Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - this week's edition starts out with the news that Republican Spencer Bachus has signed on as a co-sponsor to Democrat Maxine Waters' proposed legislation to establish SEC user fees that would help fund increased investor adviser oversight; while there still isn't likely to be anything passed into law in the immediate future, the announcement suggests that there may be some traction building for the user fee approach to close the examination gap as the SEC remains underfunded. Also in the news this week was an announcement that the SEC is considering whether to update the definitions for Accredited Investors (which still haven't been updated, or even adjusted for inflation, in more than 30 years since they were first established in 1982!), and a new round of fighting between the American College and the CFP Board as the American College announced updates to its ChFC curriculum to 'compete' with the CFP certification and the CFP Board responded by noting that the ChFC still doesn't require a comprehensive exam (amongst other differences).
From there, we have a firm retirement planning articles this week, including some recent research suggesting how a focus on combining partial annuitization with portfolios may be a better way to frame annuities than the typical all-or-none discussion, a look at how cash balance plans are exploding forth in popularity and are already approach $1 trillion in retirement assets (compared to about $4 trillion in 401(k) plans), and a powerful discussion of how retirement is a joy for many but also a time where the depression and suicide rate for men doubles and advisors may be one of the few in a position to intervene and encourage a client to get help.
We also have several practice management articles this week, including a look at the FA Insight "People and Pay" study that finds team-based firms are growing more rapidly than firms that run in silos, a discussion from Angie Herbers about how the real challenge for existing advisory firms to grow is not about "making rain" and generating new prospects but about improving the closing ratios the prospective clients firms are already getting via referrals, and the last reporting on a recent industry survey that finds - despite all the discussion of the coming wave of retiring advisors - that there are still twice as many buyers as sellers in the next 1-5 years, suggesting that it's actually still very much a seller's market for the few firm owners that are willing to sell at all.
We wrap up with three interesting articles: the first looks at the challenges of businesses that have "co-founders" who struggle to keep their business and personal interests aligned as the business grows (while written in the context of co-founded startup tech firms, the challenge seems equally relevant for advisory firm partnerships as well!); the second examines some of the latest research on motivation, which finds that not only is internal motivation better than "external" factors like incentivizing with money and fame, but that offering too much in external incentives can actually damage the outcomes of otherwise-internally-motivated people (so think through your compensation structures carefully!); and the last is a discussion of the so-called "End of History Illusion" and recent research that finds we're actually terrible at predicting our personality, values, and preferences more than a decade into the future... which raises interesting questions about how to effectively save for retirement in the long run when you really may not have any idea what you'll want to do in retirement until you're almost there!
Enjoy the reading!
Weekend reading for July 19th/20th:
Rep. Bachus Backs Waters' User-Fees Bill - Proposed legislation by Representative Maxine Waters that would implement user fees on RIAs to help fund increased investment adviser exam frequency for the SEC appears to be gaining some traction, as Republican Rep. Spencer Bachus signed on this week as a co-sponsor to the bill, H.R. 1627 (the Investment Adviser Examination Improvement Act of 2013). For the past year since it was introduced, the legislation has languished without any Republican support in the Republican-led House. At this point, the next step would be for the full House Financial Services Committee to convene a hearing to consider the user fee proposal (along with others), which Waters has been calling for, though Committee chairman Jeb Hensarling has not moved forward yet, simply stating "I intend to give the request the attention it deserves." While ultimately it still appears unlikely any real action will occur in the near term, the bipartisan support for user fee legislation in the House is significant, especially when coupled with the recent recommendation from the SEC's Investor Advocate also calling on Congress to enact a user-fees bill to improve investment adviser exam funding. In the meantime, though, the SEC remains underfunded, and a proposal to attach Rep. Waters' user fees legislation onto a recent spending bill was blocked by Republicans.
SEC Investor Advisory Committee Mulls ‘Accredited Investor’ Criteria - The SEC and its Investor Advisory Committee is exploring ways to potentially update the Accredited Investor rules, particularly as they apply to "natural persons" (i.e., individuals, as opposed to institutional investors), in light of the fact that the original rules were written more than 30 years ago (in 1982) and haven't even been updated for inflation over the intervening decades. Barbara Roper, director of investor protection for the Consumer Federation of America and the head of the Investor as Purchaser Subcommittee, notes that inflation adjustments alone would make requirement for $200,000 of income in the past two years (or $300,000 of joint income with a spouse) more like $500,000 (and $700,000 for couples) in today's dollars. Another committee member noted that when the rules were written, most investors had little in the way of self-directed retirement accounts, and that an update to the rules might exclude (or "back out") retirement assets to meet the other Accredited Investor requirement of a $1,000,000 net worth (which also already excludes the value of the primary residence). Under the Dodd-Frank Act, the SEC is supposed to evaluate its accredited investor definition every four years, and given the upcoming first four year anniversary since the passage of Dodd-Frank, the SEC is beginning to take a fresh look at the definition and take input for how it might be modified. Ultimately, Roper's subcommittee is aiming to have a formal recommendation regarding modifications to the Accredited Investor definition to the full SEC Investor Advisory Committee at its upcoming October 9th meeting.
