Weekend Reading for Financial Planners (Feb 20-21)

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.

DoL Greenlights New Fiduciary Rule But Leaves Door Open To Changes (Andrew Welsch, Financial Planning) - This week, the Department of Labor officially confirmed that it will not halt the pending overhaul of its fiduciary rule that will, for the first time, allow brokers providing advice on retirement plan rollovers to receive commission compensation for their advice (and for their firms to engage in principal transactions) as long as the advice was otherwise determined to be in the best interests of the client under the DoL's new "Impartial Conduct Standards". The new DoL fiduciary rule was created to align the Department of Labor's ERISA fiduciary rules with the SEC's recently updated Regulation Best Interest, but was widely criticized by fiduciary advocates for 'watering down' the relatively stringent ERISA fiduciary standard to Reg BI's intentionally not-fiduciary approach to regulating advice from brokers. Nonetheless, given that the rule had already been finalized and was simply pending its effective date and publication in the Federal Register, the DoL decided that the industry had already made enough updates to their systems to accommodate the new rule that it would be unduly costly to unwind it now. That being said, the Department of Labor's new leadership under the Biden administration did note that it may still "improve" the exemption allowing such conflicted compensation for ERISA fiduciary advice and establish other "related exemptions", raising questions of whether the DoL may still seek to tamp down on the scope of commissions and other conflicted compensation amongst ERISA fiduciaries in the future.

New DoL Prohibited Transaction Exemption May Impact RIAs Advising On IRA Rollovers (RIA In A Box) - One of the most controversial aspects of the 2015 Department of Labor fiduciary rule was that it expanded the DoL's scope of oversight beyond "just" ERISA retirement plans and into the realm of IRA rollovers as well. When the DoL fiduciary rule was vacated by the courts in 2017, though, the standards reverted back to the prior fiduciary framework that was solely focused on employer retirement plans. With the newly updated Department of Labor fiduciary rule, though, the DoL's regulatory purview is once again being expanded to cover IRA rollovers, which means it will impact not just those providing advice directly into 401(k) and other ERISA employer retirement plans, but also brokers and RIAs advising on IRA rollovers. Specifically, the new rule states that brokers and RIAs may still provide "general investment education" regarding rollovers without additional rules, but in situations where investment advice is provided and the advisor will be compensated for that advice, advisors will need to meet the new Impartial Conduct Standards obligations. In practice, most of the Impartial Conduct Standards will not be difficult for RIAs to meet, as the core requirements - a best interest standard, earning (just) reasonable compensation, and a requirement to make no misleading statements - are already akin to the fiduciary obligation that RIAs have under the Investment Advisers Act. However, the Impartial Conduct Standards also include additional disclosure requirements, including a fiduciary acknowledgment, description of services and conflicts of interest, and specific reasons for the rollover recommendation, an obligation for firms to establish written policies and procedures to ensure compliance with those rules (and mitigate any associated conflicts of interest), and a requirement to maintain the associated documentation and records (for a period of six years). Fortunately, though, while the new rules technically just took effect on February 16th, the DoL's recent Field Assistance Bulletin 2018-02 stipulates that the DoL will not pursue enforcement against firms otherwise working "diligently and in good faith to comply" until December 20th of 2021, providing approximately 10 more months for advisory firms to update their policies and procedures as necessary.

