Weekend Reading for Financial Planners (Jan 16-17)

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 January 16th/17th:

How Exactly Invesco Plans To Get A Return On Its Jemstep Robo Purchase With A TAMP-Evoking Strategy (Lisa Shidler, RIABiz) - This week, mega-asset manager Invesco (with $800B AUM) bought robo-advisor Jemstep for an undisclosed sum. The newly acquired company will be renamed Invesco Jemstep, and Invesco has indicated it plans to wind down Jemstep's direct-to-consumer offering and focus entirely on using it as a B2B investment platform for advisors. The acquisition, similar to Blackrock's purchase of FutureAdvisor, appears to be a strategy for Invesco to use the robo platform as a distribution channel for its investment solutions (particularly for ETFs, as Invesco owns PowerShares, which produces the QQQ Nasdaq ETF amongst others). However, Jemstep is somewhat different than other "robo" platforms - it does not actually manage assets directly, and instead has been primarily lauded for its smooth onboarding system (where clients can digitally enroll themselves into the advisor's investment management solutions and RIA custodial platform). In addition, it's not entirely clear whether increasingly independent-minded advisors will necessarily accept Invesco's proprietary investment solutions if they are 'pushed' into the Jemstep platform - which is viewed as inevitable by many commentators, as that's the only reason for Invesco to buy the platform - though Jemstep leaders emphasize Jemstep's open architecture and non-proprietary nature, with perhaps "just" some model portfolios that may get preloaded into Jemstep using Invesco funds. In other words, Jemstep may ultimately become a form of TAMP or internal trading and portfolio management platform for advisors (e.g., managing models in a similar manner to how rebalancing software has been used in the past).

Why Retirees Go Broke (Dirk Cotton, The Retirement Cafe) - While the 'traditional' approach to retirement planning is to evaluate a retiree's "probability of ruin" (or failure, or depletion) based on their current assets, planning spending, and the potential impact of market volatility, Cotton points out that in reality there are may other reasons a retirement plan may fail that have nothing to do with the investment markets modeled in a Monte Carlo retirement projection. For instance, almost 10% of those who file for bankruptcy are retired, and amongst elder Americans the most common trigger reasons include credit card interest and fees (i.e., debt problems that compound), illness and injury, housing problems, divorce, birth or adoption of a child, or death of a family member. Of course, some debt-related bankruptcy filings, along with involuntary retirement, may indirectly be related to investment portfolios being depleted by market volatility, but Cotton further notes that the research shows that 40% of elder bankruptcies are filed between the ages of 65 and 74, and the bankruptcy rate for age 85 and older is negligible (which in theory is when sequence of return risk would be most manifest). In other words, despite the financial planning community's focus on modeling investment risk in retirement, the research implies that most elder bankruptcies are driven by unexpected life events, either by an unanticipated loss of income (e.g., involuntary retirement), or shocks to spending (e.g., health events). And notably, even in the context of spending shocks, the research suggests that it's rarely a single financial event that triggers the bankruptcy; instead, it is more commonly a cascading effect, where one problem triggers another, which triggers another, until the compounded effect is a feedback loop that culminates in retiree bankruptcy. In addition, Cotton notes that retirees who experience market disruptions - but still have assets - are also capable of adjusting their retirement spending, which implies ultimately that while sequence of return risk might threaten a decline in someone's standard of living, sequence of return risk appears to rarely be a direct trigger of bankruptcy itself, which is more likely a result of "spending risk" instead. Furthermore, Cotton points out that spending shocks can actually topple a retirement even faster than market volatility alone, since spending can be cut to manage market volatility, but spending shocks themselves can't be managed by cutting spending (since by definition it's a need for higher spending that triggered the issue in the first place)!