Redesigned ChFC Mark Aims To Top CFP Education - This week, the American College announced that it is revamping the Chartered Financial Consultant (ChFC) designation to focus more on applying strategies to client situations, and will also be introducing new coursework on "topical" issues like divorce, retirement income planning, and concerns specific to same-sex couples; overall, the program will switch from offering some electives for its program to a series of nine required courses. The American College claims that the updates to the program will make the program more advanced and more "hands-on" than the CFP curriculum; the College will also add material on "applied legal and ethical principles", including a discussion of duties of an advisor under suitability and fiduciary standards (and when they conflict), and reiterated its "compensation neutral" focus with respect to its material and designation, highlighting the criticism the CFP Board has drawn over its compensation definitions in the past year. In response to its ChFC announcement, the CFP Board fired back at the American College this week as well, noting that the ChFC still does not have a formal code of ethics that it enforces, nor a comprehensive exam, and points out that the CFP curriculum is also updated over time, based on its regular job-task survey process to affirm that curriculum updates actually align to what practitioners face in the actual execution of their role as a financial planner.
How to Frame Annuities More Attractively - For nearly 50 years now, economics researchers have recognized that lifetime annuities are one of the most efficient vehicles for funding retirement, and that retirees should probably convert far more of their assets into income annuities at retirement than they actually do; the gap between what retirees theoretically "should" do and what they actually do is so significant, it was acknowledged in Modigliani's Nobel Prize acceptance speech in 1985, and has since been dubbed "the annuity puzzle". A recent paper from the Journal of Public Economics entitled "What Makes Annuitization More Appealing" explored this issue, and tried to offer some suggestions about what might be done to convince retirees to take greater advantage of income annuities, recognizing that just changing defaults alone may not be enough (as even when a pension is a default in a defined benefit plan, as many as 50%-75% of retirees still take a lump sum when able to do so). Some changes offered up from the research to improve use of income annuities included: offer partial annuitization, rather than framing as an all-or-none choice (though in practice, retirees "could" partially annuitize their wealth any time they wish, yet few choose to do so); discuss annuities more as an income guarantee solution, rather than as an investment product (and generally, de-emphasize investment attributes); and address concerns of potential insurance company default by recognizing financial strength of insurance companies and the state guaranty funds that help to back them. The bottom line: while these changes may not lead to full adoption of annuitization as a retirement income strategy, how they're framed and presented can still have a significant impact on their use.
The Fastest Growing Retirement Plan You Never Heard Of - This article looks at the surging growth of cash balance plans at large employers, as the ongoing shift away from defined benefit plans continues. Based on the latest (2012) data from the IRS, cash balance plans now have nearly $1 trillion in assets (compared to "only" $4 trillion in 401(k) plans), and grew by 22% in 2012 (compared to only 1% for 401(k) plans, albeit growing from a lower base), and are concentrated in a relatively small number of companies; while there are nearly half a million 401(k) plans, there are fewer than 10,000 cash balance plans, and just IBM and AT&T alone account for nearly $100B of cash balance plan assets. The plans aren't only for large corporations, though; some well-known hospitals use them, as well as large law firms, and ultimately 87% of cash balance plans are being used with companies that have fewer than 100 employees. In the large employer marketplace, the appeal for cash balance plans has been the opportunity to better control funding obligations, as the fixed rate of return that employees earn eliminates the need for companies to constantly recalculate their liabilities and obligations based on fluctuating equity performance. With small employers, the appeal is the age-weighted contribution rules that allow business owners to put away large (pre-tax) contributions in relatively few years, and to be able to make those contributions on top of take-home pay (rather than needing to reduce take-home pay to get money into the retirement plan, as is the case for 401(k) salary deferrals and maximizing employer matches). Notably, though, cash balance plans are being used in most businesses as a retirement plan supplement, rather than as an alternative; 96% of all companies offering cash-balance plans have some type of defined contribution plan as well.
