Weekend Reading for Financial Planners (Feb 14-15)

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 February 14th/15th:

Boston Firm Buys Orion Advisor Services As Part Of NorthStar Succession Deal (Brooke Southall, RIABiz) - Continuing the theme of last week's major announcements of advisor FinTech acquisitions, the big news this week was private equity firm TA Associates acquiring a majority stake in popular portfolio accounting and reporting software platform Orion Advisor Services, as a part of an overall purchase by TA of Orion's parent company NorthStar Financial. With the Orion acquisition, coupled with last week's $2.7B purchase of Advent (which itself had previously bought Black Diamond), all five of the major RIA portfolio accounting technology solutions have now been acquired (the others are Tamarac being acquired by Envestnet, PortfolioCenter's Performance Technologies being acquired by Charles Schwab, and Morningstar Office buying DBCams). Notably, the company's current leadership - Eric and Todd Clarke - are still expected to run the business, and the sale may have been done in part to facilitate a liquidity event after the unfortunate death of their father (and NorthStar co-chairman) in a plane crash in 2012 and a desire of co-chairman Michael Miola to step down to pursue other duties. Notably, the TA Associates acquisition of NorthStar is also believed to have been driven heavily by its Gemini Fund Services division, which facilitates the creation and operation of pooled (e.g., mutual and ETF) funds, including in the increasingly popular channel of alternative investment products. While the terms of the deal were not announced, NorthStar administers a whopping $275B of AUM on its various platforms (up from $2.5B in 2000!), and has approximately 700 employees.

Schwab Spills Robo-Beans To Wall Street (Lisa Shidler, RIABiz) - On a recent 4-hour update with Wall Street analysts, Charles Schwab recently revealed significant new details about its soon-to-be-launched "robo-advisor" platform, Schwab Intelligent Portfolios, including that it ultimately anticipates accumulating a whopping $400B of assets on the platform by building on its existing size and scale. And notably, while many have accused Schwab of simply using its new robo platform as an opportunity to sell its own OneSource ETFs (for which it has revenue-sharing agreements), Schwab executive Walt Bettinger noted that at this point only one Schwab OneSource ETF has actually made the cut, and pointed out that as a standalone RIA the new robo platform will still have to satisfy all the usual RIA rules regarding objective criteria to select funds. Yet while Schwab maintains the objectivity of its platform, its leaders also noted that the anticipated success will be based in part on its proprietary Schwab Bank and Schwab OneSource platforms, leaving the question open of just how independent the offering will really be. In the meantime, Schwab also defended that its offering will not cannibalize its business with advisors, pointing out that its RIAs provide a wider array of services than "just" the portfolio management, and that while 53% of existing clients who have asked about the online RIA have more than $200,000 invested (the segment most commonly served by advisors), only 16% are currently in an advisory relationship (who might leave to use the new robo platform instead). In addition, Schwab reiterated that the robo solution will also be available for its RIAs, and that in fact many have expressed interest in using the platform to offer services to clients they have typically had to turn away in the past.

Strategizing Like a Statesman (Eliza De Pardo & Dan Inveen, Investment Advisor) - While there's little about politics to be admired, De Pardo and Inveen make the case that there's much advisory firms could learn about the strategic visioning and especially the disciplined execution of a political campaign. For instance, just as with any business, a political strategist must carefully evaluate competitors, anticipate changes, plan for contingencies, and identify and accentuate the positive attributes to differentiate from the competitors. Yet when it comes to advisory firms, most appear to focus primary on current growth factors (revenue, assets, clients) and financial milestones, but less with the "leading" indicators of long-term business health like client retention and satisfaction, efficiency, and staff growth and retention. In fact, overall the authors note that advisory firms seem to spend far more time planning than actually executing on the plans; accordingly, while 85% of all advisory firms in the latest 2014 FA Insight Study have strategic plans (94% of firms with over $4M) a whopping 61% also stated that those plans lack the necessary detail to actually implement them effectively. Similarly, while a whopping 69% of firms indicate that business development is becoming a key issue for future growth, just 13% of firms reported their marketing plan to be effective (and half do not have a marketing plan at all). On the other hand, though, the FA Insight study shows that strategic planning does appear to pay off; the firms that had the greatest ability to convert their plans into action (including implementation details in their strategic plan, better buy-in from team members, etc.) had median revenue growth that was 4% higher than the rest of the firms studied.