When it Makes Sense to Reverse an IRA Conversion (Donald Jay Korn, Financial Planning) - While Roth conversion strategies are increasingly popular, it's important to remember that it is possible to "undo" a Roth conversion with a Roth recharacterization, which can be done as late as October 15th of the year after the conversion. In some cases, this is done simply because the account owner changed his/her mind, but another reason to consider a Roth recharacterization is because of market declines. For instance, if a Roth conversion of $200,000 has declined to being worth "only" $160,000 instead, it makes little sense to pay the tax bill on $200,000 for an account now worth 20% less; instead, the Roth conversion can be recharacterized, eliminating any tax exposure for the original transaction, and then the client can try the conversion again after a requisite 30-day waiting period (now only paying taxes on the new $160,000 base). In addition, it's important to recognize that a Roth recharacterization doesn't have to be an all-or-none transaction; a partial Roth recharacterization is permitted as well. This may be appealing in situations where the goal is to fill a certain tax bracket (but no more), so the client converts more than enough to fill the bracket and then after the close of the year (when income and deductions are known for certain) a partial recharacterization occurs for the exact "excess" above the bracket threshold to ensure that only the desired bracket is filled. A similar strategy would be to do a Roth conversion in a year where there is an unusual low income year (e.g., a year of unemployment, or after a recent retirement) for more than enough to fill the lower tax brackets, and then again recharacterize any excess after the close of the year once final income and deductions (including portfolio distributions) are determined. If there's a plan to recharacterize, it may even be appealing to split the Roth conversion into multiple separate accounts, each with a different investment, allowing the client the opportunity to cherry pick keeping the accounts/investments that are up and had good performance, but characterizing the ones that turned out poorly.

Default Risk Doesn’t Pay (Larry Swedroe, ETF.com) - Most "anomalies" in the world of finance are focused on opportunities for investors to earn excess returns in an otherwise-mostly-efficient market. But as Swedroe notes from a recent research paper by Chris Godfrey and Chris Brooks entitled "The Negative Credit Risk Premium Puzzle" one of the more unusual finance anomalies is that those who take credit risk in fixed income have been rewarded far less than would be anticipated given the risks involved. In fact, the data shows that historically, long-term corporate bonds have only outperformed long-term Treasuries by a mere 0.3%/year, despite the default risk involved in corporate bonds. In addition, stocks with a higher risk of defaulting on debt (e.g., that have lower debt ratings) have produced consistently lower returns, then that lower return expectation hasn't been arbitraged out by the markets either! The reason for this appears to be driven by the fact that such lower quality investments tend to be less liquid with lower turnover, have wider bid/ask spreads, and experience more idiosyncratic volatility, which actually limits the ability of arbitrageurs to successfully short the stocks and correct the overpricing (both because it leads to higher costs, less ability to exit the position, and the outright reduced availability of shares to short in the first place). The inability to arbitrage these anomalies appears to also be driven by the "disposition effect", a behavioral bias where people tend to sell their gains but hold onto and ride their losses all the way down, further reducing trading activity and increasing trading costs (and it also appears that those more inclined towards the disposition effect seem more likely to invest into high-credit-risk stocks, exacerbating the situation). And the situation is further compounded by the fact that most investors have an aversion to leverage (at least, significant leverage) which further limits the availability of dollars to short stocks and correct mispricings. Regardless of the reason, though, the fundamental point is that for those seeking higher returns, arguably investing in corporate bonds (or high-risk stocks) to capture a "default risk premium" is a poor way to enhance long-term returns!

The Growing Influence of Impact Investing (Jamie Green, Investment Advisor) - Investors are increasingly expressing a preference to invest according to their values, which is reflected in the rise of everything from impact investing (where funds are allocated to companies seeking to drive a positive societal impact), to Socially Responsible Investing (SRI) and Environment Social and corporate Governance (ESG) investing (which screen out 'undesirable' companies based on various factors). The convention view is that these investment approaches are just at the fringe, but recent consumer surveys find that as many of 3/4ths of women and Millennials in particular want to invest with their values - implying that impact investing, SRI, ESG, and the like, could experience explosive growth in the coming years as those investor cohorts increasingly control more investable assets. In fact, even regulators are beginning to acknowledge the rising interest in values-based investing, as the Department of Labor recently updated its guidance on SRI investing in retirement plans to acknowledge that SRI is a permissible fiduciary investment, and the IRS also recently stated that foundations can invest with a values-based tilt and not run afoul of foundation investment rules. Even Morningstar has announced that in the coming months it will add ESG scores to its mutual fund ratings. Arguably, perhaps the biggest hindrance to growth in these kinds of investment strategies is the fact that there is no consistent nomenclature to label them, and different companies implement impact, SRI, and ESG investment strategies differently. Still, investment firms are increasingly rolling out various forms of values-based investment opportunities, from mutual funds and ETFs to separately managed accounts, to give advisors more opportunities to implement such strategies with their own clients, especially as a growing base of research suggests that such investment strategies may really offer competitive investment returns as well.

