Weekend Reading for Financial Planners (Jan 28-29)

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 28th/29th:

New TD Ameritrade CEO Will 'Reassess' Putting TD Brand On Products And Redefining Open Architecture (Janice Kirkel, RIABiz) - On a recent earnings call with stock analysts, TD Ameritrade's new CEO Tim Hockey noted that the company is "reassessing" its current position as an open architecture RIA custodian, in part because advisory firms have reported that they so trust the TD Ameritrade brand that they would be willing to consider a branded product. Yet at the same time, arguably part of TD Ameritrade's meteoric success since 2000 – with custodial AUM up from just $10B then, to a whopping $300B today – is that TD Ameritrade built its brand by embracing open source software APIs and differentiating itself as an open architecture platform. As a result, it seems the "reassessment" isn't necessarily likely to close down the open-architecture nature, but could lead to the introduction of TD Ameritrade proprietary/branded products as an "offering" to its RIAs, ostensibly akin to Schwab's recently introduced ETFs. Notably, TD Ameritrade is also considering whether to ramp up proprietary products in its consumer channel as well, as retail consumer asset growth slows to a trickle, and appears to be eyeing an expansion of its own hybrid robo-human Amerivest platform, though that offering's growth has also recently slowed (perhaps because it is still priced at 100bps, compared to 15bps for Betterment, and 0/28 for Schwab's Intelligent Portfolios/Advisory solutions). On the other hand, with the recently announced acquisition of Scottrade and its extensive branch offices, TD Ameritrade may see an opportunity to introduce new branded products into its new branches... and at that point, crossing them over to at least be available to RIAs as well seems only natural.

More States Likely To Approve Senior Financial Abuse Regulations (Mark Schoeff, Investment News) - Last year, the North American Securities Administrators Association (NASAA) released a model rule to "Protect Vulnerable Adults from Financial Exploitation" which would require financial advisors to report suspected abuse to state and other authorities, give them discretion to stop disbursements from seniors' accounts, and give advisors protection from liability for engaging in such client interventions. So far, four states – Alabama, Indiana, Louisiana, and Vermont – have passed laws based on the model rule, and six more are expected to enact similar rules in 2017 as their legislative sessions get underway. In the meantime, Senator Susan Collins reintroduced legislation on Capitol Hill this week that would also give financial advisors civil liability protection for reporting senior financial abuse. And FINRA has also created a proposed rule to help curb senior abuse, that is being reviewed by the SEC. The collective implication of these parallel efforts is that financial advisors should soon have a lot more leeway to help spot and report financial abuse of seniors, given our role on the "front lines" with consumers, without needing to worry as much about potential liability for reporting such incidents... though notably, the proposals do vary as to whether they would require advisors to report potential abuse, or simply give them liability protection if they choose to intervene.

Now Is The Time To Review And Correct 1099-R Tax Forms (Ed Slott, Investment News) - As January comes to a close, we reach the deadline for Financial Institutions to issue Form 1099-R to report distributions from various types of retirement accounts. The caveat, though, is that often 1099-Rs are issued with errors, particularly regarding how distributions are "coded" for various tax circumstances, from rollovers and RMDs to Roth conversions and early withdrawals. Which means now is the time to review 1099-Rs and spot potential mistakes, while they can still be more easily corrected and before clients have actually filed their tax return relying on the (potentially incorrect) form. Key areas to review include: Box 7, which might include Code 1 (early distributions subject to an early withdrawal penalty, though if the distribution really was reported as subject to penalty when it really was not, this can be 'corrected' by explaining the appropriate exception on Form 5329, filed with the client's tax return);  Box 7, Code 7 (normal distribution with no penalty, though if this was really a rollover distribution, request the Financial Institution to update Box 7 to code G instead, and if it was an IRA trustee-to-trustee transfer there actually shouldn't be a 1099-R at all); and Box 6 for Net Unrealized Appreciation. Also, it's important to note that if the client did a Qualified Charitable Distribution, there is no "proper" code yet for Form 1099-R, and the IRA custodian will likely report it as Code 7 for a normal (taxable) distribution, for which the client needs to note on their tax return that it was actually a non-taxable QCD. And of course, be certain to review the actual numbers on the Form 1099-R as well, and verify that the total distributions and/or rollover amounts have been reported correctly in the first place (though most commonly, the problem is whether Box 7 is coded correctly!).

