Weekend Reading for Financial Planners (January 20-21)

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth, which provides an evidence-based approach to private wealth management for near- and current retirees, and Buckingham Strategic Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors through the scaling phase of growth.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

Read all of Michael’s articles here.

Weekend reading for January 20th – 21st:

BlackRock’s Message: Contribute to Society, or Risk Losing Our Support (Andrew Ross Sorkin, New York Times) - This week, Blackrock founder and CEO Larry Fink sent a message to business leaders across the nation: make a positive contribution to society (in addition to delivering financial performance), if you want access to Blackrock capital. Which matters, because Blackrock now manages more than $6 trillion of investments through everything from 401(k) plans to ETFs and mutual funds, making it the largest investor in the world (and one with an outsized influence on the selection and removal of public company board members). Fink suggests that this shift is simply an acknowledgement that society itself is increasingly looking to the private sector to step up and respond to broader societal challenges, as governments themselves are not (in Fink's view) effectively preparing for the future (on issues ranging from retirement to infrastructure to automation and worker retraining). Yet when the world's largest investor makes this demand, it's hard for publicly traded companies not to pay attention, and the call-to-action may compel other investment managers to take up a similar position or risk being left behind. Which raises questions not only about whether or to what extent investors really can compel companies to be more socially responsible when the time comes, but also whether socially responsible investing may soon become so "mainstream" that it will no longer be relevant to rate investment managers on sustainability and cease to be a distinct investment category with any outperformance potential at all; after all, when all investors follow an SRI approach, they become the market itself!

FINRA Releases Budget For First Time, Foresees Declining Operating Revenues (Mark Schoeff, Investment News) - After years of being criticized for opacity regarding its revenues and expenditures, FINRA this week released its first-ever publicly available 2018 Annual Budget Summary, which highlights that even FINRA recognizes that the broker-dealer community is now in aggregate decline. Revenues are projected to decrease by about 1% (to $822M in 2018), to their lowest levels since 2013, even as expenses are projected at $888M... which, on top of nearly $90M in projected capital expenditures, means that FINRA will need to take a whopping $136M out of its reserves to cover the shortfall (while still maintaining at least one years' worth of expenditures as a reserve, which means FINRA is still reserving nearly $1B in cash). At the same time, FINRA is notably not increasing its assessment on broker-dealers this year (despite the shortfall), while also reducing incentive compensation and holding senior officer salaries flat (again for the 3rd year in a row). The shifts appear to be part of a broader initiative of new FINRA CEO Robert Cook to "right-size" FINRA, given both the declining number of broker-dealers (down nearly 10% in just the past 5 years), and the fact that with broker-dealer margins continuing to erode there simply isn't room to keep pushing through fee increases. And while the new budget summary still doesn't provide full transparency about how FINRA utilizes its substantial cash flows, the budget does at least provide some further details into key areas (e.g., that FINRA fines have been used in the past to fund technology improvements), and FINRA has committed to provide a "full accounting" of how fine money is being used as a part of its next 2018 annual report.

SEC's In-House Judges Draw Scrutiny From U.S. Supreme Court (Greg Stohr, Bloomberg) - The Supreme Court has announced that it will hear the case of Ray Lucia v. SEC about whether the SEC's in-house administrative law judges are being appointed in a manner that violates the Constitution. Lucia was fined $300,000 and barred from working as an investment adviser after an SEC judge found that he misled prospective clients with inappropriate assumptions in the projections for his "Buckets of Money" (retirement bucketing) strategy, but sued the SEC claiming that its judges should be treated as officers (which must be appointed) rather than employees (which the SEC can hire internally). The decision came in part from a request by the Trump administration, which indicated last November that it would no longer defend the SEC's system. Ultimately, if Lucia wins, it may force the SEC to (re-)appoint all of its judges, which could substantially delay current and pending cases before the SEC (and even ripple to other government agencies that use a similar structure). In the long run, though, the expectation is that by having a clearer and more independent appointment process, the SEC's administrative law judges will be more independent (and potentially less inclined to side with the SEC as their "employer").

