Weekend Reading for Financial Planners (Dec 7-8)

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.

Schwab Taps Former TD Ameritrade Leader Tom Bradley To Lead Smaller RIAs At Schwab (Bruce Kelly, Investment News) - One of the biggest points of angst in the advisor community since the announcement that Schwab would be acquiring TD Ameritrade is whether the future "Schwabitrade" would continue to support 'smaller' solo RIAs, in a world where a significant portion of TD Ameritrade's advisor base are firms that went there specifically because they had been previously rejected by Schwab for failing to meet the custodian's firm-AUM minimums. And so it's notable that today, Schwab announced that it is hiring Tom Bradley - who previously had a 12-year stint as the head of TD Ameritrade's RIA custody business, especially during its growth years in accepting a large number of below-Schwab's-minimums RIAs - to become the head of its new "Core" custodial support services specifically for RIAs with less than $100M of AUM. The move is being seen as both an acknowledgement of an ongoing strategic shift at Schwab to be more proactive in supporting smaller RIAs (underway since last year when Schwab found that 70% of the addressable RIA market consists of <$100M AUM firms, and that 90% of them are still eager to grow), and a strong message to TD Ameritrade advisors that Schwab intends not only to maintain smaller RIAs but to make them feel like they are 'coming home' to TD Ameritrade's own Tom Bradley (who was in charge of TDA's RIA business when many/most of those firms joined TDA in the first place). On the other hand, the reality is that Schwab already was willing to accept firms "under $100M of AUM", as firm-AUM minimums have more typically been in the $20M to $50M range, raising the question of whether Schwab still intends to support smaller RIAs 'all the way down' to startup RIAs with $0 of AUM. Still, though, Schwab is publicly maintaining that the new Core segment is for firms "up to $100M AUM" (with no stated minimum), and Bradley has experience scaling an RIA offering all the way down to new-firm startups (where TD Ameritrade was very active during the Tom Bradley years). The only question now is exactly what level of service Schwab will reasonably be able to staff for those Core firms after the Schwabitrade merger closes?

Galvin Posts Revised State Fiduciary Duty Proposal For Massachusetts (Mark Schoeff, Jr., Investment News) - Earlier this June, Massachusetts regulator Galvin issued a "Preliminary Solicitation of Public Comments" for a prospective fiduciary rule the state was considering whether to adopt, and now Massachusetts has announced it is proceeding forward to formally propose a new "Fiduciary Conduct Standard" rule for advisors and broker-dealers operating in the state. The core of the proposed rule remains the same as what Massachusetts floated earlier this summer - that advisors, whether working at a broker-dealer or an RIA, would be required to disclose material conflicts of interest, avoid conflicts, and "make recommendations and provide investment advice without regard to the financial or any other interest of any party other than the customer or client". However, the rule as proposed did soften the depth to which advisors must go to identify appropriate recommendations for clients, stipulating that it would be a fiduciary breach if a recommendation were made "in connection with any sales contest, implied or express quota requirement, or other special incentive program", but backing away from a requirement that the recommendation must be "the best of the reasonably available options for the customer or client". In issuing the state's fiduciary proposed rule, Galvin reinforced that the rule is necessary to protect Massachusetts investors because the SEC's own Regulation Best Interest is insufficient, even as the financial product manufacturers and distribution firms suggest that the state should defer to the SEC. In the meantime, Massachusetts indicated that public hearings will soon be held, ostensibly in preparation for a final rule to be issued sometime in 2020.

Proposal To Amend SEC Testimonial Rule To Greatly Expand Advisers' Advertising Efforts (Blaine Aikin, Investment News) - It was only just a year ago that the SEC announced a series of charges and settlements with several advisors and an advisor marketing consultant for violating the SEC's Testimonial Rule by using a service called "Squeaky Clean Reputation" to solicit testimonials from their clients and post them to platforms like Yelp (along with posting videos containing client testimonials on their website and on YouTube)... transgressions that were so far afield, they even violated the SEC's somewhat-more-relaxed guidance about social media and third-party advisor review sites from 2014. But just last month, the SEC decided to update the Testimonial rule, issuing a new proposal that would finally allow advisory firms to use client testimonials and reference their ratings and reviews from third-party platforms like Yelp. Notably, though, the SEC's core requirement of RIAs - to not engage in any form of false or misleading advertising - still reigns, and the SEC has stated that it still expects RIAs to adhere to those principles when using testimonials in the future. Of primary concern is that in permitting advisors to use testimonials or talk about their results, RIAs may do so 'selectively' and cherry-pick favorable investment strategies or certain clients over others; as a result, while testimonials themselves may be permitted going forward, there will still be significant scrutiny on how advisors selected and procured those testimonials, if they choose to promote them. Ultimately, the rule may still be amended before being finalized - as currently, the SEC has only issued a proposed version for public comment. But in recognizing that the rules haven't been substantively updated in nearly 50 years, and that testimonials, reviews, and ratings have become ubiquitous in the modern world of social media, it seems inevitable that some form of testimonials and advisor reviews/ratings will be permitted with a final rule in 2020. The only question is how expansive those rules will really be, and whether the potential consequences of running afoul end out being so concerning that advisors still eschew testimonials anyway?