Have Indexed Annuities Become Too Complicated? (Greg Iacurci, Investment News) - Fixed indexed annuities appear to be growing more and more complex, a progression that is driven at least in part by the inevitable desire of annuity companies to stand out and try to differentiate their products. Yet some are raising the question of whether the contracts are becoming too complex, and unnecessarily opaque, as evidenced by trends like the uptick in new "exotic" and proprietary indices being by insurers, and the use of increasingly complicated crediting formulas. The underlying structure of an indexed annuity remains simple – 90% to 95% of the contract's assets are simply invested into fixed-income investments, with the remaining cash value used to purchase options contracts (which are what delivers the index participation); however, as insurers seek to differentiate or stretch their participation rates, they're eliminating 'standard' indices like the S&P 500 or Russell 2000, and using their own hybrid indices, which both confuse the upside potential, and can even introduce new costs as the hybrid index providers (often investment banks like Goldman Sachs, Morgan Stanley, and Merrill Lynch) themselves charge an additional fee (roughly 50bps) to use/manage the index. On the other hand, with the DoL fiduciary rule looming, new scrutiny may be coming to these contracts, including hard questions about whether/why it ever makes sense to use a more expensive 'exotic' index over a cheaper plain vanilla one, if the whole point is not to actively manage the solution but simply create a participation rate on an underlying index in the first place. Annuity companies defend that such alternatives as "managed volatility" indexes make it possible to offer "uncapped" indexed annuities with no upside limitation, but it's not entirely clear whether the managed volatility index itself may have limited upside simply because of how the volatility is managed in the first place. And in fact, some broker-dealers are already backing away from the contracts, fearful that if a consumer asks hard questions about "how did you calculate the return I got" that the broker may not be able to provide an effective explanation (given the opacity of the exotic indices and how they're managed).

The Risks & Rewards Of ESG-Based Investing (Michael Finke, Research Magazine) - A recent Gallup survey found that the number of Americans worried either "a great deal" or "a fair amount" about the risks of climate change are up significantly in just the past few years, but the notable recent shift for financial advisors is that now an increasing number of clients are not just getting politically active about climate change, but want their portfolios to reflect their concerns as well. Of course, historically this has been challenging, as the primary metric for evaluating a portfolio is returns, and returns are maximized by managing the business to maximize profits and shareholder value (and not necessarily environmental issues). To promote a shift, though, in 2005 a United Nations Finance Initiative established a framework for evaluating companies on their Environmental, Social, and Governance (ESG) impact, providing a new rubric for evaluating which companies to invest in or not. And a growing depth of research on companies that score well for ESG purposes is finding that they actually can outperform in the long run as well; for instance, the iShares KLD 400 Social Index (which screens for corporate social responsibility) has outperformed the S&P 500 over its 25-year track record. And notably, the success of high-ESG companies may not merely be the impact of ESG policies on long-term company performance; to the extent that investors begin to favor good ESG practices, companies that score well on ESG screens will have easier (i.e., lower cost) access to investor capital, which can become a self-fulfilling prophecy that ensures those companies really do have better odds of outperforming in the future. Fortunately, recent new tools like Morningstar's Sustainability Ratings make it easier for advisory firms to evaluate and screen prospective mutual funds and ETFs by their ESG ratings, making it easier to craft such portfolios for clients who demand them (for investing purposes, social purposes, or both).

Dollar-Cost Averaging Using The CAPE Ratio: An Identifiable Trend Influencing Outperformance (Jon Luskin, Journal of Financial Planning) - Despite its popularity, a long-standing base of research shows that on average, dollar-cost-averaging a lump sum into investment portfolios underperforms just allocating the lump sum all at once. The reason for this is rather straightforward – on average, stocks go up more often than they go down, which means allocating into the markets over time is most likely to just buy later at higher prices. Of course, that's not always the case, and the data does show that dollar cost averaging does better about 1/3rd of the time, in scenarios where the markets do stumble shortly after the initial investment. Which raises the question of whether there's any way to predict when lump sum investing is more or less likely to do well? Luskin notes that one way to address this is to look at the P/E ratio at the beginning of retirement – for instance, using P/E5 or Shiller's CAPE (P/E10) – which has been shown to at least have long-term predictive value about both expected returns and potential market volatility. Accordingly, Luskin tested whether Shiller CAPE can help predict when it's better to dollar cost average versus lump sum invest... and finds that, at least over 15-year time periods, Shiller CAPE was highly predictive of whether a DCA strategy would outperform, with a 100% chance of DCA outperforming, based on historical data, when the starting CAPE was over 31, and only a 25% chance of outperforming when the Shiller CAPE was under 16. Which is important, given that the Shiller P/E ratio is close to that threshold today. On the other hand, it's notable that even investors who dollar cost average an available lump sum rarely do it over periods as long as 15 years – arguably, 6-12 month time horizons are far more common – and it remains unclear whether CAPE would be an effective predictor of dollar cost averaging over more typical time periods (given that Shiller CAPE has very low predictability over time periods as short as 1-2 years).

