Weekend Reading for Financial Planners (Jan 4-5)

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 4th/5th:

Finra Warns Against Conflicts In Retirement-Plan Rollovers - Just as 2013 came to a close, FINRA issued one of its final notices - Regulatory Notice 13-45 - warning that it is looking to crack down on potential conflicts of interest that could affect brokers when they roll over a client's company retirement plan into an IRA, if it would have been better to leave the funds in the existing 401(k) or rollover to a new employer's 401(k) instead. Because the rollover of the funds goes into an IRA where securities transactions are involved, FINRA reminds brokers that rollovers - and the subsequent transactions - must still meet the appropriate suitability standards. The announcement is notable not just for the warning itself, but that the FINRA notice mirrors the anticipated-in-2014 Department of Labor proposal to apply a fiduciary duty to employer retirement plan rollovers, though it's not entirely clear whether FINRA is trying to lift its standard to come closer to matching the DOL, or simply to reassert its jurisdiction over IRAs to push back against a perceived encroachment from the DOL. Nonetheless, FINRA is clearly aiming to apply more scrutiny to transactions, and the notice includes a warning that even brokers who are merely providing educational information to 401(k) plan participants must monitor to be certain they're not inappropriately crossing the line into unsuitable IRA sales recommendations.

Advisors Getting It Wrong on 'Wealth Management'? - A recent report from market research firm Spectrem Group suggests that there may be a disconnect between what advisors consider "wealth management" and what consumers are expecting when they hear the term. With labels like investment management, wealth management, and financial planning, it can be confusing to know which is more or less expansive than the others. From the investor perspective, though, it's pretty clear: wealth management is the broadest, as more than 80% of investors defined the term as including both investment planning and management, comprehensive financial planning, and tax information and advice... for which they expect to pay a single fee for such a service package. Notably, the wealthiest investors - those with more than $5M to invest - feel most positively about the wealth management term; at lower net worth levels, people tend to agree with the statement "wealth management makes me believe I am paying too much for the services." Of the over-1,000 respondents, 45% stated thye obtain wealth management services form a financial planning or brokerage firm, while the rest claim they get it from banks, mutual fund companies, and accounting firms. Over the past 5 years, the percentage of investors who believe a "comprehensive financial plan" is a key component of wealth management jumped 6 percentage points to 84%.

Finding The ‘Best’ Clients - This article from Financial Advisor magazine makes the interesting point that while advisors continue to report that the majority of their new clients come from current client referrals (nearly 3/4ths of all advisors cite client referrals as the top source) and only about 11% state that the majority of new clients from centers of influence, when advisors are asked where their best (defined as "most profitable") clients come from, an astonishing 66% of advisors declare that centers of influence at the best source. And notably, the percentages are even higher amongst the advisors at the highest income levels. In fact, the survey research found that center-of-influence clients averaged a whopping 21 times the profitability! The results suggest that for advisors looking to really focus on high net worth clients in particular - which tend to be the most profitable - that establishing relationships with centers of influence may be dramatically more effective than just continuing to rely on client referrals, and that in general building with centers of influence (COIs) may be an even more effective growth strategy than is commonly recognized. However, while most advisors try to build relationships with COIs, only about 10% report they've been very successful with it, suggesting that there is still a lot of room for better training and education about how to better develop business through COIs.

The Conversation: How Young Advisors Can Spur Owners to Succession Planning - This article by practice management consultant Angie Herbers tells the story of Eric Hehman, who started as an intern at Austin Asset in 1997 when it had $25M in AUM, and who is now a partner and the CEO of the firm, which has grown to managing $540M of AUM with about $4M of revenue. One of the key aspects of Hehman's success, though, is that it happened because of his own initiative, not the firm's founder John Henry McDonald. As Hehman puts it, "John Henry never came to me and asked 'Do you want to be an owner?' You have to be a catalyst..." In the broader context, Herbers sees this as a common problem and stumbling block; today's firms often struggle around the changing roles of firm founders and advisors who were hired as the firm grew. For instance, in the early years the founder is the one who typically brings in the clients, as there is no business or revenue until clients come in; over time, though, the focus shifts to providing a consistently high level of service to keep the clients it has taken years to attract; then the nature of growth itself begins to change, from prospecting with strangers to driving referrals from existing clients. However, founders are often best at the early stages - they had the skillsets to get the business off the ground in the first place - but aren't always best at what comes to sustain the growth of the business in the later stages. Hehman calls this the "Founder's Syndrome" where the mentality is often to not change course, only address the things that have to be addressed, and then eventually the firm hits a fork in the road about whether it wants to grow or stay small. Hehman found that using outside consultants was often effective to make the case for certain initiatives and changes, and early successes led to the use of more consultants to help with various business challenges. Ultimately, Hehman pushed the founder to begin to build a management team and sell shares to them, in an effort to make the pie bigger (and justify the smaller slice); ultimately, the transition structure led to the founder selling 69% of the firm to three junior partners, who received the opportunity to buy in at a favorable price to get them excited about the purchase and growing the business.