Are Advisors Using Alts As Intended? (Bernice Napach, ThinkAdvisor) - Advisors most commonly cite using "alternatives" as a way to manage risk in client portfolios, with a recent Blackrock survey finding that 76% of advisors said they were using alts to reduce risk, and that at least one alternatives product was showing up in 30% of the models advisors are using (representing an average allocation of 8%). However, in analyzing the alts that advisors were actually using, almost half of the alt models being employed had a high correlation to stock market returns (effectively still maintaining market exposure instead of reducing it!). Notably, advisory firms were typically using alts that had a lower beta than the market... but with a still-high correlation, were more "modifiers" to traditional stock returns than real "diversifiers" (which ideally don't just have lower beta, but outright lower, zero, or even negative correlations). Of real concern, though, was that those low-beta "modifier" alts still had a material cost, such that client portfolios could have achieved a similar lower-beta risk reduction at far lower cost by simply holding an inexpensive broad-market ETF coupled with cash instead! Accordingly, Blackrock suggested that for advisors who are really seeking alts to diversify, it's better to look at market-neutral strategies (diversifiers) over options-based or long-short equity strategies (modifiers), and to be wary even of multi-alternatives strategies that , in practice, still have a fairly high average correlation of 0.61 to simply owning the S&P 500.

A Simple Five-Point Investment Framework Checklist (Mark Rzepczynski, Disciplined Systematic Global Macro Views) - With the ongoing shift of advisory firms towards using standardized (or marketplace-selected) model portfolios, it's becoming increasingly necessary for advisory firms to analyze and scrutinize not just individual investment products that may be available for client use, but specifically investment 'strategies' that a third-party has developed for them. Rzepczynski provides a straightforward checklist of how to think systematically through the due diligence process of evaluating such investment strategy solutions, broken into 5 core areas: 1) Strategy Design (can it be easily described to clients, are the underlying assumptions clear, is there a strong economic or structural rationale for why it should work, and can the manager explain not only the conditions where the strategy succeeds but also when it would be expected to fail?); 2) Expected Returns (what are the realistic expected returns, and given the volatility that may go along with those returns, is there a favorable [and stable and consistent] Sharpe ratio?); 3) Reliability (all strategies do better in some time periods than others, which is inevitable, so is it at least clear when the strategy would be most likely to do well and do poorly?); 4) Convexity (i.e., does the strategy go up at least as much as the market when the market goes up, and ideally go down less than the market when the market goes down... which may be hard to achieve; at a minimum, it's important to ensure the investment won't likely do the opposite!); and 5) Costs (which clearly matter, but notably should only be evaluated after the rest, as even a low-cost investment isn't worthwhile if it can't pass muster on the rest, and a high-cost strategy could still conceivably be worthwhile if it checks the rest of the boxes). And notably, given that some investment strategies can have lock-ups or other illiquidity provisions, be certain to consider the cost/benefit trade-off in the context of any illiquidity or "high cost of exit" that may apply if/when the strategy is no longer working!

How Can Advisors Retain More Clients? In A Word: Communication (Kristine McManus, Commonwealth) - A recent survey from Financial Advisor magazine found that the #1 reason why clients fire their advisors is the failure to communicate on a timely basis (and the #3 reason was failing to return phone calls promptly!), trumping even poor investment performance, failing to understand the client's goals and objectives, and failing to deliver as promised. And notably, most of the non-communication reasons listed are still, ultimately, communication issues (e.g., failing to set expectations properly, and failing to fully understand the client and what they wanted/needed in the first place). In fact, a similar 2017 study from Vanguard and Spectrem Group found that the top 5 reasons clients stay are: 1) returning phone calls promptly; 2) returning emails in a timely manner; 3) proactively contacting clients; 4) providing good service; and 5) portfolio performance. So what can advisory firms do to improve their client communication, and ideally on a standardized basis to reach and improve retention with all clients (and not just the more affluent clients we tend to stay in closer communication with anyway)? McManus suggests that the starting point is to set clear standards for communication expectations in the first place - in what time period will you commit to return a client's phone call or email, and do you want to have a different standard for more 'extreme' circumstances or volatile conditions compared to standard service needs? Once clear standards are set, have a plan to communicate them (in client meetings? on the advisor's website? in a Client Engagement Standards document?), so clients understand what to expect. From there, consider how to support one-to-many communications to clients, such as posts to social media, email newsletters, or via the firm's own website (e.g., with investment updates posted/sent to all when markets get volatile). And ideally, find ways to communicate about non-financial moments as well (e.g., birthdays, sympathy for an illness, sharing joy when there's something to celebrate, or just an unexpected call to say "hi"), as research from the book "Cultivating the Middle-Class Millionaire" found the most loyal clients were contacted in some way by the firm an average of twice per month (24x per year).