10 Steps To Programming Clients For Referrals (Tony Vidler) - For most advisors, it's becoming increasingly hard in recent years to generate new clients via referrals, which in turn is raising questions from whether it's better to ask for referrals (or not) to how referrals should be asked for. Vidler notes that if advisors are going to ask for referrals, it's crucial to change the language and try not to paint clients into the corner and pressure them to do something they don't feel comfortable doing – the days of the high-pressure-referral are over. Instead, Vidler suggests that the best strategy is to "program" clients to simply understand that referring others is part of the business relationship, and that referrals aren't a requirement but they are an expectation from the start (and of course, you still have to deliver the quality of service to actually deserve them, too!). So how do you actually program clients to give referrals? Vidler gives 10 tips: Stop using the word "referral" (it's time has passed!), and instead ask for "introductions" (where the client actually connects you to the prospect) or "recommendations" (where the client guides you on who to reach out to) of who else they know that you should be talking to; point out at the very first meeting, when you discuss cost, that part of how you are "paid for your time and repaid for your ongoing service" is to receive introductions to other potentially suitable clients; provide clients some indication of your "buyer persona", or the type of potential client who is a good fit for you (which, notably, means you need to identify who your ideal client is in the first place!); reinforce your expectation of appropriate recommendations (i.e., referrals by another name) into your supporting materials, such as review letters, newsletters, your website, etc.; acknowledge (with gratitude) every introduction you get as quickly as you can (whether it's actually ideal or not), so the client feels good about making the introduction; and be certain to report back to the referrer how things worked out (since they will be curious, and perhaps even nervous, to know how it went, even if it's just a nondescript privacy-protecting "we were able to help them, so they are happy and we are happy – thank you"). The bottom line: in many cases, the reason why clients don't refer more isn't because they don't want to refer, but because the advisor makes it too uncomfortable, doesn't make it clear to them who to refer (and no one wants to make a referral who gets rejected!), or doesn't give appropriate positive reinforcement when the referral does occur (which means the next one isn't going to happen!).

The Art Of Qualifying Prospects (Beverly Flaxington, Advisor Perspectives) - One of the biggest frustrations for financial advisors trying to grow their clientele is the experience of talking to and meeting with a prospective client, feeling like it was a "good" meeting, but then having the prospect go silent and unresponsive after the meeting (and never move forward to actually becoming a client). In some cases, this is because the advisor misreads the prospect's desire to gather information with actual enthusiasm to do business, while in other situations, it may be that the prospect already had plans to move forward with another advisor (and was just screening you to "check the box" on due diligence), or perhaps simply didn't feel enough pain/discomfort to actually overcome the inertia and move forward. So how can an advisor prevent or manage this? Flaxington suggests that the starting point is to better qualify the prospect and their interest in the first place – asking questions like "Why are you seeking a financial advisor at this point?" and "How will you evaluate a decision like this?" and "What are your top three priorities for choosing an advisor?" In some cases, the prospect themselves hasn't considered these issues, but the key from the advisor's perspective is that it helps to set up the initial meeting for success and guides the advisor on how to keep the process moving forward. Other key steps in the process include: at the end of the first meeting, be certain you have a list of to-dos for both you and the prospect (rather than trying to follow-up after the fact, which may lead to a non-response scenario); outline what the next steps should be for the client to take (as their willingness to engage on those steps provides an indication about whether they're really engaged in the process and likely to move forward); and in some cases, you may even want to ask the prospect outright "What's the best way to work together to ensure I'm communicating so you have the information you need to make the best decision for you and your family?"

