Weekend Reading for Financial Planners (Feb 5-6)

Smaller Firms May Not Be Ready For DOL Fiduciary Rule Now In Force

(Mark Schoeff | Investment News)

On February 1, the Department of Labor began enforcing its new fiduciary rule. In a nutshell, the rule allows, for the first time, for broker-dealers to receive commission compensation for giving clients advice involving retirement plans governed by ERISA (e.g., 401(k) plans and IRAs), as long as the broker-dealer otherwise acts in the client’s best interest when giving that advice (akin to the SEC’s Regulation Best Interest approach). The establishment of the new rule is the culmination of a long journey for the DOL fiduciary standard, which was first formally proposed in 2016 under the Obama administration in a more stringent fiduciary approach (where commission-based conflicts of interest had to be avoided altogether), but encountered numerous delays under the Trump administration, and was ultimately vacated by the Fifth Circuit Court of Appeals in 2018, before being resurrected and adopted in its current more conflicts-permissive form in December 2020 (while numerous pandemic-related delays pushed back its enforcement date for over a year).

With all the changes and delays to the rule, it is possible that some firms – in particular, smaller firms with limited resources to dedicate to compliance – may not be fully aware of their new requirements. For example, because DOL’s rule is similar in scope to the SEC’s Regulation Best Interest rule, which began enforcement on June 30, 2020, some firms may simply assume that complying with Regulation Best Interest will keep them compliant with DOL’s rule as well. However, DOL’s rule contains other requirements that the SEC’s rule lacks, like declaring the advisor’s fiduciary status in writing, and providing clients with the rationale for making recommendations to roll over retirement accounts (which applies even for advisors who don’t work directly with 401(k) plans, but do counsel clients to engage in rollovers from 401(k) plans to an IRA that the advisor may manage) – meaning even firms that have updated their compliance policies and procedures to comply with Regulation Best Interest may yet find themselves out of compliance with DOL.

Nevertheless, despite the challenges of complying with the DOL’s fiduciary rule, its enforcement is now part of the new reality for both RIAs and broker-dealers who give investment advice. Because, after years of wrangling over competing philosophies between those who believe financial advisors should be fiduciaries at all times, and those who believe that a fiduciary obligation would be too disruptive and costly for product salespeople, the compromise made by the SEC and DOL – that broker-dealers don’t have to eliminate their commission-based sales structures, but that brokers themselves must act in their clients’ best interests at least in the moment when they are giving financial advice – has resulted in a middle ground with few clear boundaries on the limits of fiduciary duty but many requirements for proving that the duty was met. Which ultimately still leaves the burden on clients to understand what type of advisor or broker they are working with, what that person is getting paid for, and when their advisor or broker is (or is not) expected to act in the client’s best interest.

Private Equity Influence On Wealth Management Is Big And Getting Bigger

(Jeff Benjamin | InvestmentNews)

It would be an understatement to say that the past few years have seen a surge in RIA Mergers & Acquisitions (M&A) activity. The industry has seen eight consecutive years of record transactions, and in 2021 the number of deals had exceeded 2020’s record total by the end of the third quarter (and nearly doubled that total by the end of the year). And according to Echelon Partners, an investment banking and consulting firm that publishes quarterly and annual research on the RIA M&A landscape, a growing share of that M&A activity involves capital flowing from private equity.

Private equity investment in RIAs typically comes in one of two forms. First, the PE firm can buy out the RIA’s owners and acquire the RIA entirely (often in order to combine the acquired firm with another RIA owned by the PE firm); this was traditionally how most PE-funded M&A activities worked, as firm owners consolidated together to (for the buyer) achieve scale and acquire talent and (for the seller) retire or otherwise transition away from ownership. Alternatively, though, PE firms may also buy a partial stake in an RIA – without purchasing it outright – to provide its founders with capital to generate greater future growth. This strategy is having an increasing impact on the industry, as large RIAs become involved with building (or acquiring) their own technology platforms (like TAMPs, alternative investment platforms, and direct indexing technology), requiring infusions of cash but promising high growth, and ultimately proving attractive to (private) equity investors.

Ultimately, as the biggest RIAs continue to invest in financial technology and the delivery of advice increasingly blends together humans and technology, it is likely they will look for acquisition partners to acquire talent and client assets, and that this expansion will attract even more private equity investors who want a stake in that growth. The continued infusion of private equity funds, meanwhile, means that the demand for firms to acquire could continue to exceed the supply, keeping the “seller’s market” in M&A (and strong valuations for advisory firms) going for the foreseeable future.