A Matter of Perspective (Angie Herbers, Investment Advisor) - As small businesses, advisory firms live and die by the actions of their owners. But Herbers makes the case that the driver of whether firm owners execute successfully is not simply their knowledge, expertise, or even "people skills" but the perspective they bring to the table, which in turn colors how they think through the decisions they make about everything from the business to their staff, clients, and even themselves. The good news, though, is that it is possible to think better and gain better perspective; in fact, the opportunity to gain new insights and perspective is exactly why many advisors hire practice management consultants (like Herbers) for their services in the first place. From the consultants perspective, then, Herbers shares what she sees as the most common thinking mistakes made by owner-advisors, including: putting too much pressure on yourself (trying to do too much, too fast, can drive yourself [and your team] to high anxiety and exhaustion]); acting rashly (making decisions too fast, leading to bad decisions, and then more pressure to reverse course and fix those mistakes, so create a "36-hour" rule that no major decision will be made in less than a day and a half, to give yourself time for the clarity you need); shooting from the hip (in addition to making hasty decisions, many advisors don't think out their decisions sufficiently in advance, leading to even more wasted time); all-or-nothing thinking (if an initiative isn't working, don't try to go back to square one to fix it, just figure out how to tweak and adjust it from here!); being too rigid (it's good to have clear values and use your experience and knowledge, but it's crucial to be open change and not overly attached to the ways things have been done in the past); and refusing to accept mistakes (your first impression isn't always right and your first idea isn't always good, so if it becomes clear there's a problem with a prior action, be ready to admit the mistake, correct it, and move on).

Nine Key Communication Points For Advisors (Harold Evensky & Robert Huebscher, Advisor Perspectives) - This article summarizes a recent presentation delivered by Harold Evensky at the recent AICPA Personal Financial Planning conference, which focuses on how advisors can better communicate with clients and prospects, the media, and their peers. The starting point is to make sure you can effectively articulate the "what" of your practice, and talk about the advisory firm's philosophy, its process, and its people, including critical elements like how the firm invests, its compensation methods with clients, and its credentials and capabilities. Next, focus on how you articulate the value of what you provide to clients - is it beating the markets, or something else? Once you've covered the "what" and its value, you also need to think about the "who" - who are the prospects you're trying to reach, and when you talk to them do you ask them why they reached out to you to understand what their key drivers may be? Recognize as well that the behavioral finance research, which shows all the ways clients act irrationally around investing, can impact their decisions about whether to work with you as well, so plan accordingly in how you communicate, and realize that how information is presented and framed can impact the client's decision. Beyond communicating to prospective clients, Evensky also gave tips on communicating with the media, from reading publications clients read to be aware of what's in the news cycle, to being available for reporters when they call (often with tight deadlines), to being willing to actually have an opinion (reporters don't want bland platitudes!), and recognize that sometimes you'll be a resource on background but not actually quoted (but that's still good for building a relationship with the media in the long run).

Cutting-Edge Estate Planning Strategies for Effective Wealth Transfer (Philip Herzberg, Journal of Financial Planning) - In today's environment, most Americans will not face a Federal estate tax, given an exemption of $5.43M and portability between spouses. For those who do have a net worth high enough to have some exposure to the estate tax, some current strategies, especially appealing in today's low interest rate environment, include: Using Grantor-Retained Annuity Trusts (GRATs) to transfer the future appreciation on large assets to heirs without any gift tax exposure (the implied "gift" is reduced to nearly zero by retaining income payments from the GRAT, but given low interest rates any appreciation above the Section 7520 interest rate assumption can accrue to heirs tax-free as long as the grantor survives the term); using a Charitable Lead Annuity Trust (CLAT), where the charitable receives income for a term and (family or other heir) beneficiaries receive the remainder, is also appealing in the low interest rate environment as the low discount rate leads to a more favorable charitable deduction (but watch out for GST tax issues); intra-family loans are also appealing at low interest rates (using the Applicable Federal Rate [AFR]), though be certain that the loans are properly documented, legitimately structured, and actually paid back (and to the extent the children use the money for something that appreciations at more than the AFR, additional family wealth accrues to the next generation without gift or estate taxes); another loan-based strategy for property that will appreciate at more than today's low interest rates is the sale of property to an Intentionally Defective Grantor Trust (IDGT), where property is sold without any current income tax consequences (as a transaction between the grantor and the grantor's trust) but future appreciation (above the interest rate assumption) is shifted out of the grantor's estate; for those who want to leave assets for multiple generations of the future, the use of a Dynasty Trust designed to last in perpetuity while making discretionary distributions to future descendents as needed may be appealing, as a number of states now allow such long-lasting trusts. Herzberg also notes that asset protection considerations should also be incorporated into the estate plan.

