g., required cash flows from a pension fund to its retirees), has been explored in the concept of individuals planning for retirement (who also have specifically timed cash flow needs), and simply as a "rolling ladder" vehicle to manage interest rate risk by having a series of bonds to be held until maturity and then reinvested (to alleviate any potential "risk" of needing to liquidate while the price is down after an interest rate increase). However, Tomlinson points out that these strategies can still be problematic. For instance, as an individual retirement income strategy, a bond ladder can secure payments for each year of retirement, but given the uncertainty about the time horizon of retirement, it's difficult to effectively construct an appropriate bond ladder - and if the ladder is made "conservative enough" (e.g., by securing laddered TIPS payments all the way to age 100, which few clients have any danger of materially outliving), the payments are significantly lower than just buying an immediate annuity. In the case of a rolling ladder, Tomlinson points out that technically, if the maturing bonds are just going to be reinvested to maintain the same duration, then it may not be necessary as an alternative to a bond fund at all, as a fund with a specifically targeted duration could (and likely would?) effectively implement the exact same strategy anyway. Yes, if interest rates changed, the mutual fund (with its own rolling bond ladder) would experience a price decline in its NAV, but it would still be the same short-term price change as owning the individual bonds, and if the mutual fund has the same duration as the (retirement) cash flows it must ultimately satisfy, the client actually is still immunized (as the present value of the cash flow obligation will change in price by the exact same amount as the bond mutual fund itself). In fact, in this context, Tomlinson's biggest caveat to using bond funds is that if the bond fund is more "tactical", it may shift its duration and holdings in a manner that doesn't simply replicate a laddered bond strategy, and it's only at that point that the investor is truly at "risk" that the portfolio and cash flow needs may truly become disjointed.

One Weird Trick To Shore Up Social Security's Finances (Matthew Yglesias, Vox) - A recent NBER paper is studying a new policy option to help shore up Social Security: whether people would be willing to delay claiming Social Security benefits in exchange for receiving a (moderate) lump sum payment when their benefits ultimately begin. The idea is that instead of giving people a higher monthly benefit for delaying (as the system currently works now), those who delay would have the option of receiving the same payment at a later date but an (actuarially fair) lump sum payment alongside it - for instance, the retiree with a $1,000/month benefit could delay four years to boost the benefit to $1,320/month, or wait four years and get the same $1,000/month along with a lump sum check for $10s of thousands of dollars (the actuarial equivalent of the extra $320/month for life). Notably, the strategy is not intended directly to save Social Security funds in the payouts themselves - since they would be actuarially fair - but some survey research has suggested that such a lump-sum-option program would convince people to keep working longer and delay retirement by an average of 6-8 months. Such a shift in working habits, population-wide, would increase the overall size of the economy, and put more wages on the table to be subject to Social Security taxation, which itself would improve the tax inflows into the Social Security system, reducing the need for liquidations from the Social Security Trust Fund and further extending its life.

A Comparison Of Retirement Strategies And Financial Planner Value (Terrance Martin & Michael Finke, Journal of Financial Planning) - This research study drew on data from the 2004 and 2008 administrations of the National Longitudinal Survey of Youth (which began in 1979, and now consistents of participants who are in their late 40s and early 50s) to evaluate the intersection of retirement savings and the use of financial planners. Amongst the overall data set, about 70% of the households had not even evaluated where they stood for retirement, nor did they use an advisor; amongst the remaining 30%, there were 13% who were deemed "self-directed" (they had evaluated their retirement needs on their own), 11% who used a comprehensive planner (had an advisor who helped them to evaluate their retirement needs), and 6% who used a (not-comprehensive) advisor (an advisor who had not done any retirement needs analysis for the client). When segmented in this manner, the households that used a comprehensive planner had significantly more income, net worth, and retirement assets, than the other groups (and notably, the self-directed had more retirement wealth than the non-comprehensive planner group!), and a historical trend analysis found that going back to the early 1990s, the comprehensive planning group had consistently been growing their retirement wealth faster than the others. Of course, there's a possibility that the results may simply be an artifact of the fact that certain groups - e.g., those with more income, education, etc. - may be both more likely to accumulate wealth and use a comprehensive planner; however, a subsequent analysis controlling for socioeconomic status still found that those who used a comprehensive financial planner had significantly higher retirement wealth accumulation (and also higher than simply preparing a self-directed retirement strategy).