New Technology Directory Launched For Independent Advisors

(Cheryl Winokur Munk | Barron’s)

The number of technology solutions for financial advisors has exploded in recent years. Where it was once possible for an RIA firm to get along with a few core tools like financial planning software, a performance reporting and trading platform, and a CRM system (and each of these categories had only a handful of major players), new solutions have proliferated for purposes like billing, business intelligence, digital marketing, and behavioral assessments – while whole new categories like advisor lead generation, client note taking, and client survey solutions have also appeared. For the last four years, we at Kitces.com have published (and regularly updated) the AdvisorTech Solutions Map to bring together all of these solutions into one location; however, the growth of advisor technology during that time has crowded the Map so much that using it has grown difficult to use due to the sheer number of solutions listed!

In order to make it easier for advisors to browse and compare technology solutions, this week Kitces rolled out a new AdvisorTech Directory, turning the static Map into a searchable database of solutions organized by category. The directory allows users to search for specific tools or browse categories of tech solutions, and includes solutions that have multiple purposes (like eMoney Advisor, which can be used both as a financial planning platform and a client portal) in each category where it can be used. Furthermore, the directory includes an interactive “Build Your AdvisorTech Stack” function, where advisors can create an overview of the solutions they use (and consider new solutions in categories where they might have a need).

Notably, the new AdvisorTech Directory will not include asset management offerings, and instead is solely focused on technology that (independent) advisors can buy directly to use for themselves in their own firms. Which in addition to a listing of the companies themselves, in the coming months will include even more details such as pricing and major features of technology vendors, data from Kitces AdvisorTech Research on how commonly each solution is adopted by other advisors, and satisfaction ratings from advisors who use the technology.

Because in the end, as technology becomes an ever more crucial part of an advisor’s business (to aid them in time-consuming or repetitive back-office tasks and deliver deeper value in their advice), the ability to discover and choose the right technology solutions is becoming an increasingly important need for advisory firm owners, which means it’s important to have resources to navigate the increasingly crowded AdvisorTech landscape.

RIA Compensation Costs Continue To Rise, Schwab Report Shows

(Cheryl Winokur Munk | Barron’s)

Compensation is typically the largest expense item for an RIA, so even just ‘modest’ changes in relative pay levels can materially impact a firm’s bottom line. And at a time when compensation is rising across industries amid a tight labor market, the financial advisory space appears to be feeling these effects as well.

According to Charles Schwab’s 2021 RIA Compensation Study, cash compensation at RIAs rose 14.5% between 2016 and 2020 (an average annual growth rate of 3.4%/year over the 4-year period). The increase in compensation varied across a range of positions, though, from ‘just’ a 7% increase for portfolio managers to a bigger 20% cumulative rise in compensation for senior relationship managers (as the squeeze for experienced advisor talent continues).

Schwab’s data shows that base salaries represented 79% of total cash compensation, but performance pay also remains an important tool to motivate staff, with 74% of firms offering this in 2020. And the use of performance pay can improve a firm’s bottom line, as firms using performance-based incentive pay saw 54% greater revenue based on a five-year compound annual growth rate. In addition to cash compensation, equity ownership remains an increasingly key component of the total compensation package for advisors, particularly for larger firms, which saw an increase in equity ownership among their staff between 2016 and 2020.

Though while compensation remains important, firms can also attract and retain talent by offering a strong employee value proposition (which can include meaningful work, professional development opportunities, and a diverse and inclusive workplace) that helps them stand out from competitors. Overall, the report found that firms with a greater commitment to staff (by investing in employee professional development and career paths, along with compensation levels greater than the median firm) were significantly less likely to experience staff turnover than the average firm with more than $250 million in AUM.

Which means in the end, the firms that are the most successful not only offer employees strong compensation packages, but also the perks that motivate employees to perform at their peak and remain committed to the firm!

Adding [Part-Time] Talent Amid The “Great Resignation”

(Crystal Butler | Advisor Perspectives)

The current tight labor market has made it more challenging (and more expensive) for employers to bring in new talent. But for some tasks, bringing on a full-time employee might not even be necessary. In these cases, hiring a contractor can save money and provide flexibility for the firm (particularly for solo and small firm owners who might want to outsource some tasks but are not interested in the management responsibilities of bringing on full-time staff).