Long-Term Care Insurance: Comparisons for Determining the Best Options for Clients (Finefrock & Gradisher & Nitz, Journal of Financial Planning) - As the need for long-term care grows (with an estimated 8.36M people needing some take of LTC service annually), and the costs continue to rise (at an average annual cost of $43,472 for adult day care services to $87,600 for a nursing home), the breadth of potential long-term care insurance solutions to fund it has also increased, including both "traditional" LTC coverage, hybrid products, and more. And which type of coverage/solution is best depends in turn on the client situation, including their need for coverage, desire for flexibility in coverage (ability to choose varying years of coverage, elimination periods, etc.), certainty of coverage (both in terms of premium pricing, and whether the insurer will be around to pay benefits when the time comes), client liquidity needs and investment goals, potential underwriting complications, and more. In fact, even comparing the costs is difficult, as some require lump sum contributions, while others have ongoing premiums, though notable the authors find that once discounting is applied over reasonable time horizons, traditional long-term care insurance actually requires the least capital to fund (by such a margin that it would lead even with some potential rate increases!). Ultimately, the article provides detail in each of these categories on how to assess the pros and cons of various types of coverage, including a summary graphic at the end scoring the relative value of each type of coverage in the various categories.

'Life Expectancy' Calculators Not Helpful (Robert Powell, Marketwatch) - Most prospective retirees aren't very good at estimating their own life expectancy. Commonly cited life expectancy in the media is based on the life expectancy at birth, which doesn't reflect how much longer a retiree is expected to live given that he/she has already survived infant mortality, childhood diseases, and decades of potential accidents. And estimating life expectancy based on family history can understate how much longer a retiree may live, given that what killed prior generations is often curable (or at least treatable) today. Yet in turn, while it has become more popular to use personalized life expectancy calculators to estimate how long a retirement might last (given these issues with general life expectancy), Powell has found that the publicly available life expectancy calculators vary tremendously; a test of four found that his life expectancy was either 79, 82 1/2, 83, or 92, depending on which was used, which is too wide of a range for effective planning. Of course, the caveat is  that not all life expectancy calculators are equal in the first place; there are a wide range of mortality tables used (and notably, some mortality tables may not accurately reflect the typical clients of financial planners), some take into account more factors than others (does it ask about gender? smoking status? family history? lifestyle issues?), and it's important to verify whether you're looking at a single or joint life expectancy to appropriately match it to the client situation. And of course, there's always the question of whether the software developer implemented the life expectancy calculator correctly! So what's the alternative? The article suggests that instead of just trying to determine an individual personalized life expectancy, the better approach is to pick a target probability survival rate - for instance, at what age do you have a 25% change of still being alive, or 5%, or 1%, as a means to manage the risk. Although ironically, this is arguably what many advisors already do today simply by assuming that clients will live to age 95 or 100 in the first place!

Introducing The Retirement Wealth And Affordability Indices (Wade Pfau, Advisor Perspectives) - To help clients better assess where they stand for retirement, researcher Wade Pfau has developed two new metrics he calls the "Retirement Wealth Index" and the "Retirement Affordability Index". The Retirement Wealth Index examines how effective the traditional approach of saving 15% of one's salary for 30 years would actually be for a retiree today, given the historical sequence of returns a prospective retiree has actually experienced up until now; using historical data for the S&P 500, 10-year Treasury bonds, and an asset allocation that glides down from 90% at age 35 to 50% by age 65, Pfau finds that retirees would end out accumulating anywhere between 5.9 and 18.4 times their final salary in retirement savings. For today's retirees, the strategy would have accumulated about 10.7X final salary (suggesting that today's retirees have had what is historically not a very good sequence of returns during their accumulation years!). In turn, the Retirement Affordability Index assess how effective this salary multiplier value would be at actually sustaining retirement from here, given market conditions (i.e., interest rates and stock market valuations) at the beginning of retirement. To calculate this, Pfau determines what an annuity would pay assuming a real long-term interest rate equal to the real return implied in current long-term TIPS; at today's numbers, this would only allow today's retiree to safely replace 38.9% of their pre-retirement salary (it was as high as 105.2% just 15 years ago), given the 10.7X final salary accumulation from the Retirement Wealth Index. Going forward, Pfau will be maintaining a dashboard of the Retirement Wealth and Affordability Indices on his updated Retirement Researcher blog for those who want to use it as a reference about how "good" or "bad" of a time it is to be a retiree.