Lowering the Boom: How to Bring In Gen X and Gen Y Clients - This article from Investment Advisor magazine covers an interesting consumer panel discussion from last fall's "Peak Advisor Alliance Excell Meeting" which features seven affluent baby boomers and seven affluent Gen Xers and Gen Yers and asked them for their views on various financial services issues. As the ensuing discussion highlighted, the expectations and interests of Gen X and Y prospective clients differ materially from baby boomers, as well as how they'd prefer to be marketed to. Notably, all the generational groups agreed that often advisors talk too much about themselves in their initial pitch, and that brevity is preferred when initially discussing fees (as one panelist stated, "if the advisor doesn't give a number pretty quick, it starts to sound as if they are trying to hide it"); the panelists also agreed about the benefits of having two advisors working directly with them, especially if each had a different approach. Surprisingly, the panelists also stated that they did not like 100% money-back guarantees; their preference was to hear something like "We'll work with you to make you happy" instead. In terms of the some of the differences, boomers indicated that they wanted to hear communication and updates from advisors regarding troubling current news (even if just to briefly reassure them), while current events were less important to Gen X/Y. Instead, the younger folks were more concerned about getting value from advisors in today's digital world, as one panelist stated that all the advisors were offering were things he/she could just do themselves. In addition, Gen X/Y were much more focused on the cost of advice than tracking the results, and in the context of results were much more concerned about investment results than getting a broader range of financial planning. The younger clientele also expected faster answers on issues, but that communication would be shorter (they outright laughed at the prospect of a 90-minute meeting). The bottom line: Gen X/Y have some very different expectations about how they'll relate to their advisors.

Have Commodities Futures Lived Up to Their Promise? - Two recent studies on the performance of commodities futures suggests that the last decade's hype about commodities being capable of producing high "stock-like" returns with low correlation to actual stocks has not panned out as expected. The original expectations that commodities would produce favorable results were driven primarily by two seminal studies in 2006 - the first by Gorton and Rouwenhorst in the Financial Analysts Journal, and the second a 63-page white paper by Tom Idzorek of Ibbotson that was commissioned by PIMCO (which subsequently launched one of the first and biggest commodities futures funds). Yes in practice, the PIMCO COmmodity Real Return Strategy fund (PCRDX) has performed poorly over the past 5 and 10 years, accentuated by the fact that it used TIPS (rather than ordinary Treasury Bills) as collateral, intended to boost inflation protection yet performing even worse as inflation has failed to materialize. Now UBS is out suggesting that commodities will be a low-return, high-volatility asset class, and Eric Nelson of Servo Wealth Management has dissected many of the commodities future funds claims and found them lacking, including that returns for commodities have been closer to about 1% above Treasury Bills per year once the returns of the bond collateral are stripped out, that commodities have had a positive correlation with globally diversified stocks (and that higher-performing globally diversified bonds were actually a more favorable negative correlation with stocks), and that when they matter most to diversify - during the global financial crisis - commodities actually lost more than equities. On the other hand, Nelson notes that annual advisor fees to PIMCO have been upwards of $16M per year to do little more than roll futures contracts, buy bonds as collateral, and provide exposure to an asset class that "probably won't do any better than a bank CD." Ouch.