When outsourcing tasks, the hiring firm can decide exactly how many hours they want the contractor to work, and can manage costs by not needing to pay employment taxes or benefits (which the contractor has to cover themselves). Further, hiring a contractor who is already competent in their area of expertise can also reduce the time (and cost) of training for the work that is needed compared to hiring a full-time employee. Contractors can cover a range of firm needs, from operations (e.g., compliance, accounting, IT, and human resources), to administrative tasks (e.g., document management, scheduling, and client support), investment management, and marketing. Of course, the firm will want to hire a skilled contractor, and Butler (who runs a marketing firm for RIAs) suggests consulting fellow advisors and other professional networks to get recommendations for individuals or firms that can cover the tasks needed.

Ultimately, different firm needs can require various types of human capital, and outsourcing certain tasks to contractors can not only save the firm owner money compared to hiring a full-time employee, but also time that can be used for more profitable activities! Though ironically, for firms that do want to hire but can’t find the time, the hiring process for financial advisors can now be outsourced, too!

Finding And Cultivating Wealth Management’s Next-Gen CEOs

(Charles Paikert | Barron’s)

Succession planning can be a challenging topic for many advisory firm owners. While owners recognize that they will not want to run their firm forever, the idea of handing off the reins to an individual with less experience can seem like a daunting proposition for owners who have built their firms from scratch. However, a reluctance to delegate tasks and cultivate next-generation leaders can make a successful succession less likely. And unlike large corporations, many smaller firms do not have a process where managers master their skills as they ascend the organizational chart. But without hands-on expertise running different parts of the firm’s business, a successor might be unprepared to take over the firm.

One solution to this problem can be found in coaching programs that develop management and leadership skills that next-gen leaders will need as they prepare for increasing management responsibilities. Younger leaders can also bring different perspectives to the firm and help align its culture to cultivate the next generation of clients as well. For example, whereas legacy firms were often siloed, with individual advisors ‘owning’ their client relationships, newer leaders appear to favor a more team-based client service approach. Also, as digital natives, next-gen leaders can help modernize the firm’s tech stack, not only to improve internal operations, but also to provide a seamless tech experience for clients as well.

In the end, cultivating young leaders can not only improve a firm’s performance today, but also ensures that these individuals will be ready to take over the firm when the time comes for the owner to pass the baton to the next generation.

8 Reasons To File Your 2021 Tax Return Early

(Kay Bell | Don’t Mess With Taxes)

The 2022 tax filing season officially began on January 24, as the IRS began accepting tax returns for the 2021 tax year. And though waiting until the last minute to file a return is an annual tradition for many people, there are good reasons to get a head start this year.

The best reason to file early in most years is – if a refund is expected – to receive one’s refund as soon as possible. This year many families could have higher-than-usual refunds, owing to the expanded Child Tax Credit (of which only 50% was paid in monthly installments last year, while the remaining half can be claimed when filing), and the third Economic Impact Payment (i.e., the last ‘Recovery Rebate’, which was paid in 2021 based on 2019 or 2020 income, but could be claimed as a credit if it wasn’t paid and 2021 income was within the range for a payment).

But taxpayers may also want to file early simply to get to the head of the line. 2021 saw extensive delays in tax return processing (with some 2020 returns still being processed to this day) due to a lack of staffing and resources, and the IRS has already warned that filers could see delays again this year. Filing early decreases the odds that one’s return will be caught in the backlog as the filing deadline approaches, and for some families could provide access to much-needed funds following the lapse of 2021’s monthly Child Tax Credit payments.

For advisors, the reasons that Bell gives to file early – which also include avoiding identity theft from criminals who file fraudulent returns, knowing how to adjust withholding and estimated tax payments in 2022, and hiring a tax professional before client rosters fill up – can be valuable touchpoints for clients heading into tax season. And one other reminder to add may be that, unlike 2020 and 2021 (which had their filing deadlines pushed back due to the pandemic), this year’s filing deadline will be “on time” on April 18, meaning that many people will be filing earlier than they did in the last two years anyway!