Pulse Of The [Large RIA] Advisory Industry At The Start Of 2021 (Philip Palaveev, Ensemble Practice) - In a survey of 73 mid-to-large-sized-RIAs (averaging $1.65B in AUM), Palaveev highlights a number of recent trends on how the coronavirus really did (and did not) impact advisory firms over the past year. Overall, the results show that growth was remarkably strong for advisors in 2020, despite the market volatility, with large RIAs ($1B+ of AUM) averaging 13.4% growth, mid-sized firms ($500M to $1B of AUM) averaging 18.7%, and "small" firms (defined here as <$500M of AUM) averaging 20.7% growth. Of course, that rise was driven in large part by the recovery of markets themselves (with the S&P 500 up nearly 16.3% in 2020), but Palaveev finds that when drilling down to growth in clients, large RIAs grew their client headcount by an average of 3.4%, mid-sized firms grew by 7.3%, and small firms added an average of 3.8% to their client count (though notably, overall client 'churn' was up from a long-term average of 2.9% to 4.0% in 2020, signaling that volatile markets did at least take a slight toll on advisory firms' retention rates... albeit with only a slight downtick of 1.1% in client retention). In turn, the net growth of most advisory firms also meant that most didn't have to engage in any layoffs either, with the average firm still increasing its headcount in 2020, and hiring plans looking even more ambitious in 2021 (with the average firm projecting to increase its staff headcount by 9.9% in the coming year, to meet the service needs of a targeted average growth rate of 8.5%). Other priorities for the coming year include a focus on improving processes and efficiency amongst mid-to-large-sized firms, a focused push to add new clients and assets amongst smaller firms, and a focus in small-to-mid-sized firms to spend more time on training and development of their people.

How To Build An Online Brand Using Social Media (Samuel Deane, Morningstar) - As social media has exploded in consumer popularity, it has increasingly attracted financial advisors as a potential channel to market to prospects. The appeal of using social media for marketing purposes is that not only is it densely populated with opportunities - given the sheer number of people who regularly log into and use such platforms - but the remarkably low cost that it takes for advisors to market themselves on such platforms, where prospect reach does not necessarily require paying advertising dollars, but simply sharing content that makes others want to follow, read, watch, share, and connect. That being said, when there is so little cost to create a social media account and start to market oneself, the low bar quickly makes social media platforms a crowded space, which makes it especially important to be different as a way to stand out from the crowd. Which means first and foremost having a clear understanding of the advisory firm's target niche or ideal client in order to figure out what would stand out and connect with that audience in particular. In turn, getting clear on the who first - the ideal client profile - also helps answer the question of "which platform" in a sea of choices, including Twitter, LinkedIn, YouTube, Facebook, Instagram, TikTok, and more; the answer, simply put, is to go wherever your target audience is as a financial advisor. When it comes to what to post, the topics should be determined by what's relevant to that ideal client, but the type of content - e.g., a blog post or newsletter, a picture or a video or a podcast, etc. - is best determined by the advisor's own communication preferences, as the reality is that "any" type of content can work, so in the end, it's crucial to produce something that is comfortable for the advisor to produce (while still staying on topic for the target clientele audience). At its core, though, the 'secret' to social media really just comes down to leading with education as a means to build awareness, engaging on the social media platform as a way to create connections and relationships, and then allow time to compound the opportunities that come as the (ideal client) audience builds.

Viral Or Vicious? Financial Advice Blows Up On TikTok (Nicole Casperson, Investment News) - One of the hottest new social media platforms is TikTok, which makes it easier for participants to post short-form (e.g., 60-second) videos... and in recent months, TikTok videos tagged to #PersonalFinance, in particular, are flourishing, having garnered more than 3.5 billion views amongst the more-than-1 billion monthly active TikTok users (as compared to "just" 2.6B for #CookingTips and 2.1B views for #HealthTips). Of course, the caveat is that not all TikTok personal finance videos are from financial advisors - or people necessarily in the "advice" business at all - and some of the biggest personal finance followings on TikTok are built around those promoting their own strategies and solutions (e.g., one user who shared a video with 64,000 followers on how to use Robinhood to invest in speculative options to make money), or social media 'influencers' trying to promote certain companies. In fact, TikTok has specifically expanded its tools built to support content creators entering into brand partnerships, sponsorships, and representation deals for those who have at least 10,000 followers and at least 10,000 video views in the past 30 days. Nonetheless, with TikTok becoming such a popular channel, especially amongst next-generation consumers (and potential clients of advisors), some financial advisors are finding traction on TikTok, such as now-former Merrill Lynch advisor (turned 'full-time' social media influencer) Humphrey Yang who produced a viral TikTok video where he scaled a pile of rice where each grain was meant to represent $100,000 of Amazon CEO Jeff Bezos' net worth, and popular social media and blogging financial advisor Josh Brown has also noted he is now focusing more on TikTok (and YouTube) for social media (and less on Twitter, despite having 1M of his own followers there). Notably, though, because of the more short-form video approach to TikTok, it is arguably best served to teach small finite financial concepts (that can both teach and educate), not necessarily to directly promote an advisor's services (or teach more complex subjects).