Housing “Bubble 2.0″; Same As “Bubble 1.0″, Only Different Actors - From the blog of real estate commentator Mark Hanson, this article makes the interesting point that we may already be in "Housing Bubble 2.0" right now, even as consumers are just once again warming up to real estate. The key distinction is that the primary actors driving a housing bubble are different this time versus last time; while in the 2003-2007 bubble, it was all about the general consumer ("Ma and Pa") participating in the bubble. This time around, it's primarily around local area private investors and a handful of giant private equity firms. The concern, though, is that while Housing Bubble 1.0 deflated slowly, because there was still a wide base of people who have housing needs that kept "hitting the bid" on housing prices all the way down, a popping of this bubble could be more dramatic, are private investors and private equity flows can wane or reverse much more quickly. In addition, Hanson makes the case that housing affordability is actually much worse right now than it was in the last housing bubble; while affordability comparisons based on 30-year fixed mortgage rates look appealing, those types of mortgages were actually in the minority of originations during the last bubble, and when affordability is adjusted to compare the common mortgages back then (ARMs, subprime with teaser rates, no-doc high leverage exotic loans, etc.) to fixed mortgages today (given that many of the others are no longer available), affordability looks very concerning (e.g., in California house prices are down 26% from the peak in 2006, but it costs 12% more on a monthly payment to buy today's median-priced house given the mortgages used then and now). In fact, Hanson points out that affordability based on 30-year mortgage rates had actually peaked in 2002, and arguably the only reason the bubble formed from 2003-2007 was the availability of high-leverage exotic loans representing "easy money"; similarly, Hanson suggests the same thing is happening again today, except the easy money is flowing to private and institutional investors who have become the speculative buyers that are once again divorcing supply from demand. Ultimately, Hanson suggests that the housing market will "reset" once again as liquidity tightens, and that ultimately a return of true organic demand based on better affordability is necessary to set a real floor below housing prices.

Debunking The Myth Of College Rejection Rates - This article makes the interesting point that all of the media - and advisor and client - fears about how hard it is to get into college may actually be very overblown. Yes, the top tier of schools now are ultra-competitive, with Harvard at a mere 5.9% acceptance rate and Stanford at 6.6%, and even some well-regarded public universities have gotten tough, as UCLA accepts only 22% and UNC at Chapel Hill only 31.3%. Yet the reality is that only 2% of all schools reject 75% or more applications; in other words, these scenarios are very much the exception to the rule. In reality, most schools accept most students who apply to them; the national acceptance rate was 63.8% in 2011, which was only a modest decline from 69.6% in 2002 as the population of college-age people has swelled. And some of the decline in acceptance rates may simply be attributable to the fact that there are more applications bouncing around than there used to be; these days, 79% of students apply to at least 3 schools, and 29% apply to 7 or more. Notwithstanding the proliferation of applications, a recent annual survey of incoming freshman still found 76.7% were accepted by their first/top choice in 2012. And the odds may actually be getting better, as the number of high school seniors peaked in 2011 and has been declining since then, and isn't even expected to start growing again until 2020... as a result, an increasing number of colleges are actually concerned about just meeting their enrollment goals. Notably, though, competition remains tougher at the coastal schools, "since that's where kids want to be," which leaves competition higher and financial aid less generous/available. Of course, many affluent parents are especially concerned about the consequences of their children not getting into an "elite" school, yet the research suggests that there isn't much impact, and that what little earnings differences are seen between those who go to elite schools or not disappear once simply controlling for the motivation and ambition of the students; in fact, ironically, just being a student who was interested in and applied to an elite school (as a sign of ambition and motivation) was actually a better predictor of future income than whether someone actually intended!

File-And-Suspend Strategy Works For Singles, Too - An election to "file-and-suspend" Social Security benefits is a strategy normally used for married couples, where one member of the couple chooses to file-and-suspend to activate spousal benefits for the other person, while still allowing delayed retirement credits to accrue for the primary worker. However, retirement and Social Security expert Mary Beth Franklin points out that technically, an individual can choose to file-and-suspend benefits as well. What's the point of doing so, if the only outcome is just to delay retirement benefits, which would have been delayed anyway by simply not making an election at all? The difference is that after a file-and-suspend election, you can choose to change your mind and retroactively receive benefits back to your original filing date, while if you simply delay the best you can do is request a retroactive payment of 6 months of benefits if you change your mind. Thus, arguably any single person who is planning to delay benefits should still choose to file-and-suspend at full retirement age. At worst, the person will simply delay until age 70 as was originally planned, and there will be no impact; at best, though, if the person changes their mind later - or perhaps has an adverse health event that reveals it will no longer be beneficial to delay at all - it's still possible to retroactively get all benefits back to the date of the election. Notably, though, the individual has to be full retirement age (which would be 66 for today's retirees) to make a file-and-suspend election in the first place.