What Got You Here Won’t Get You There (Ric Edelman, Financial Advisor) - As both the world changes and an advisory firm grows and evolves, Edelman makes the case that whatever you've done to build your practice will not be sufficient to maintain it from here, and certainly not to get the firm to the next level. For those who have been in practice for a long time, this is evident in how most advisors' careers have already evolved over the past few decades; "advisors" were originally just order-taking clerks who simply sold whatever clients wanted (stocks, bonds, annuities, etc.), and only later did they evolve to the approach of actually trying to persuade and "sell" people what they actually need to improve their own lives. But over time, being an advisor shifts from just finding clients to offer solutions, to bringing on new clients and serving existing ones, which requires a different focus and skillset. Eventually, the landscape shifts again, as the advisor hits a capacity limit, and you need to hire staff to support growth from there (and then learn to manage them). Overlaying these evolving growth stages of advisory firms is the fact that the environment in which we practice is changing as well. With the speed of computer power continuing to double roughly every 24 months, the estimates are that by the late 2020s we may reach the "singularity" - a point where software intelligence will be indistinguishable from biological intelligence (i.e., human beings) - and even between now and then, the disruption potential is significant, as crowdfunding sites threaten investment banks, virtual currencies threaten the profits of credit card companies and banks, and robo-advisors threaten to commoditize as least some of what advisors currently do. Other parts of the changing environment that may require advisors to change include the fact that clients are far more educated and experienced than in the past, the environment is becoming increasingly competitive (and clients are more capable of finding and checking out those competitors thanks to the internet!), and the ongoing burden of regulation threatens to impact advisors as well. Ultimately, Edelman's conclusion for these challenges is somewhat negative - he predicts that advisory firms with 100 clients and $100M won't survive, and that advisors will have to try to grow much larger, join (or create with several partners) a $1B+ firm with enough scale to survive, or throw in the towel - and while some might disagree, the point remains that the world of running an advisory firm in the future is probably going to look quite different than it has in the past.

In a World of Self-Driving Vehicles, Car Ownership Would Plunge (Brad Tuttle, Money) - Continuing the theme of how the world may dramatically change in the future, the University of Michigan Transportation Research Institute recently released a study making the case that if Google and others are successful in rolling out self-driving cars in the next decade, it could dramatically reduce how many cars most households need. The key change is that while the average household currently owns 2.1 cars, due to the fact that several members of the household may be out at the same time, most households actually have very little "trip overlap" where the household is actually driving two cars at the same time (and it's estimated that only 42% of households actually "need" two cars in the first place). The reason this matters is that, with a self-driving car, the vehicle can not only take someone from one place to another (e.g., from home to work), but the car can also automatically return home for the next passenger (e.g., taking one spouse to work, then returning home and taking the kids to school, then returning home again to take the other spouse to work, etc.). While this wouldn't work for all households, the study estimates that widespread adoption could drop the number of cars per household from 2.1 to 1.2 on average (and the number of 3-car households would drop from 26.5% to less than 2%). While the ramifications of these kinds of transportation changes are significant for the automotive industry, it also has significant ramifications for financial planning decisions, as it may impact where people live, their need for homes with two-car garages, and their budget for purchasing new cars (or not!) in the decades to come!

It’s All About The Numerators (Dick Wagner, Financial Advisor) - The fundamental challenge of financial planning is that while we can run projections and scenarios, the law of large numbers does not apply one client at a time, and ultimately there's far more uncertainty in most clients' lives (from changes in health and acts of nature, to volatile business cycles and more) than the spreadsheets and graphs would predict. And while clients may find some sense of certainty and predictability in those numbers as a roadmap, "the map is not the territory" and the real world doesn't always conform perfectly. That doesn't mean it's better to eschew the analysis altogether - Wagner notes that number crunching does help us understand relevant issues with greater clarity than no analysis at all - but it's still crucial to keep the uncertainty in perspective. The situation is further complicated by the fact that this "age of money" we live in - around which all of our financial projections revolve - is itself a relatively new post-World-War-II phenomenon, and before that (in a more agriculturally-driven world) your "financial plan" was basically your family, your farm, and your community. As people migrated to urban areas, work was done in more centralized locations, and money facilitated all the transactions necessary to make that happen, money and its accumulation (and decumulation) took on a role never before seen in society. Accordingly, Wagner makes the case that while we may do a lot of analysis around the common "denominator" of money and the force it has in our lives today, its relatively newfound role in our society means we need to pay more attention to the client (the "numerator") and their relationship with money and how to live with it and use it properly.

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.