Instagram Reigns... For Now (Nicole Casperson, Investment News) - While #PersonalFinance is booming on TikTok, the more photo-centric Instagram is also becoming increasingly popular as a social media platform for financial advisors to build a following and share content to highlight their expertise (and attract prospective clients). The appeal of Instagram is that it has been especially popular amongst those in their 30s and 40s - otherwise known as those in the focused accumulator stage of building wealth, or "good long-term clients" - and some advisors are, in fact, finding that Instagram followers really do reach out to initiate an advisory relationship. For instance, advisor Brittney Castro now has nearly 16,000 followers on Instagram, and reports that nearly 90% of her new clients are coming from her Instagram account, where she posts at least 5 times per week, and also hosts Instagram "stories" (a series of 10-second video clips that disappear 24 hours after publishing) that are mapped out in advance as part of a broader social media marketing strategy. Other advisors building successful followings include Jacqueline Shadeck (@JacquelinePlans), who has 7,400 Instagram followers and is averaging 12 new client consultations per month from her followers, who then 'refer' her by showing and reposting her Instagram content with their own friends and family. Notably, though, one of the particular appeals of social media platforms like Instagram (and TikTok) is that it's not just about posting 'professional' content to educate prospects, but also humanizing the advisor by sharing tidbits of their personal life and story as well.

Optimizing Fixed Annuity Tax Deferral (Aaron Brask, Advisor Perspectives) - Over the past 20 years, deferred annuities have increasingly been used for their various retirement income guarantees, particularly in the context of variable and indexed annuities. Historically, though, one of the primary selling points of annuities was their tax deferral, and when it comes to "old-fashioned" fixed annuities, tax deferral remains a significant planning opportunity. After all, for growth-oriented annuities (e.g., variable annuities), tax deferral comes at a 'cost' of converting what might have been long-term capital gains (at favorable tax rates) into ordinary income (as withdrawals from variable annuities are taxed), but when it comes to fixed annuities in particular - where the most common alternative would simply be another fixed income investment like a bond - the reality is that growth in the form of income yield will be taxed as ordinary income either way, which means there's little downside to trying to shelter that growth from current and ongoing taxation. Accordingly, even if a fixed annuity merely offers the same yield as a bond, it can still generate a better long-term after-tax compounded return by avoiding the impact of tax drag along the way (where a yield of 2.5% compounded for years and taxed once at the end is still better than being taxed every year along the way and 'only' compounding at 2% instead). Of course, the caveat is that for retirees taking withdrawals - when annuities automatically distribute their taxable income/growth first - the benefits of tax deferral are more limited, though Brask notes that the exclusion ratio treatment of annuitizing (even if only for a fixed time period and not taking the risk of 'lifetime' payments) still implicitly provides some tax deferral by levelizing the taxable income distributions given how the exclusion ratio for taxable immediate annuity payments is calculated. The end result is that Brask finds combinations of fixed and deferred income annuities, thanks to the tax deferral benefits, can reduce aggregate taxes by as much as 12% relative to standard fixed-income investments (for an investor facing a 25% marginal tax rate).