IRS Will Soon Require Selfies For Online Access

(Brian Krebs | Krebs On Security)

Many taxpayers have become familiar in recent years with the IRS’s Online Account feature, which allows taxpayers to make tax payments and access information such as prior-year return transcripts, Economic Impact Payment information for their Recovery Rebates, and IRS correspondence. This year, however, the agency is transitioning to a new login system that will require all users – regardless of whether they have previously established an online account – to create new login credentials, and be subjected to a stringent identity verification process, with existing users no longer able to use their old credentials by the summer of 2022.

The IRS has contracted with a third-party vendor called ID.me to enhance its identity verification and reduce the fraud and identity theft that have plagued taxpayers in recent years. And though the goal of added security is worthwhile, the service is experiencing a backlash as users run up against its invasive and burdensome verification process. Because not only does the process’s requirement to upload a “selfie” and supporting documentation rely heavily on users’ fluency with technology and access to working hardware (with even Krebs, the author of a cybersecurity blog, running into issues that required him to wait on hold for customer support), but many people have additional concerns about ID.me’s use of facial recognition technology, which has been shown to exhibit significant racial bias. The pushback has become large enough that the IRS is considering alternatives to verification through ID.me.

Ultimately, however, the stringent new verification requirements, and the subsequent blowback, illustrate the inherent tension between security, privacy, and ease of use. Making IRS accounts easier to access would make them more susceptible to the hacking that has shaken private corporations and government institutions alike; likewise, reducing the amount of personal data collected makes it more difficult to verify that a user is actually the person they claim to be. In light of this fact, Krebs concludes, the IRS’s new ID.me-enabled verification process may be an unpleasant but necessary place for people to “plant their flag” and create an online account before identity thieves do it for them (along with other sites such as the U.S. Postal Service, Social Security Administration, the three major credit bureaus, and banks and financial institutions).

The Huge Tax Bills That Came Out Of Nowhere At Vanguard

(Jason Zweig | Wall Street Journal)

Annual capital gain distributions are a familiar phenomenon for owners of mutual funds. At the end of each year, a fund must distribute any capital gains income it incurs throughout the year to its shareholders (in order for the fund itself to avoid owing taxes on those gains). Distribution is generally paid out in December, and is often reinvested automatically by shareholders and therefore may go by unnoticed.

For investors who hold mutual funds in retirement accounts like 401(k)s and IRAs, there are usually no tax consequences for capital gain distributions in the year they are received, because income tax in those accounts is typically deferred until the funds are withdrawn (or is entirely tax free, in the case of Roth accounts). However, when a mutual fund is owned in a taxable brokerage account, capital gain distributions are recognized and taxed at capital gains rates in the year they are received.

In typical years, the average capital gain distribution often averages from 5-10% of the fund’s value each year. But in the years when the markets boom – creating higher gains as the mutual fund sells holdings for rebalancing and to pay out investors who redeem their shares – the distribution can climb higher. And sometimes, additional factors can cause unforeseen spikes in capital gains distributions – resulting in a “surprise” jump in income that can lead to unexpected tax planning challenges just as the year is coming to an end (and the window to implement any strategies to counteract it is nearly shut!).

This is what happened to many investors in Vanguard’s Target Retirement funds, which are held by many individuals in their IRAs and brokerage accounts, but also by a large number of employer retirement plans like 401(k)s and 403(b)s. Near the end of 2020, Vanguard reduced the minimum investment of its lowest-fee “Institutional” share class from $100 million to $5 million. This allowed many more employer retirement plans to access the Institutional shares, and so in 2021, they sold their shares in the standard share class to switch to Institutional shares. The change worked out well for participants on those plans, who could now invest in the same Target Retirement funds at a lower average expense, but for those investors who remained in the standard share class, the combination of a large number of investors selling out of the fund and a booming year in the market amounted to a perfect storm of factors that led to a capital gain distribution of about 15% for the year.

Between the surprise tax bill, and the perception that small investors were disproportionately affected (since they were largely left to absorb the capital gain distributions after corporate investors sold their shares), Vanguard has subsequently received criticism for not doing more to inform investors of the potential tax consequences of holding its mutual funds. But in reality, all mutual funds carry the risk of capital gains distributions and their attendant tax consequences, so while Vanguard is treated as the villain of this story, it is really about how any mutual fund, when held in a taxable account, can generate a 'surprise' capital gain distribution when it faces net outflows of existing shareholders, and how tax efficiency and location for investors with multiple types of accounts can end out having a significant dollar value impact.