Social Risk And Referrals: A Game-Changer (Russ Alan Prince & Brett Van Bortel, Financial Advisor) - While historically financial advisors have said that client referrals were the most important way to cultivate new clients, industry research suggests that the pace of client referrals seem to be declining, especially amongst affluent clients. In fact, Prince and Bortel find that while prior to 2008, almost 9-in-10 affluent individuals were referring their advisors, the rate has plummeted to fewer than 1-in-10 since then. The decline appears to be driven in large part to the perceived social risk that affluent investors seem to feel when referring a peer, and their fear that the market will decline and/or that the advisor will "lose money" for a recently referred peer. In other words, affluent individuals are so concerned they might offer a referral to an advisor who ends out losing money, that instead they just don't make a referral at all to avoid the social risk of having the referral go wrong. In fact, the social dynamics of asking for referrals appears to be so complex, that the research also findings that the majority of advisors who don't ask for referrals decline to do so because they are uncomfortable with the social risk of asking, as well! Ultimately, Prince and Bortel do not conclude that referral marketing and asking for referrals is 'dead' altogether, but do emphasize that the "social cost" of referrals seems to have increased in recent years, which appears to be hindering the referral process more than ever before.

Advisors: Update Your LLC Operating Agreement! (Chris Stanley, ThinkAdvisor) - While a Limited Liability Company (LLC) is very easy to establish, and is popular amongst advisors seeking asset protection, it is equally easy to "screw up" in a manner that limits the liability protections of the entity. The biggest issue with an LLC in terms of liability protection is failing to treat it as a separate entity; if the LLC is used as though it's just the alter ego of the LLC owner, the courts are more likely to ignore the LLC protections. And one of the most common omissions of an LLC that can undermine its asset protection is failing to have an operating agreement for the entity, which stipulates key provisions like the members and their obligations, how capital is contributed and withdrawn, how new members are added or removed, who will manage the entity, the accounting and bookkeeping conventions that the entity will follow, and the transfer and dissolution procedures. Notably, it is not required to have an operating agreement just to form an LLC, but the failure to honor such formalities can undermine the asset protection benefits if a lawsuit should occur. Accordingly, Stanley suggests that as a New Year's resolution, any advisory firms operating as an LLC should review their operating agreement and verify that it is still up to date and in good order. And if you don't have an operating agreement, now might be a good time to formally create one and put it in place, not only for the asset protection benefits, but also because an operating agreement can expedite a transition if there is a business disruption (e.g., death or disability of an owner) and help the firm comply with looming new continuity planning rules for advisory firms!

Can Your Firm be Required to Cover an Employee’s Mistaken Trades? (Anne Wallace, Advisor Perspectives) - As advisory firms increasingly hire operations and "trading" team members to execute client trades, the question arises about who faces liability in the event that a trading mistake occurs that causes a financial loss for a client? Is the firm required to make the client whole? Can the liability ever be attributed directly to the employee themselves? And if the employee is liable, can the employee ever sue his/her employer to recover the cost? Notably, the matter is generally not addressed in traditional financial regulations - which are mostly designed to define the relationship between clients and advisors, not between advisory firms and their employees. Wallace points out that under most state laws, the answer is that salaried employees cannot be debited for 'mistakes' they make on the job (at least not for a substantive amount), as the presumption is that the employer already has other remedies to address the misdeeds of salaried employees (including terminating the employee). In fact, under most state law employment protections, an employer cannot require an employee to be directly/personally responsible for a trading error even if there is a separate agreement, as such an agreement would itself violate employment laws. Which means that ultimately, the liability will still come back to the advisory firm for a trading mistake, and why it is so important for firms to carry appropriate Errors & Omissions insurance!