Year-End Charitable Investment Strategies (Christine Benz, Morningstar) - December is the season of year-end tax planning, for which one of the most popular strategies is to take advantage of the charitable deduction with year-end giving. However, the basic charitable tax deduction for simply writing a check to a charity is more limited than it once was, thanks to the higher standard deduction threshold introduced by the Tax Cuts and Jobs Act of 2017. Accordingly, other year-end charitable planning strategies take on relatively more importance and opportunity. For those over age 70 1/2, one appealing option is to engage in Qualified Charitable Distributions (QCDs), where the individual donates directly to charity from an IRA, for up to $100,000/year, which both does not have to be included in income (making it effectively a 100% pre-tax payment from a pre-tax IRA), and satisfies any remaining RMD obligation for the year (if not already distributed) to keep the RMD amount out of the retiree's Adjusted Gross Income (which could otherwise have adversely impacted other tax rules from the taxability of Social Security benefits to the IRMAA surcharges on Medicare Part B and Part D premiums). Of course, the caveat is that if the client isn't already charitably inclined, it's still better to take the RMD, pay the taxes, and keep what's left, so QCDs are still only relevant for those who want to give to charity in the first place. For those who are especially charitably inclined, though, it may be even better to donate (long-term) appreciated investments with very low basis, which both provide a full-value charitable tax deduction for whatever the shares are worth when donated, and allow the embedded capital gain to be fully avoided. For those who want to maximize their deductions in the current year, but don't necessarily want to give away so much to a particular charity all at once (e.g., a desire to offset a high-income year but make the actual donations over time), it's feasible to donate the appreciated investments (or even cash) to a Donor-Advised Fund (DAF) instead, front-loading the deduction and then making the charitable distributions out from the DAF to the desired charities over time (which can be especially helpful to ensure enough charitable deductions are lumped together in a single year to clear the standard deduction threshold in the first place).

IRS Ruling Could Alter Year-End RMD Check Timing (Melanie Waddell, ThinkAdvisor) - Earlier this year, the IRS issued Revenue Ruling 2019-19, which stated that distributions from a retirement plan are taxable in the year the distribution occurs and is "received"... which technically means an individual must only receive a distribution check for it to be taxable, even if the check is not cashed (at all, or in a timely manner). In a world where most people deposit their checks in a timely manner after receiving them, the distinction between when a distribution check is received and cashed makes no difference. However, when it comes to year-end RMDs, the timing issue is more relevant, as it means on the one hand that a check distributed in December but not cashed until January still counts as an RMD made in December... which ironically may be good news for those who receive but fail to cash their RMD checks in a timely manner. On the other hand, it also means that a received-in-2018-but-cashed-in-January-2019 check actually may not count towards this year's 2019 RMD, and so any distributions that were deposited early in the year should be verified to determine if they were actually distributed this year (or were in reality a distribution for last year). And notably, the distribution-vs-cashed timing issue isn't unique to just RMDs; it also means that if a check is sent in any circumstance (e.g., for a terminating employee from a 401(k) plan), receipt of the check but failure to cash it (e.g., because the individual was moving at the time) won't prevent that distribution from being taxable in the year distributed. So be certain not to lose those distribution checks and end out with a tax surprise! Ultimately, the ruling was specific to 401(k) employer retirement plans in particular, and not necessarily IRAs, though the IRS didn't limit the ruling to 'just' 401(k) plans either.