Workers Care More About Flexible Hours Than Remote Work

(Katherine Bindley and Chip Cutter | The Wall Street Journal)

The pandemic has changed the work environment for companies around the globe. While many companies transitioned into a fully remote work environment at the start of the pandemic, some have since taken a more hybrid approach, with employees expected to be in the office at certain times during the week.

However, companies operating on a hybrid basis face unique challenges because of the potential effects of proximity bias, and must take steps to ensure that workers spending more time in the office (who are more likely to be white and male) are not given preferential treatment (because they are more likely to be seen by and interact with leaders who are also working in the office). Which in turn means that creating a more equitable environment requires managers to both lead by example (e.g., by working in the office the same number of days each week as employees), and also improve transparency in developing and communicating remote work policies.

Yet while this dynamic may create tensions with employees, who increasingly appear to prefer the newfound flexibility in work locations and hours. According to a report from the Future Forum, 95% of knowledge workers want flexibility in when they work, and 78% want flexibility in where they work. But while companies might have certain expectations for when and where their employees work, the tight labor market (and the experience working remotely) has given employees more latitude to pursue positions that offer flexibility in work location and hours. According to the report, 72% of workers who are dissatisfied with their current level of flexibility at work said they are likely to look for a new job in the next year (compared to 58% of workers overall).

The key point, though, is that the shift in demand towards remote work may not actually be about remote work, per se, but that flexibility is becoming an expectation of many employees (and remote work is just one way to accomplish this). So the employers that are best able to meet this demand, including and especially while maintaining a productive and equitable workplace for an in-person environment, are more likely to be successful in the coming years!

You Can Redraw Work Boundaries This Year – And Make Them Stick

(Rachel Feintzeig | The Wall Street Journal)

During the past two years, more workers have taken advantage of the opportunity to work from home. Yet while working from home can be a time-saver compared to being in the office (no more commute!), it can lead to a blurring of the lines between work and home life.

After all, checking email from home has long been a part of life for some workers, full-time remote work can create a sense of being always ‘on’ and available to do the full range of work responsibilities well beyond normal business hours. Workers in this position have several options to redraw boundaries to ensure they have enough personal time while working remotely. One strategy is to adopt a mindset of being accessible (i.e., being able to be reached at certain times) rather than being available (e.g., being at someone else’s disposal at any time). Similarly, clearly communicating expectations for working hours with managers and coworkers can prevent confusion as to a worker’s accessibility. In addition, collaborating with co-workers to cover for each other when one person needs flexibility (e.g., to take care of a child when schools are closed) can ensure that the team’s duties are covered without having to sacrifice responsibilities at home.

Managers can also support employees by setting expectations for remote work hours and being clear about when tasks need to be completed so that workers do not assume they all must be finished right away (workflow tools like Asana or Trello can be helpful in this regard). So while remote work offers the promise of time and location flexibility, workers need to be deliberate in how they set expectations and structure their workdays to ensure that they have the work-life balance they desire!

The High Cost Of An Easy Job

(Nick Maggiulli | Of Dollars And Data)

When you are in the midst of a 60-hour workweek or are having a hard time balancing work with responsibilities at home, the prospect of finding a job that offers sufficient pay for minimal work (or better yet, winning the lottery and no longer having to work!) might seem enticing. But at the same time, work can not only provide an income, but also a sense of purpose.

And so, Maggiulli argues that life is not about maximizing reward while minimizing effort, but rather finding what you like to do and doing it for as long as you can. By finding challenging assignments, an individual can build skills and gain experiences that can compound on each other and lead to even better opportunities in the future.

Of course, most individuals do not work until their deaths, so it is also important for those who retire to consider what activities (which could include part-time work) will provide a sense of purpose that might be missing after leaving their full-time job. In this sense, retirement is less about a life of leisure, but more about achieving ‘financial independence’, where full-time work is no longer necessary to support one’s lifestyle, but rather an opportunity to pursue a range of interests that provide fulfillment.

The key point is that a life of leisure might not lead to happiness in the long run, and that if you find yourself struggling for a sense of purpose at work, it might be more beneficial to reevaluate what kind of work might be a better fit and perhaps seek out a new job or even a new career path that could bring about a renewed sense of satisfaction!

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We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.