Stop Winging Your First Prospect Meeting (Stephen Boswell & Kevin Nichols, Wealth Management) - For most consumers, the first meeting with a financial advisor can be an awkward challenge... after all, few people wake up in the morning thinking "I'd love to spend an hour divulging my personal financial situation to a stranger." So how can financial advisors adjust the way they handle their first prospect/discovery meeting to ease the process? Boswell and Nichols provide the following guidelines: 1) Start by trying to build rapport (using whatever 'intelligence' you can gather beforehand to make a connection); 2) Clarify the timeline and how long the prospect has for the meeting (so you can manage your time accordingly, and minimize the risk that the prospect is distracted thinking about the next meeting they have to go to and might be late for!); 3) Use an agenda (both to keep the discussion on track, and because an agenda helps to show the prospect you're organized and prepared); 4) Use a purpose/benefit/check system to lay the groundwork for the meeting (e.g., "the purpose of our meeting today is..." and "through this process we'll [benefit]..." and then check in with "How does that sound?"); 5) Remember the value of reverse psychology (if prospects think you're chasing them, they'll run; if they think you're selective, they may try to step up because they want to "get to" work with you); 6) uncover their motivation for the meeting (as understanding why the prospect is meeting with you gives you an understanding of how to frame your value); 7) Plan to gather the information you need at the meeting, rather than asking in advance (as too much advance homework may dissuade the prospect from coming in to meet at all!); 8) Be clear in differentiating the value in working with you over the prospect's alternatives; and 9) Use an "assumptive close" where you end the meeting by detailing the further steps to take leading up to the next meeting (which makes an "assumptive close" that there will be a next meeting, but it often works out!).

Advice Or Selling? Why Language Matters In U.S. Fiduciary Battle (Mark Miller, Reuters) - In their marketing to consumers, most major broker-dealers and insurance companies state something to the effect of "We are financial advisors you can trust", yet when those companies are challenged in court, their defense is commonly that "we are just salespeople." This language gap was highlighted recently in a report from the Consumer Federation of America, which noted how financial services firms are saying one thing to the public and the direct opposite to the courts and regulators. The reason why the difference matters is that advisors are regulated by a fiduciary standard, while salespeople are regulated by a suitability standard – in point of fact, the whole reason why the DoL fiduciary rule matters is that it's attempting to hold those broker-dealer and insurance company reps to the standard for "advisors" since that's how they're now marketing themselves. On the other hand, given that the scope of advice spans beyond just retirement accounts, arguably the DoL fiduciary rule is still too limited, though a rule from the SEC wouldn't necessarily be better as it may cover taxable investment accounts (in addition to retirement accounts) but would then fail to cover various types of fixed and indexed annuities. In the meantime, consumers can still fall back on asking whether their "advisor" is actually a fiduciary or not, though arguably the best outcome is simply to get back to a world where salespeople really have to describe themselves as such, and the only ones who can call themselves "advisors" are truly accountable as (fiduciary) advisors.

Lessons For RIAs And Vendors From A Platform Provider's Demise (Charles Paikert, Financial Planning) - After nearly 8 years helping breakaway brokers become successful independent RIAs (by providing a platform offering compliance, reporting, investment management and consulting services, and more), Sanctuary Wealth Services is shutting its doors at the end of March, as detailed in a blog post by founder Jeff Spears. The opportunity to serve breakaways, who often underestimate the cost and hassle of maintaining an office and support staff, led to the growth of firms like Sanctuary (and competitor Dynasty Financial), which typically charged 20% to 30% of topline fees for their services (intended to be less expensive than the typical 35% overhead expenses of an independent RIA). However, once firms transition and spend a few years on their own (with the support of a provider like Sanctuary), and get a better understanding of what it takes to run the business themselves, they begin to break away once again and use their size and scale and resources to truly go "totally" independent, which began to undermine Sanctuary as advisor turnover rose. And the challenges got worse as competitors like Dynasty grew to 39 advisors (while Sanctuary only had 9 even at its peak), and began to offer deeper resources and solutions to their platform firms. Ultimately, this doesn't necessarily mean the idea of being a "platform" for financial advisors is dead, but does serve as a warning of the hyper-competitive marketplace of serving large advisory firms.

Will Future Advisors Be Able To Build A Career At A Call Center? (Suleman Din, Financial Planning) - Historically, financial advisors got started on the telephone, "smiling and dialing" while doing cold-calls for new business. Now, a new career track is emerging: financial advisors who will once again start their careers on the telephones, working in a financial planning call-in center like Vanguard Personal Advisor Services or the new Schwab Intelligent Advisory platform. Some suggest that this will be a great way to learn financial planning, giving young advisors a chance to work directly with clients early on, without any requirements for business development and bringing in new business; others, however, raise concerns that the "disembodied" experience of working with clients virtually won't give advisors the breadth and depth they need to really learn how to counsel clients on their finances. And call centers have long had negative connotations as a place to work, with high burn-out and churn rates of employees, in addition to the challenge of even seeing the positive results of the advice (given that clients won't be face-to-face). Still, given that historically the industry would lose 70%+ of its new recruits in the first three years of doing cold-calling for new business, arguably an opportunity to get and use your CFP from the start in working with clients as a new advisor is still a much better way to cut your teeth as a financial advisor than the ways of old – not to mention expanding access to financial planning in the process.

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

In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.