Tony Robbins Prohibits Reporters From Covering His Two-Hour MarketCounsel Speech (Brooke Southall, RIABiz) - The advisory industry has been abuzz for the past 3 weeks, ever since it was announced that Tony Robbins was going to keynote the upcoming MarketCounsel Summit conference, in conjunction with the launch of his new "Money: Master The Game" book and his entrance into the advisory world as a newly self-proclaimed "voice of independent advisors" and the fiduciary cause. Yet now, just days before the MarketCounsel conference kicks off, it has been announced that the public will not be allowed to know anything Robbins says in his formal speech at MarketCounsel, that reporters will not be allowed to cover and write about the session (though they will be allowed to listen to it), and furthermore that it will be more "generic" in nature and won't actually be all that specifically tailored to RIAs (despite MarketCounsel being an RIA-centric event). Conference organizer and MarketCounsel chief executive Brian Hamburger defends the decision by noting that high-profile professional speakers like Robbins often have clauses of this nature in their contracts, and that Hamburger's first priority was to ensure the best content for attendees (and that how it affects anyone other than attendees is of secondary consideration). Yet given that Robbins has also been proclaiming himself the new voice of the independent advisor, the decision to make his debut 2-hour keynote appearance to RIAs entirely off the record has a lot of people scratching their heads and raising an eyebrow of concern.

Clash Of The Titans: Bionic Advisors vs Robo-Advisors (Joe Duran, Investment News) - More than $100M of venture capital flowed into "robo-advisor" platforms in just the third quarter of 2014 (after similar stunning rounds of venture capital in the second quarter), all seemingly built around the premise that technology can help individuals get educated, act rationally, and do the right thing, all by themselves. Yet Duran suggests that none of the robo-advisor platforms as currently designed are really a serious threat to the core business of successful advisors, because - regardless of the industry - people need human help whenever there is significant complexity, and/or when the cost of being wrong is too high, both of which are present in the realm of planning for our financial futures. That doesn't mean robo-solutions will be useless or ineffective, but simply that they will only thrive in tackling the subset of problems that are less complex and have a lower cost of error - the parts of the financial picture that really are commoditized. For instance, in the travel industry, the reality is that booking a hotel room or airline is relatively easy to do and being wrong doesn't have huge financial consequences, so sure enough travel agents were extremely disrupted (except in high-end markets where there is more cost and complexity). On the other hand, in the real estate market, the disruption has been slower, as websites like Trulia and Zillow are fine at giving an estimate of a home's value, but a real estate agent is still important because the cost of being wrong about the purchase of a house is so huge. In realms like law and accounting, the marketplace has segmented, with "simpler" needs that can be solved by platforms like LegalZoom (or Turbo Tax), but professionals still involved in businesses and higher net worth scenarios where the complexity rises and the cost of being wrong grows. Ultimately, Duran suggests that the technology coming in from robo-advisors will have an impact on the shape of the advisor landscape, but that in the end the winners will be the "bionic" (or as I call them, "cyborg") advisors who blend together human judgment and empathy with technology that leverages their skills, and that robo platforms will either have to stay simple, hire humans and morph into bionic platforms, or pivot into a B-to-B channel where they provide their technology to other advisors to make them bionic instead.

The Agony And The Ecstasy (Michael Cembalest, J.P. Morgan) - This article takes a fascinating look at the risks and rewards for those who hold highly concentrated positions in individual stocks. On the one hand, a number of entrepreneurs and business founders have created extraordinary wealth by creating/investing/owning a concentrated position in a single stock; on the other hand, an analysis of the universe of Russell 3000 companies since 1980 reveals that a whopping 40% of all individual stocks have suffered a "permanent impairment" decline of 70%+ from their peak value (especially in the sectors of Technology, Biotech, and Metals & Mining), and the (relative) return of the median stock since its inception vs the broader Russell 3000 index was -54%, with 2/3rds of all stocks underperforming the index (and for 40% of all stocks, their absolute returns were negative). The driving theme throughout is the simple recognition that in a capitalist world, there is a "steady drumbeat of creative destruction" - such that a whopping 320 stocks have been deleted from the S&P 500 since 1980 due to either an outright failure, a substantial decline in market value that led to removal (as the stock no longer fit the top-500 criterion), or an acquisition that followed such a decline before the stock could be deleted anyway. Notwithstanding all these caveats, the study does point out that there is a subset of (concentrated) stock positions that do materially outperform as well; in addition to the carnage of individual stock failures, there are also a surprising number of "golden swans" with a whopping 7% of companies that generated lifetime excess returns more than 2 standard deviations. Yet even with the extraordinary winners, the study finds that after considering the associated single stock volatility as well, in only about 6% of cases that it truly optimal to own a 100% concentrated stock position, and in the majority of cases it made sense to own no more than 30% of the concentrated stock (and often none of it at all) and just hold the more diversified index instead.

I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!

In the meantime, if you're interested in more news and information regarding advisor technology I'd highly recommend checking out "Bill Winterberg's "FPPad" blog on technology for advisors.