Weekend Reading For Financial Planners (July 1-2)

NAPFA Rewrites Its Fee-Only Rules To Lift Membership Ban On (Limited) Trailing Commission Revenues

(Lisa Shidler | RIABiz)

As the financial advice industry has changed over time, so too have the ways in which advisors are compensated. While commissions from the sale of investment or insurance products historically made up the bulk of many advisors’ revenue, over time a large number of advisors have shifted from commissions to fees, many now providing advice on a “fee-only” basis (with no commissions at all) to reduce their conflicts of interest compared to selling products and be able to market themselves as “fee-only” to consumers who want an advisor that isn’t incentivized to sell them something at the end of the advice process. But while these advisors who have transitioned might currently charge their new clients going forward on a fee-only basis (e.g., based on Assets Under Management [AUM] or on a fee-for-service basis), they might also receive “trailing” commissions (i.e., ongoing commissions from the previous sale of a financial product) based on products they sold before they went fee-only. Which technically made them not fee-only, as even if they’re only charging fees on new clients in the future, trailing commissions from prior products sold in the past were literally still part of their compensation.

This dilemma of whether an advisor who accepts trailing commissions (but currently charges 100% of clients on a fee-only basis going forward) can be truly considered a fee-only advisor has been a point of contention for several years. For instance, CFP Board in 2017 proposed that a CFP professional holding themselves out as being fee-only advisor could not receive any “sales-related compensation”, including trailing commissions and 12b-1 fees, even if all of the advisor’s ongoing relationships with new clients involve no new sales-related compensation. This policy, adopted in 2020, required CFP professionals who wanted to hold themselves out as being fee-only to terminate all ongoing trailing commission payments to themselves (which can involve significant red tape with the investment or especially insurance company that created the financial product). But while this was intended in part to ensure the ‘purity’ of the “fee-only” moniker (compared to murkier terms such as offering “fee-based” accounts in the midst of also selling commission-based products), in reality CFP professionals who genuinely wished to serve clients on a fee-only basis going forward were actually being induced to increase costs to clients and/or try to justify potentially questionable product replacements, because there was often no way to convert old existing products paying servicing trails into fee-only alternatives that would not adversely impact the client’s tax situation or contractual product guarantees. And notably, earlier this year, CFP Board announced a new policy that allows CFP professionals to call themselves fee-only while receiving trailing commissions if certain circumstances are met (e.g., if they try to re-assign the commissions but can’t, try to terminate the commissions and can’t, and after failing the first 2 options, ultimately agree to donate any un-terminable trailing commissions to charity), expanding the pool of CFP professionals allowed to use the “fee-only” title.

Another organization adjudicating the use of the “fee-only” moniker is the National Association Of Personal Financial Advisors (NAPFA), which originated and coined and championed the term over the past 40 years, in turn requiring its members to be fee-only with what was historically a zero-tolerance policy for accepting members who receive any commission revenue (including trailing commissions). However, the organization on June 23 announced in an email to its members that it would no longer exclude advisors who are dedicated to fee-only principles but receive trailing commissions from previous product sales, adhering to the CFP Board’s new rules (that advisors can be fee-only if they attempt-and-fail to re-assign the trails, attempt-and-fail to terminate the trails, and then ultimately agree to donate the trails to charity), with the added NAPFA requirements that the trails must be less than $2,500/year, and the advisor must actually document the donation with a charitable receipt.

NAPFA’s announced policy change has been met with a flurry of reactions from its members. Many of those opposing the change argue that it dilutes NAPFA’s brand of being the home for advisors who accept no compensation outside of the fees they receive from clients (unlike organizations such as the Financial Planning Association [FPA], which is open to advisors receiving a broader range of compensation types, including commissions), as going forward anyone in the media who claims that NAPFA is “fee-only” will have to caveat it with “well, at least mostly, but they might still have some old trails that are being donated…”. Furthermore, critics have suggested that allowing any commissions into NAPFA is a slippery slope, and could portend the organization allowing other types of non-fee compensation in the future if it is willing to compromise its long-held standards for the sake of membership growth. Especially when NAPFA has long been the organization that was ‘willing’ to have a smaller membership in exchange for being the ones that push the profession forward by taking a stronger fiduciary position than the industry’s ‘consensus’ view. Nonetheless, others have argued that because members would only be able to accept (and then donate) commissions from previously sold products, and that on a forward-looking basis those advisors are just as fee-only with their new clients as any other fee-only advisor, it would be acceptable to let in advisors who now charge clients on a fee-only basis and not ‘punish’ them for compensation arrangements of the past that they have intentionally moved away from and are trying to leave behind (and can even support more advisors becoming fee-only by giving them a better pathway to it).