The Secret Sadness Of Retired Men - In Investment Advisor magazine, this article reviews the growing base of research finding that retirement significantly increases the risk of clinical depression and even suicide amongst men. The most common trigger of depression in older men is loss, which includes not only the potential death of a spouse or peers, but also "losses" that are often associated with the retirement transition, including the loss of work relationships, moving away from lifetime attachment to home and friends, and even losing a sense of identity and self worth if they attached their value to the work that they have left. The problem is exacerbated by the fact that men are often reluctant to seek help or even raise the issue, due to stereotypes about masculinity that often lead men to feel they must hide their depression or feel ashamed of it, which only compounds the problem further. Given these challenges, advisors should be alert to the signs of depression - which can include not just "feeling blue" and losing a sense of pleasure, but changes in sleeping and eating habits, increased drinking, more irritability and aggression, or other changes in personality. Unfortunately, some of these changes can also be triggered by physiological issues, including the beginning of dementia and Alzheimer, but either way planners witnessing these concerns in their (male) clients should confront the issue, making themselves available as a listener and even suggesting a professional therapist, counselor, or pastoral advisor, or calling in a spouse or adult child. While it can be difficult to catch depression and suicidal tendencies sometimes - even trained professionals can fail to detect the risks - the article emphasizes that it's important not to ignore clear signs and gut feelings, especially given that men commit suicide at four times the rate that women do (and the rate doubles again between the ages of 65 and 85), with the greatest times of risk being right after the retirement transition, and at the death of a spouse.
Team Up to Stand Out: The 2013 People and Pay Study - According to the FA Insight "People and Pay" study, the industry's best and biggest firms are three times more likely than otherwise-similar large firm peers to maintain a team-based service structure for client; however, proper structure for teams is crucial, as a badly executed team can damage (rather than enhance) the client experience, and a dominating portion of an advisory firm's payroll is typically spent on its advisors. The FA Insight study finds that while 80% of advisory firms now have more than one advisory professional, and the majority do work collaboratively in some manner (though a few remain in standalone "silos"), most "team" work is actually ad hoc collaboration of multiple professionals across the firm serving a common client, and only about 11% of firms truly run multiple dedicated teams that each have their own distinct client base. In fact, the results suggest that most firms start out with ad hoc firm-wide collaboration as they initially grow and add professionals, and then ultimately evolve to silos or teams as the firm gets even larger. When examining these three different "types" of firms - silos, firm-wide collaboration, and dedicated teams - the study found that: silos facilitate independent of firm professionals and have strong profitability due to low overhead costs (given that there are fewer non-professionals supporting each advisor), but owner income is not always as strong and the firm may struggle to grow a cohesive brand (as each silo services clients differently) and struggle with a broad base of advisors who are all generalists; firm-wide collaborators often do a better job leveraging all the resources and specialties of the firm, but tend to struggle with standardizing servicing procedures and workflows, leading to higher overhead expenses and lower operating profit margins; team-based firms (with sufficient scale) appear to enjoy the most benefits though, including the highest professional productivity and lowest overhead expense margins (by ensuring team members are all focused in their highest/best use), strong profitability and revenue growth, and better sustainability as teams provide more natural career paths for new professionals to grow and develop within the firm. Although exact team structure does vary from firm to firm, the "typical" team is comprised of a lead advisor, an associate advisor, and a client services associate, all working with a specific dedicated base of clients.
The Death of the Rainmaker - From the latest issue of Investor Advisor magazine, this article by practice management consultant Angie Herbers points out that for many advisory firms that are struggling to grow, the real problem is not their ability to generate prospective clients but that their rate of turning those prospective clients into actual clients is very low. In other words, the problem is not about how to do a better job "making rain" and getting more prospect, but in how to solve the challenge of low client closing ratios. In fact, Herbers suggests that many owners of successful advisory firms today and fixating far too much on the ability (or lack thereof) for their future successors to "make rain", failing to recognize that while in the early years of a firm the key to success is just getting new clients in the door at all, with established firms it's more about providing the great service necessary to drive referrals, essentially turning the clients themselves into the "rainmakers" of the firm. In turn, though, this means that while successor owners might not have to make rain (in larger firms, the entire marketing and sales function is split apart from the advisory function), someone does still have to close prospective client (referrals) that come in. Herbers advocates a three-step closing process, where the first meeting is about "discovery" (advisor learns about clients, and clients learn about the advisor/firm), the second is about "possibilities" (what do the clients need, and how can the firm help), and the third meeting is a final attempt to close the client (if they don't sign up at the end of the second meeting). Herbers also notes that the key for turning younger/newer advisors into "closers" is to simply have them focus on talking about the process of what they do for clients, and let the clients who value that process sign themselves up.