10 Things My Blog Forces Me To Do - While many people talk about the business growth benefits of blogging, this article from insurance advisor Frank Haney provides some interesting examples of the purely personal-growth benefits that also come from blogging. For instance, blogging - and writing down those thoughts to be shared with others - forces him to really organize his thoughts, and always be growing professionally and personally to improve the content. It also forces him to really walk his talk - after all, once you write it in a blog article for the world to see, it really strengthens the resolve to follow through! Blogging has also led Haney to grow his network, look at issues from multiple perspectives, consider life events and news from a different point of view (where it's not just about how it matters to him, but whether there's something to be gleaned and shared with others). Blogging also forces him to stay humble - growing a blog can be slow, and there will always be bigger fish in the sea - and to be more careful about thinking before acting (once you say it publicly, it's out there, so "measure twice and cut once" as the saying goes!). At the same time, it also helps to force him to weigh in versus just sitting on the sidelines and letting others define the conversation. And perhaps most beneficial, continuous blogging and writing gives him the opportunity - and sometimes forces him - to constantly reinvent himself as the message and focus continues to evolve over time. So consider how starting a blog might "force" you to be more accountable in your own professional development - if you don't have a blog already, is that something worth considering?

How The United States Is Reinventing Itself Yet Again - This article from the Washington Post Innovation column makes an interesting case for how the United States is about to go through another reinvention and renaissance, this time built around the ongoing (and yet still emerging?) digital revolution. The pessimists point out that our economy has so far just moved from the "Great Recession" to the "Great Malaise" with stubbornly high unemployment and sluggish growth despite massive government stimulus, that emerging technology has been more along the lines of Facebook - a social media company - than true technology innovation, that red tape and regulations is driving the development of drugs and medical devices overseas, and that despite mounting evidence that skilled immigrant entrepreneurs drive a wildly disproportionate share of the country's technology innovation and technology job growth, there has been no immigration reform. And of course, there's still the aging demographics problems and ballooning health costs. Notwithstanding this, authors Vivek Wadwha and Alex Salkever suggest that after peeling back the layers of the onion, the U.S. stands on the cusp of a dramatic revival, driven by what happens as the digital world permeates all industries and fields. Computer-assisted design and fabrication will slash manufacturing waste and replace nearly all conventional manufacturing with more environmentally friend and cost-effective additive manufacturing (think giant 3D printers); A/B testing and paralellization of research & development processes will become commonplace, allowing for far more rigorous testing of products and processes; dirt-cheap digital delivery platforms for educational content (along with improvements in understanding how we learn) will yield a sea change in how we gain knowledge, resulting in a smarter, more learned, constantly learning populace; energy is revolutionizing as the cost of solar has dropped by 97.2% over the past 35 years, making it increasingly cost effective as a renewable energy source (and in the interim, enhanced availability of natural gas extracted domestically via fracking is reducing energy costs). The end result of these shifts: manufacturing in the U.S. is poised for a dramatic rebound, as the benefits of cheap foreign labor are rendered irrelevant by the benefits of automation and mechanization; people will learn faster and better; healthcare costs will fall as medicine becomes more personalized; connected hardware - from cars to thermostats to appliances - will provide a stream of data to allow us to be more and more efficient. And Wadwha and Salkever predict that the U.S. will lead the way, given its abilities to adapt to, incorporate, and develop new systems and technologies. Eventually, the changes will expand worldwide as mobile devices proliferate; "A Masai warrior on a cellphone in the middle of Kenya has better access to knowledge than President Reagan did 25 years ago."

A Simple Tactic To Get Your Clients Engaged With Their Financial Plan - This article makes an interesting point about the value of engaging clients visually in their financial plan. The author starts out with a story of how, in a prior job, she was required to create a "dream chart" where each staff member would make a collage of personal and professional goals - which her "skeptical, logical, analytic brain" resisted. Yet after eventually acquiescing, she found that the process of having created the dream chart was actually quite valuable; seeking out appropriate images that represented her goals forced her to focus on and really refine her goals, painted a clearer (and more motivating) picture of where she was trying to go, and got her more emotionally involved with the goals. While the concept was applied in an employment context, though, there's no reason that such an approach couldn't be incorporated into a financial plan (or as part of the "Statement of Advice" as the plan documents are called in Australia where this blog originates). Thus, for instance, imagine if the cover of the financial plan wasn't just a list of the names of clients, but a picture of the people of them and the family members most important in the plan (e.g., parents and children); similarly, what if goals weren't just articulated as written goals, but the written goal was simply the caption to a vacation image that the clients had selected as their real goal. Once established, review meetings could then recall and revisit those images to help keep clients motivated towards action, and a conversation around how they're progressing towards achieving those images. In fact, the planner could even make postcard-sized representations of key goals to give clients to carry around with them as a constant reminder, and something they can mark up/check off/move-to-completed when the goal is achieved. And of course, this kind of client experience is also something that could get clients talking to their own friends and family... which means referrals as well. Of course, it may be difficult to get clients to fully engage in this process - after all, the author herself was resistant for months in an employment situation before acquiescing - but would you at least consider trying it for one single client, just to see how it goes?

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 new Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!

I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!