Ultimately, the key point is that by adjusting their policies to enable advisors who have made the transition from selling their clients financial products with embedded commissions to charging their clients fees (but are still receiving trailing commissions) to describe themselves (and their firms) as being fee-only, CFP Board and, now, NAPFA appear to be siding with the point of view that it is the advisor’s current method of charging clients, and not how they earned compensation in the past, that determines whether they can hold themselves out to be “fee-only” in the future. Which could not only have the effect of bringing more advisors into these organizations (which hold their members to a higher standard than what is required by federal and state regulations), but ultimately benefit these advisors’ clients by allowing them to continue to service previously sold products and avoid costly (or difficult to implement) product changes? At least, as long as consumers are willing to accept that advisors can be “fee-only going forward” even if some of their existing clients are still incurring commission trail costs?

RIAs Would Face Fees, More Exams Under SEC Committee Proposal

(Tracey Longo | Financial Advisor)

As more advisors have adopted the Registered Investment Adviser (RIA) model, the burden of regulating these firms has increased as well. For instance, the Securities and Exchange Commission (SEC) currently oversees 15,000 RIAs and 900 new investment advisers registered with the SEC in 2021 alone. However, SEC examination staff has increased only 4% since 2016 (while the number of SEC-registered RIAs has grown by 25%), challenging the regulator’s ability to maintain its pace of examining each RIA at least once every 7 years.

With this in mind, the SEC’s Investment Advisory Committee (IAC) on June 22 introduced a proposal recommending that the SEC permit third-party examinations of RIAs and (in the absence of Congressional funding to increase the SEC’s examination staff) request Congressional legislation that would authorize user fees for SEC-registered investment advisers (notably, the House has passed such legislation but the Senate has yet to take up the measure). IAC member Paul Roye said the recommendation to allow third-party examinations would allow for more frequent exams of RIAs, perhaps moving from a 7-year cycle to 4 or 5 years, with higher-risk firms being examined more frequently. Further, the user fees (which the IAC said could be assessed based on factors such as the complexity and size of a given firm) would be used to fund the SEC’s investment adviser examination program at a level designed to allow exams to be completed every 4-5 years.

In the end, while it is unclear whether the SEC will adopt the IAC’s proposals (which will now be subject to a public comment period), they could potentially create increased burdens for RIAs, both in terms of the frequency of examinations (which require time from firm owners and staff to meet examiners’ requests for documentation and other information) and in terms of the fees they might have to pay to support the SEC’s exam program. Which means the SEC will ultimately have to decide whether the potential benefit to the public of an increased pace of RIA exams justify these increased costs for the firms themselves (which could potentially be passed on to clients in the form of higher fees?).

More Than 72% Of Rookie Advisors Still Fail Out Of The Industry

(Lisa Fu | AdvisorHub)

The oft-reported ‘graying’ of the financial advisor population means that there is potentially significant room for new advisors to enter the industry to eventually take over for retiring advisors (and perhaps expand the pool of consumers receiving financial advice as well). But the financial advisory industry (particularly those segments reliant on commission-based compensation) has long faced the problem of a high churn rate among individuals to enter the field, which, combined with advisor retirements, has limited the industry’s overall personnel growth.

In fact, a recent report from research and consulting firm Cerulli Associates found that advisor headcount grew by just 2,579 in 2022, in part due to a rookie advisor washout rate of more than 72%. And given that an estimated 106,000 advisors (or 40% of the total advisor population) are expected to retire in the next decade, the report highlights the importance for firms of reconsidering how they recruit and train advisors. First, the report suggests that firms could expand their advisor recruiting efforts beyond word-of-mouth referrals, which is currently responsible for 64% of new hires, in order to attract a more diverse group of recruits, including younger advisors who might be able to attract a younger client base (and while younger clients might bring fewer assets to the firm initially, they are likely to accumulate additional assets over time and have greater longevity than older clients). In addition, the report highlights the importance of mentorship for new advisors; for example, rather than having new advisors be solely reliant on themselves to attract and serve clients, they could be paired with a more experienced advisor, allowing the veteran advisor to share some of their workload while giving the newer advisor valuable experience. Further, the report suggests that firms could invest more in new hire training programs to better ensure new recruits have the skills needed to attract and provide advice to clients on their own.