Why Single-Pay LTC Insurance Might Be The Right Strategy Now (Tom Riekse, LTCI Partners) - One of the biggest challenges for those buying long-term care insurance over the past 20 years is that sometimes policyowners get a notice, years or even a decade or two later, that their LTC insurance policy is going through a (potentially significant) premium increase. And while the frequency of premium increases has declined in recent years (if only because the upfront cost of LTC insurance has gone up enough that there's less risk of needing a subsequent premium increase in the future), many prospective LTC insurance buyers (and the advisors recommending such policies) are still wary about the risk of premium increases. Yet in practice, one of the most straightforward ways to ameliorate the risk of a future premium increase is simply to purchase a single premium long-term care insurance policy, which by definition is "paid up" at the very first payment and therefore cannot face an increase in ongoing future premiums (because there aren't any future premiums to be increased!). Unfortunately, because of the struggles of many long-term care insurers to maintain premiums, few single-premium LTC insurance policies are available today, but Riekse notes that National Guardian Life still offers a traditional single premium LTC insurance policy, and several major insurers (including OneAmerica, Nationwide, Lincoln, Securian, Pacific Life, and Brighthouse) offer life-plus-LTC-insurance hybrid policies with a single premium structure. Of course, the upfront cost of LTC insurance itself is significant - often $100,000 or more all at once - but for those who may have otherwise spent $5k+ every year on traditional LTC insurance premiums for 30+ years anyway, a single premium policy can still be a "good deal" on a time value of money basis... especially given forecasts of low returns (given low yields and high market valuations), or as a means to park the no-longer-necessary cash-value life insurance policy that can be 1035 exchanged without incurring any taxes on the policy's historical gains.

The Future Of Social Security (Joel Greenblatt, Advisor Perspectives) - When it comes to saving and investing, financial advisors know (and try to teach their clients) about the benefits of starting early and allowing the power of growth compounding to work in our favor. Of course, the reality is that when it comes to the US, we've had a lot of difficulty being able to save, with nearly half of all working-age families having zero retirement savings, and one recent study finding nearly 40% of Americans couldn't even meet a $400 emergency expense without borrowing or selling something. Yet in countries like Australia, the state of retirement is far better, with nearly $2 trillion of retirement savings in their "superannuation" fund (which adjusted for popularity would be the equivalent of nearly $30 trillion of savings for Americans!)... which, notably, has come about by a requirement that Australian employers are required to contribute 9.5% of their income into a superannuation fund chosen by the employee (which then goes into private investments from stocks to bonds to real estate and more). And for those for whom the superannuation fund still isn't enough, Australia has a supplemental Age Pension program provided by the government. Notably, the Australian structure is roughly akin to the US system of IRAs and employer retirement accounts (as a superannuation fund) and Social Security (as the age pension), except that in the US the savings accounts (IRAs and 401(k)s) are voluntary, and in practice is resulting in far less savings. Which in turn has led some to suggest that the US should implement a more 'forced savings' approach akin to Australia, and/or turn Social Security allocations themselves into a privatized account that can be invested. Except that, as most financial advisors have witnessed firsthand, a lot of investors don't do a very good job of managing their own savings and investments (especially in long-term but volatile growth investments like stocks). So what's the alternative? Greenblatt suggests that one approach is to increase the Social Security wage base (and associated cap on Social Security taxes) and allocate the excess to a mandatory private retirement account that favors those at the lowest income levels, allowing for more savings to supplement but without undermining the core Social Security benefit (though with growth such accounts might eventually supplant Social Security over the span of decades). Another alternative would be a form of surtax on high-income savers who would be permitted to contribute more than the current $19,500 contribution limit to 401(k) plans, but the additional tax would be used to supplant lower-income savers. At its core, though, the basic point is simply about whether and how America can adopt a system that makes it easier (or automatic, or even mandatory) to start saving for compounding growth at an earlier age (e.g., as soon as we start working and earning income)... but without leaving the average person to their own when it comes to (potentially mis-)investing their retirement funds, and/or undermining the current foundation that Social Security already provides?