The Wrong Way To Split An IRA In A Divorce (Ed Slott, Financial Planning) - It's typical to split assets in a divorce, but due to the special tax-deferral treatment associated with pre-tax accounts like IRAs, special rules apply to ensure that assets can be split properly and without any tax consequences... and failing to follow them can result in adverse tax consequences, even if both parties intended to do it properly, as was recently illustrated in the Tax Court Memo 2017-125 (the case of Jeremy and Karie Summers). In this case, the couple decided to split Jeremy's IRA, and use the proceeds to repay Karie's existing debts as a part of the divorce; however, the couple liquidated the IRA in April of 2013, before the divorce itself was finalized in June of that year, and as a result the IRA distribution was both taxable and subject to an early withdrawal penalty. And the penalty couldn't even be avoided by being deemed a QDRO (Qualified Domestic Relations Order) payment to an alternate payee, because QDROs only apply to employer retirement plans (and not IRAs), though the matter was further complicated by the fact that the IRA was liquidated into the couple's joint account and then half was transferred to Karie (which means the IRA clearly was not paid directly to an alternate payee anyway). The key takeaway lessons: 1) for an IRA to be divided without triggering a tax consequence, there must be a divorce decree in place before the transfer (a casual agreement between the couple is not sufficient, and the funds must move after the divorce is finalized); 2) QDROs do not apply to IRAs (including SEP and SIMPLE IRAs), and are only meant to be used for ERISA plans; and 3) even when an IRA is properly split in a divorce, there is still no exception to the early withdrawal penalty if the funds are actually liquidated by the receiving spouse (as the 10%-penalty-exception for a divorce withdrawal applies only for a QDRO from an employer retirement plan).

Cash Reserve Buffers, Withdrawal Rates, And Old Wives' Fables For Retirement Portfolios (Abraham Okusanya, Finalytiq) - As the concept of "sequence of return risk" has become increasingly popular in recent years, so too has the strategy of setting aside a large cash reserve as a "buffer" to help mitigate the impact of a market downturn (by providing an alternative source of cash that eliminates any need to sell from equities when they're down). Yet despite the intuitive nature of the strategy... prior research using U.S. data has shown that it rarely actually helps mitigate bad sequences! To further test the strategy, Okusanya uses his Timeline safe withdrawal rate software to test the cash reserve strategy using a globally diversified portfolio (global stocks and global bonds) and whether adding a 10% cash allocation (equivalent to 2-3 years' worth of spending) actually helps, with a series of 11 different rules for utilizing the cash buffer account (e.g., from withdrawing evenly across all asset classes, withdrawing from cash first and then bonds and then equities, using equities when markets are up but cash when markets are down, etc.). Results are reported in terms of both success rates (and probability of failure), how long the portfolio lasts (in the 10th percentile scenario), and the median portfolio balance after 30 years. The results reveal that at a 4% initial withdrawal rate, the best strategy is actually to liquidate bonds first while not rebalancing at all (a form of rising equity glidepath where equity exposure increases over time throughout retirement), and that cash buffer allocations actually reduce the success rate across the board (even if cash is used first), producing both lower withdrawal rates, shorter portfolio longevity, and lower median account balances. In essence, the problem was that "mere" rebalancing, and the availability of bonds, is already more than enough to mitigate market declines, and that a multi-year cash allocation ultimately just drags down long-term returns (eventually reducing the success rate and/or longevity of the portfolio). Of course, if a cash allocation helps clients to not panic and sell, it may still be worthwhile; as Okusanya puts it, "while cash might not help mitigate sequence risk, it does help with mitigating stupidity risk!" Although ironically, Okusanya finds that if a substantial cash allocation will be held, it's better to use the cash to replace bonds, which does result in slightly lower wealth accumulations in the good scenarios (given that bonds underperform cash on average), but can slightly mitigate some adverse scenarios (i.e., the longevity of the portfolio in some of the worst case [inflationary] scenarios).

Integrating Home Equity And Retirement Savings Through The "Rule Of 30" (Peter Neuwirth & Barry Sacks & Stephen Sacks, Journal of Financial Planning) - A common debate amongst retirement advisors is whether or to what extent the value of a primary residence should be included as part of the available retirement assets. In some cases, there is a preference to hold the value of home equity aside as an implicit reserve, and just not count it unless it's needed. In other cases, there's simply no feasible way to tap that available home equity in the first place. But with the rise of reverse mortgages, it is now possible to tap existing home equity as a coordinated part of an overall retirement plan. Which matters, not only because it adds a potentially substantial asset to the retirement balance sheet, but also because tapping home equity earlier rather than later through a reverse mortgage can actually allow a portfolio to remain invested longer, potentially further increasing long-term retirement sustainability. And Neuwirth et al. find that the effect is, not surprisingly, especially material for those who really need their home equity in retirement, including those who otherwise haven't saved enough, and those who are especially "house rich and cash poor" (with a substantial net worth that is mostly or fully tied up in the value of the primary residence). Of course, limitations on the amount of home equity that can be tapped through a reverse mortgage means that not all of the home's value even can be tapped (nor would it necessarily be desirable to do so). Nonetheless, the authors find that planning to coordinate home equity as a part of the overall plan, by opening up a reverse mortgage line of credit to be tapped later as needed, and then tapping withdrawals based on a "Rule of 30" (a withdrawal rate that is 1/30th or about 3.33% of the total of all retirement and home equity assets, as contrasted with a 4% rule that is 1/25th of just the retirement assets alone) can be sustained in a wide range of scenarios.