Buyer Beware: The Reality Of Tax-Loss Harvesting Benefits (Maneesh Shanbhag, Alpha Architect) - The traditional view of tax loss harvesting is that it's a highly valuable tax strategy to minimize tax exposure, as losses that are harvested can be immediately and fully offset against other capital gains recognized in the same year. The caveat, however, is that by harvesting a loss - selling at a lower-than-cost-basis price and buying back again after waiting out the wash sale period - also reduces the cost basis of the investment, effectively stepping the basis down to the re-purchased value, which increases capital gains exposure in the future by the same amount as the loss that was claimed today. Which means in practice, tax loss harvesting isn't really a tax savings strategy, but merely a tax deferral strategy that reduces capital gains today in exchange for higher (offsetting) capital gains in the future. And notably, because the value of tax loss harvesting is really only based on the tax deferral - and the ability to grow those tax-deferred dollars until the future - the value of tax loss harvesting is also contingent on the future growth rates themselves, with low-return environments further reducing the value of tax loss harvesting (to as much as 0.57%/year over a 10-year period at 10% returns but only 0.10%/yr at 4% returns). In addition, it's notable that by deferring capital gains taxes to the future, there's also a risk that tax rates will rise (especially given that capital gains are at all-time historical lows), which can actually turn tax loss harvesting from a positive to a negative. And of course, that's before considering the costs, including transaction costs (which even without trading commissions, may still include bid/ask spreads), and the risk of tracking error when buying a not-substantially-identical security (where the substitute investment during the wash sale period underperforms, or ends out generating a short-term capital gain that must be recognized at higher tax rates to switch back). As a result, in the end it turns out that the value of tax loss harvesting is limited at best, and in many decades historically was actually a net negative (even with "just" a 0.1% transaction cost).

Two Hours A Week Spent Outdoors In Nature Linked With Better Health (Adam Vaughan, New Scientist) - In a recent study of nearly 20,000 people in England who had reported how long they spent in natural environments in the past week, plus their health and well-being, researchers found that spending just 2 or more hours outdoors was associated with consistently higher levels of health and well-being (even after controlling for the health benefits that might otherwise be a byproduct of the physical activity that happened to be outdoors). And notably, the research suggested that those 2 hours didn't even need to be spent all at once outdoors, and could be spread out across the week as well. The study adds to a growing base of research finding health benefits to spending time outdoors in nature, though this was one of the first to specifically try to quantify how many hours outdoors it takes, finding that 2+ hours was enough, and that there were diminishing returns beyond that point (with no more benefit after 5+ hours outdoors). Overall, the health benefits were akin to the differences between living in a well-off area versus a deprived one, and appeared to apply to everyone, regardless of age, gender, long-term illness, or existing disability (i.e., even just sitting on a bench was sufficient, no need to run around outside for the benefit!).

Want To Live Longer? Surround Yourself With Plants (Mark Wilson, Fast Company) - In a mega-study of more than 8 million people (!) across seven countries, a recent study conducted in collaboration with the World Health Organization and published in Lancet Planet Health (that itself was a meta-study of 9 separate longitudinal studies over long periods of time) found that "when you are exposed to greenery or greenness around your home, your probability to die... is less compared to those with less green-ness around their home", and specifically that for every 10% increase in vegetation within 1,600 feet of the home, the probability of death drops by 4%. Notably, the green space could be grass, trees, or gardens, public or private, and held up in every country measured. Scientists are still trying to determine why access to greenery matters, but some research  has already found that just looking at plants is known to lower stress (decreasing damaging cortisol in our blood), and that touching plants may impact the microbiome on our skin and strengthen our immune system (not to mention the improved air quality as trees pump out fresh oxygen). For urban planners, the results suggest a need to increase public green space, but ideally mean that anyone may get some of the improvements, just by bringing more plants into their home or office (though technically indoor plant life wasn't studied, but the researchers are confident the positive impact would still be present).

Why Being Kind Makes You Healthier (Chrystle Fiedler, Next Avenue) - Recent research from the book "The Five Side Effects Of Kindness" finds that being kind to another person, even just in a small way, appears not only to help others but to be good for our own health, slowing the body's aging process by reducing free radicals and inflammation through the release of oxytocin. In addition, oxytocin triggers the release of nitric oxide, which dilates blood vessels and reduces blood pressure (protecting the heart). And other research finds a link between compassion and activity of the vagus nerve, which regulates heart rate and controls inflammation levels. In fact, one study found that even just meditating on compassionate thoughts towards yourself and others (even people you dislike!) stimulates the parasympathetic nervous system and elevates the levels of dopamine (the feel-good hormone), resulting in increased positive feelings, well-being, and social connections. Furthermore, spreading kindness also tends to give us a stronger sense of purpose, leading to an improvement in our own self-care habits. And kindness itself has a contagious effect as well - when we're kind, we're more likely to inspire others to be kind as well - which helps positivity further ripple forward positively in society. So for those who want to start a kindness habit, consider either making a list of people in your life who you feel need help or assistance, be alert to opportunities throughout the day to be kind, think of five people in your life and why you are grateful for their presence, or try the seven-day kindness challenge. Or, alternatively, just keep being a great financial planner who serves their clients well!? 🙂

I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of 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 as well.