It’s a Seller’s Market - Notwithstanding all the discussion for years of the impending retirement of a massive wave of financial advisors, this article notes that in today's environment it's still a seller's market for advisory firm owners who actually want to sell their practice, and the trend doesn't appear poised to shift anytime soon. While there are about 15% of advisors who state that they expect to retire or sell their firm in the next 1-5 years, a whopping 29% of advisors say they have plans to buy a firm over the same time period (according to a recent survey from the Financial Services Institute). David Grau Sr., of FP Transitions, suggests from the data on their platform for buying and selling advisory firms that the numbers may even be more unbalanced; for example, a fee-based practice in Boston bringing in $250,000 in income (of which 70% is recurring revenue) would get 50-70 interested buyers in less than a week! The driver, as Grau notes, is that ultimately not a lot of advisors are actually selling their practices when the time comes (Grau estimates only about 8%), and far more are realizing that they can take home far more income by simply converting their business into a lifestyle practice and taking home a healthy income, rather than selling all at once for 2X revenues (if they can even get that much) and then walking away; of course, many advisors also love what they do, and don't want to leave anyway! Ultimately, the imbalance may even out - in 6-10 years, the FSI survey indicates that 24% of firms plan to buy, while 29% plan to sell - though it appears that it may remain a seller's market for the foreseeable future, especially as more and more advisors reach retirement age and realize that financial advising is something that is still emotionally and financially rewarding - and feasible - for them to continue doing.
The Perils Of Founder Fighting - This article looks at the challenge of having "co-founders" for technology companies, and the problems that often arise over time as goals and desires change (or turn out to not be aligned in the first place). Perhaps one co-founder has more risk tolerance to make aggressive moves with the business, while the other is more conservative. Maybe one wants to build a company that will last the test of time, while the other just wants to build a business to sell and make some big bucks. Perhaps one founder starts to change his/her lifestyle as the business grows, and ultimately becomes more interested in socializing and enjoying their money than actually building the business and serving clients/customers. The article shares several "sample" (from the author's real world experience) stories of co-founded businesses where the partners had to split, sometimes with adverse consequences for the business and often with permanent damage to the original relationship, such as a scenario where one co-founder was the CEO and the other was the "Chief Product Officer" (as there can only be one CEO), but after a few years the non-CEO co-founder became jealous of all the attention that was focused on the 'more visible' CEO co-founder and the resentment began to impact business decisions as well. Ultimately, the author suggests that executive coaching and mediation can be crucial to work through these kinds of differences, which will almost inevitably evolve over time simply given that human beings are involved! And while the article is written in the context of technology companies that are co-founded, it arguably has a lot of parallels to financial advisors who launch/co-found advisory firms as partnerships as well.
The Secret of Effective Motivation - According to the research, there are two kinds of motives for engaging in any activity: internal, and instrumental. An example of an internal motive would be a scientist who conducts research simply because she wants to discover important facts about the world (more generally, the desired outcomes are inherently related to the activity itself); by contrast, an instrumental motive might be a desire to do the research for the chance to achieve scholarly renown (an outcome that is external to the research itself). In practice, most people have both internal and instrumental motives for what they do, and it's now commonly known that internal motives in particular can be very powerful for achieving outcomes. However, the question arises: what if someone has internal and instrumental motives? Are two better than one, or do they actually conflict? A recent study found that those with a combination of both motives actually fared worse than those who specifically had a strong internal but weak instrumental motive. What's notable about the result is not merely that the presence of strong instrumental motives can overwhelm a strong internal motive, but raises the concern that improper incentives which stoke instrumental motives could actually lead to worse outcomes and performance. For instance, in the military if recruiting soldiers for "military excellence" and "service to country" (internal motives) fails to attract enough people, an appeal for "money for college" or "career training" or "seeing the world" (instrumental motives) might bring more recruits but could result in worse soldiers; similarly, compensating teachers based on standardized tests could be turning their internal motives (teaching for the sake of teaching) into instrumental motives (teaching for the test) and undermining the outcomes due to poorly structured incentives. The bottom line: having favorable instrumental outcomes (a job well done leads to financial or other reward) isn't necessarily a bad thing, but be cautious about turning the focus so much to instrumental outcomes that it undermines someone who was already internally motivated.
Saving for Bucket List That’s Likely to Evolve in Years Before Retirement - This article by Ron Lieber of the New York Times looks at the so-called "End of History Illusion", a phenomenon where despite recognizing how much our personality, values, and preferences have changed in the past, we often fail to recognize how much those things will continue to change in the future. We seem to be inherently biased to believe that our preferences today are far more stable than they actually are, ostensibly because if we really thought our preferences would be different in the future we'd just change now instead. In the context of retirement, this is a significant challenge - it means that our desires for things like certain (types of) vacations, hobbies, and even friends may change significantly in the time from when we are still saving for retirement until we actually do retire. In turn, this suggests that clients (and their advisors) should be cautious about overemphasizing a certain vision of retirement even if it's something the prospective retiree thinks they'll enjoy (based on what they like to do today), especially for clients under the age of 50 who still have 10+ years until retirement. Fortunately, recent research has shown that overall our retirement spending tends to decrease throughout retirement, which indirectly allows more room for other expenses and spending preferences to shift during the retirement years. Nonetheless, the research still emphasizes the fundamental point: it can be very hard to save for a "bucket list" for retirement, if you're not certain what you will even want on the bucket list when the time comes!
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!
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.
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