Need Marketing Ideas? Ask Your Target Audience (Kali Hawlk, Journal of Financial Planning) - While many financial advisors spend little time at all on marketing, there's little that is more frustrating than actually deciding to make a commitment for more proactive marketing, pouring your energy into a new initiative (whether an in-person event, an article, a social media ad, or something else)... and then getting zero results. Yet Hawlk points out that in practice, this is an all-too-common outcome for financial advisors, because most advisors start with a great marketing idea and try it, instead of starting with their target clientele and what they actually want (and indicate they will respond to) in the first place. Of course, it can be really hard to brainstorm and figure out what prospective clients will want... unless, as Hawlk notes, you simply ask them! The starting point, though, is to clearly define and understand who your target clientele are in the first place – what are their demographics (age, gender, ethnicity, location), their psychographics (their beliefs and aspirations), their pain points and challenges, their preferences and habits, and their common objections. By having this information in mind first, it's then far easier to figure out what they want, and what will resonate with them. In fact, once you've clearly identified your target audience, you can even go to other existing message boards or social media channels, and see what they're talking about, to better understand their needs and concerns, from online forums to Facebook groups or even Reddit channels. From there, delve deeper into the niche by inviting some of them out to coffee or lunch – not to make a sales pitch, but simply to (truly) learn more about them, their concerns, and their needs. Alternatively, if your ideal prospects aren't necessarily local or easily reached for a meal, you can also email them – but instead of a survey, try simply sending an email that starts a conversation by asking them a question and inviting them to reply... you'll likely get more valuable feedback, and it's more engaging for them, too!

Six Steps To Becoming A Magnet For Exactly The Right Clients (Julie Littlechild, Absolute Engagement) - In recent years, there has been a growing buzz and focus on how "elevating the client experience" can be a real differentiator for advisors. However, Littlechild notes that, in practice, few advisors have actually figured out how their client experience can actually differentiate them! In part, the confusion may stem from the fact that most advisors confuse the idea of "client experience" with client service instead. But client service is ultimately just about delivering the basics of what clients want and expect in their interactions and communication with the firm, and doesn't necessarily differentiate the firm (i.e., do you really think you'll be materially differentiated from other advisors because you meet with clients 3x per year instead of twice per year?). The client experience, on the other hand, is about "how every part of the business is organized to meet the unique needs of your clients". Which Littlechild suggests exploring and figuring out by asking a series of questions (of yourself and ultimately your clients): 1) Who, exactly, is your client experience designed to support (e.g., business owners have fundamentally different needs and expectations than retirees); 2) What is the client's journey? (How exactly does that ideal prospective client find their way to you in the first place?); 3) What does an extraordinary experience look like through the eyes of your clients? (Hint: don't ask clients about what you can do differently/better, ask them to describe an extraordinary client experience and then try to understand why they thought of it and what you can learn from it!); 4) How can you structure a communications plan that sets you apart? (From the client's perspective, what do they really want to know and hear about?); 5) Is your client experience reflected throughout your business? (Consider doing an "audit" of each step in how prospects and clients interact with the business, and see how it feels to experience it.); and 6) How do you know if you're succeeding? (i.e., figure out what you can measure to know if it's working, and then measure it!)

Can't Versus Don't, Either One Can Work (Stephen Wershing, Client Driven Practice) - When trying to differentiate yourself with a niche or specialization, ultimately it comes down to setting yourself apart by either: 1) doing things that other advisors don't do; or 2) doing things that other advisors can't do. The "can't" category includes services that others just don't have the capability to offer in the first place – for instance, a technical competency or skill that other advisors don't have, such as being an expert in the local county's deferred compensation plan for public safety workers (in a world where other advisors haven't invested the time and knowledge necessary to develop such expertise and consequently can't match the value). On the other hand, the "don't" is simply about doing something that other advisors don't do in practice, such as utilizing Mind Maps as a way to communicate with clients. Notably, it's feasible to differentiate by either delivering services that others can't, or don't; in either case, clients who value that particular solution will be more likely to work with you, and to refer others who may value it too. Although Wershing does note that in the long run, the "can't" differentiators are stronger than the "don't" variety, precisely because they're harder for other advisors to replicate and take your differentiation away! What's most important, though, is simply to have a strategy of doing something that makes you different than the other advisors who can't, or don't, do the same for their clients, too.