The High Price Of Mistrust (Shane Parrish, Farnam Street) - In his popular book "Bowling Alone", political scientist Robert Putnam explores how Americans en masse have withdrawn from public life in recent decades, becoming increasingly disconnected from their wider communities (as evidenced by declining membership in everything from bowling leagues to PTAs), and the underlying societal mistrust that emerges when we lose those community social connections. Because social connections themselves create a form of "social capital", where the connections we have to one another help us find help when need it, identify teammates to solve problems, discover new opportunities, and, in particular, help shape our careers and professional development. Which means that a decline in social capital can actually cause an outright increase in the other types of capital it takes to function; for instance, the young family that no longer has any connection to its neighbors, and as a result might have in the past asked the neighbor to watch their kids for a few hours (with an implied social reciprocity that sometime you will return the favor with a bit of your own free time), but now must hire (and pay outright for) a babysitter to do so instead. In essence, then, expectations of reciprocity, and the trust they engender, can 'lubricate' social life and connections and real-world commerce and activities, while mistrust can, in turn, result in rising transaction costs (from the need to hire the babysitter instead of relying on the neighbor for a favor, to increased legal costs to put everything into contracts because we no longer have basic trust in business transactions that aren't bound by such contracts). In the context of financial advisors, in particular, high mistrust increases the challenges of getting new clients (who don't trust the financial services industry), which in turn increases client acquisition costs, the average cost of a financial plan, and limits the ability of financial advisors to serve the masses. So what's the alternative? Simply put, to trust more. Which starts by immersing oneself into the social community and (re-)making those connections. Because the reality is that we have to give trust to earn trust.

Don't Name Your Robo-Advisor: Why We Trust Humans More For Complex Tasks (Joachim Klement, Klement On Investing) - With the rise of FinTech and various forms of "robo" advice, from chatbots to digital avatars, it is becoming increasingly common to try to 'humanize' such tools by giving them human names that make it feel and sound like we're interacting with a "real" person (even if we're really and knowingly not). But a fascinating recent study by Frank Hodge, Kim Mendoza, and Roshan Sinha finds that humanizing our technology isn't always positive. As the researchers found that when a human financial advisor shares his/her name, we're more likely to trust the person (we are, after all, "social animals" who like to connect with other humans, and sharing names is the most basic form of establishing a level of relationship intimacy). But when a robo-advisor was "named" (in this case, "Charles"), consumers were actually less likely to trust the advice of the robo-advisor! In digging deeper, the researchers discovered that the key issue was the perceived complexity of the task; when facing a relatively "simple" task (e.g., rebalancing a portfolio), consumers were more likely to follow the advice of the named robo-advisor and implement. But when the task was more complex, faith that the robo-advisor was up to the task decreased, and naming the robo-advisor seemed to just accentuate how not-human the relationship really was, reflecting a strong preference for complex tasks to be done by actual humans (and not a humanized robot). Which means that while the rise of "robos" may increasingly facilitate the automation of "simple" tasks, consumers still appear to have a strong preference to get the most complex advice specifically from a fellow human (and not just a human-sounding robot).

The Mystery Of Trust (Amanda Ripley, Comment) - In recent decades, consumer confidence surveys have consistently shown a decreasing level of trust and confidence in a wide range of our public institutions and their leaders, from banks to churches to Congress to the media to big business... except when it comes to the military, the one large institution that Americans now trust more than they did 30 years ago (and has not wavered at any point along the way). Which raises an interesting question of why the military has managed to create and maintain such trustworthiness, especially amidst a secular decline in virtually every other type of institutional trust. At its core, the research shows that trust traces back to three core ingredients: ability (do they know what they're doing), benevolence (do they have our interests at heart), and integrity (does the institution have strong admirable values to which it adheres, even and especially under pressure). Yet ironically, most Americans are actually less connected to the military than ever before, where in 1950 nearly 1 in every 3 men in the US had served, but today it's only about 1-in-8 men (and 1-in-100 women), and there are twice as many truck drivers as there are active-duty armed forces. So what else has changed? As Ripley notes, the military effectively became more trustworthy, both cleaning itself up (e.g., the use of illegal drugs amongst the military fell from more than 25% to under 3% from 1980 to 1998), becoming more representative (as women went from 2% of enlisted and 8% of officers to 16% and 19%, respectively, while blacks went from 2% of commissioned officers to 9%), implemented a more meritocratic approach to promotions and success, and implemented its own version of the 3 trust ingredients (framed as the three Cs of Competence, Commitment, and Character). In addition, the Department of Defense Reorganization Act of 1986 further weaved together the various segments of the armed forces, which at the time was highly controversial, but today results in an even more integrated military institution. Which in turn reduced the number of high-profile errors and mistakes the military was making, allowing it to better keep its trust and not break and undermine it (as so many other institutions have done in recent years).

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, and Craig Iskowitz's "Wealth Management Today" blog as well.