Errors advisers should steer clear of when updating ADVs (Liz Skinner, Investment News) - In the coming weeks, registered investment advisers will file their annual Form ADV disclosure updates (the deadline is March 30th, 2016 for those with a December 31 fiscal year-end). And while the ADV update process is normally 'routine', the SEC has been increasingly aggressive in recent years in scrutinizing ADV updates, and penalizing advisors who fail to do updates properly. The most significant problem, sadly, is still those who outright lie on their ADVs, most commonly by overstating and inflating their AUM (e.g., to make the firm appear larger to court bigger clients), though ironically sometimes RIAs actually understate their AUM (e.g., to avoid being subject to SEC regulations and instead stay under the $100M threshold to remain a state-registered investment adviser). Other areas of potential discrepancy to watch out for are that the description of fees in the Form ADV is consistent with the firm's actual advisory agreement and any of its marketing materials (e.g., fees listed on the firm's website), that the firm properly discloses all compensation from all sources, and that the firm accurately reports which state(s) it does business in (including its primary state of business). Notably, the SEC appears to be issuing an increasing number of fees in the $10,000 - $25,000 range (or sometimes more) in recent years, both as scrutiny of Form ADV rises, and because cases of misrepresentations in Form ADV are usually very "black-and-white" and easy for the SEC to enforce against.

Would You Really Be More Productive With A Personal Assistant? (Laura Vanderkam, Fast Company) - In the business world, company-provided executive assistants are increasingly rare, but Vanderkam makes the case that even if the company won't provide, highly productive entrepreneurs (e.g., successful financial advisors!) should consider just hiring their own personal assistant instead. The basic concept is rather straightforward - the personal assistant's function is to handle all the "other" stuff in your life that distracts you, allowing you to free your mind and fully focus your time on whatever it is that you do best. Tasks of a personal assistant could include everything from shopping, to managing personal purchases, ensuring that your car registration is up to date, and even helping you keep track of your iTunes database of music. Some people will start with a part-time personal assistant, hired through a site like Craigslist or even Care.com (which has a category for "household employees" where personal assistants are often included), and often a part-timer is a good place to start just to help figure out what exactly you would be ready and willing to delegate. Full-time assistants can be hired as a staff position either by listing the employment opportunity, or through your own personal network. Depending on the nature of the tasks involved in your daily life, a virtual personal assistant may be an option as well.

How A More Regular Client Meeting Schedule Enhances Advisor Productivity And Business Growth (Michael Kitces, Nerd's Eye View) - As advisors, we often go out of our way to try to accommodate clients in the name of "good service", including being flexible about when we meet with clients. Yet the problem is that so much meeting flexibility can wreak havoc on our own personal productivity as financial advisors, as it's almost impossible to have a structured focus and be proactive when the schedule changes every day and week throughout the year. In fact, a recent FPA Study on Advisor Time Management and Productivity found that the advisors who had the most structure in their business felt most in control of their time and lives, and controversy those with less structure were less likely to feel in control at all. So what's the alternative? Create a formal weekly schedule that you use for scheduling all of your internal and external meetings - for instance, client meetings are only on Tuesdays, Wednesdays, and Thursday, while Mondays are for working with the team to prepare for the week and do other (internal) financial planning work, and Fridays are reserved for both wrapping up activities for the week and also focusing on internal projects. Even email can be targeted to occur only at specific times of the day, providing structure to ensure it's not a constant distraction. Notably, while it may feel strange at first to try to impose this schedule rigor where none existed before, with enough advance notice it's often easier to implement than most advisors expect; for instance, even clients with whom you 'typically' meet with on Mondays or Fridays can almost certainly find a Tuesday, Wednesday, or Thursday to meet with you as well, as long as it's scheduled far enough in advance!

11 Differences Between Busy People and Productive People (Kelsey Manning, Levo) - We all know "busy" people who are constantly engaged in projects and working through a never-ending to-do list, but Manning makes a compelling case that there's still a fundamental difference between someone who is busy (even very efficiently busy) and being truly productive. In fact, arguably the first distinction between busy and truly productive people is that the productive ones focus on how their contributions can broadly impact the strategic objectives of the business, and not merely get a lot of work done in the business - it's the difference between just trying to get through everything on the list, versus focusing on what's going to provide the biggest bang for the buck. Similarly, the most productive people focus on the tasks that really matter (which may or may not be the ones that feel most urgent), and prioritize accordingly - which means delegating or eliminating lower priority tasks altogether, focusing on the impactful ones (where great attention is paid to detail to ensure those are done correctly), and getting very good at saying "no" to anything that isn't absolutely key. Similarly, true productivity requires having some structure to the day, taking the time to figure out how to do things most efficiently, and include an allocation of time for planning and reflection and personal development. The bottom line: you may be efficient at being busy and getting a lot done, but true productivity is about a laser-like focus on doing what really matters and has the greatest impact, and nothing else that doesn't materially contribute to the greater good of the business in the long run.

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!

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. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!