Why Feeling Uncomfortable Is The Key To Success (Rick West, FreeCodeCamp) - By definition, it's uncomfortable for us to get out of our comfort zone, but the reality is that "if you want something in life that you have never had, you will have to do something that you have never done." Which means, notwithstanding the flood of self-doubts that may come, it's essential to get out of your comfort zone in order to grow and break out to a new level of success. In fact, the very effort of doing so often begins the process of personal growth and developing new skills, without even realizing it; after all, those who are out of work but suck it up and apply for every job they can, potentially facing one rejection after another, also can learn better interview skills, gain experience, and get vital feedback that makes the next interview – the one that might actually be the dream job – go even better. And the same is true once you have a job or career as well; projects will come along that may require you to use skills you dislike, or don't have... but again, you can't progress to new levels of success by simply falling back on your comfort zone and using the skills you already have to do the work the way you've always done it. Ultimately, West suggests that this means we have to "get comfortable feeling uncomfortable"... because virtually all opportunities are likely going to be at least partially outside of our current comfort zone, which means staying there in your comfort zone will mean never stepping into the opportunities for greater success. In fact, arguably one of the greatest common facts of those who have substantial long-term success is their willingness to never stop pushing their own boundaries and limits! Which not only helps us to move forward and grow... but can even be an inspiration to help others, too!

The Four Elements Of Entrepreneurship (Seth Godin) - There's a common view that successful entrepreneurs are simply people born a certain way; the young girl who at age 14 hitches a ride to Costco, buys 100 bottles of water for $0.30 a piece, and sells them at the beach for a dollar each, or the software geek who repeatedly just finds a niche, gets some funding, builds a solution, sells it for a big payday, and then starts over again. But Godin suggests that ultimately these aren't people who are entrepreneurs, per se... they're people who are acting like entrepreneurs, because entrepreneurship is more of a verb, or an action, or a posture, than just something you're born as (or not). From this perspective, people who are acting like entrepreneurs are those who make decisions, invest in activities and assets that aren't a sure thing, persuade others to support a mission with an uncertain outcome, and they embrace (instead of running away from) the work of doing things that might not work. Notably, this means that some "traditional" paths of entrepreneurship are arguably less entrepreneurial; buying into a franchise may seem like starting a business, but ultimately it has little of any of the four elements of entrepreneurship. On the other hand, it also means that the essence of entrepreneurship is really just about being willing to embrace and step into the uncertainty... because almost all of the rest of growing an entrepreneurial business is something you can hire, and the four factors may not feel as scary when at least it's "your" business and you're in control of how you handle the four essential aspects of entrepreneurialism. Or stated more simply, entrepreneurialism isn't about size and scale... "it's about a desire for a certain kind of journey".

Becoming Your Future Self (Leo Polovets, Coding VC) - One of the biggest challenges that entrepreneurs face in a successful and rapidly growing business is their ability to scale up personally to meet the ever-growing needs of the business. Yet as the famous saying goes from executive coach Marshall Goldsmith: "What got you here won't get you there"... which means it's essential for founders to be cognizant that they don't become the bottlenecks in their own businesses. Unfortunately, though, most founders do become the bottleneck at some point, most commonly by either not recognizing that they may actually be bad at some parts of their job that they need to let go (e.g., the technical expert who is a great manager but not good at recruiting), or because they're outright unwilling to delegate (e.g., being a technical expert who doesn't let go of reviewing the work of everyone below them, eventually becoming a blocking point to getting anything done), or because they don't realize that they may be good at their job but not great at it (and therefore fail to either reinvest to improve their skills, or hire around themselves to get someone else who is even better). In some cases, though, the problem is that the founder doesn't even realize he/she is the bottleneck. If you're uncertain, listen to your gut to figure out if you're really underperforming (or if it's just Imposter Syndrome), do a 360-degree review, solicit anonymous feedback, or hire your own executive coach to get more candid feedback. Ideally, though, the best way to avoid a bottleneck is to not let it happen in the first place, which Polovets suggests you can avoid by visioning what your job will look like in several years after the business has grown to a substantially larger size, and figure out what responsibilities you will no longer have and what new ones you will need to have... and then start figuring out how to chart your course to get there (where you might need to do less technical work and more managing, or less managing and more recruiting, etc.). Once you set a vision to where your role is going, you can then take a step back to figure out what you need to do between now and then to get there – will you improve your skills, delegate responsibilities, step aside entirely in certain areas, or (if necessary) transform yourself altogether to step into the new role that you must fill to take the business level?

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.