While the above recommendations are particularly pertinent to broker-dealers and wirehouses (which often require new advisors to build their own book of business right away), RIAs looking to recruit and retain talent (whether or not the firm expect them to attract clients in the short term) also could consider whether their recruiting, onboarding, and training processes, as well as the career tracks they offer, are meeting the needs of their new hires and are encouraging them to stick with the firm for the long haul!

Investing For Money Vs Investing For Happiness

(Katie Gatti Tassin | Money With Katie)

When it comes to money, there is an inherent tradeoff between spending for today and saving for tomorrow. Because not only does an additional bump to one’s lifestyle increase income needs today, but it also increases the total amount of money that must be saved (and, perhaps, invested) to support that lifestyle in the future (e.g., in [early] retirement).

When thinking this way, it can be tempting to limit spending as much as possible on ‘luxuries’ today to boost one’s savings rate and the money that will be available in the future (particularly when taking into account the ‘miracle’ of compound interest!). But if one’s goal is to maximize happiness over the course of their lifetime, they might be sacrificing their happiness today (by reducing their discretionary spending) for the potential happiness of their future self. Accordingly, this suggests that individuals might be able to find a ‘balance’ where they are able to spend on small joys today (e.g., a weekly lunch out with colleagues) while not sacrificing their long-term saving goals.

Notably, financial advisors can play an important role in helping their clients determine what this ‘happy middle’ might look like by running a range of planning scenarios and showing how changes in spending today could impact their finances in the future (e.g., how much longer a client might have to work if they increase their discretionary spending by 10% today). Which could ultimately give their clients ‘permission’ to boost their spending (and, presumably, their happiness) today while giving them the peace of mind that they will likely have enough money to maintain their desired level of spending throughout the rest of their lives!

Should Young People Save Less And Spend More?

(Ben Carlson | A Wealth Of Common Sense)

When entering the working world, young individuals face many choices, from where to live to what job to choose. Another important decision is how to balance their spending and saving decisions, as they might want to enjoy the fruits of their work today while also getting the benefits of compounding that come with starting to save and invest early in their career. For many, the solution to this question is to save a certain percentage of their salary, so that as their income (hopefully) rises over time, they will automatically increase the amount they are able to spend and the money that goes to savings.

Though, not everyone views the ‘spending lifecycle’ this way. In a study published last year, a group of researchers suggested that workers might be better off eschewing savings in their younger years, allowing them to spend more, and only start saving later in life (notably, this finding is based on an assumption that individuals would prefer to have steady consumption over the course of their life rather than experiencing more variable spending). And so, because workers’ income tends to rise over the years (as they gain skills and promotions), they might set a fixed spending level early on (that takes up all of their income, or even requires them to take out loans) and maintain it throughout their lifetimes, then use additional income that comes in over time (e.g., from raises) to pay off the debt and contribute to retirement savings. This can allow for more a more consistent lifestyle over one’s working years rather than starting out in more spartan conditions and increasing one’s standard of living over time.

However, actually implementing such an approach could be challenging. For instance, spending all of one’s income (and perhaps adding debt) could expose an individual to significant financial risk if they faced an economic such (e.g., an extended period of unemployment). Further, this approach also requires the individual to maintain discipline with their standard of living, because if they start out with a 0% savings rate and increase their lifestyle as their income rises, they might not save enough money to support themselves in retirement. This contrasts with the fixed savings percentage approach, which naturally allows for increased spending over time as long as income rises.

In the end, there is no universal ‘right’ way to determine how much to spend and save early in one’s career. Given this ambiguity, financial advisors have the opportunity to add value to younger clients (or the children or grandchildren of clients) by helping them set spending and savings targets that allow them to enjoy their early working years while putting them on a path for financial success into the future!

Stop Asking Whether Money Buys Happiness

(Michael Mechanic | The Atlantic)

The question of whether having more money can lead to greater happiness has interested researchers for many years. For instance, a frequently cited study from 2010 by Daniel Kahneman and Angus Deaton found that while overall life evaluation was positively correlated with income as individuals’ incomes exceeded $120,000, day-to-day happiness rose up to about $75,000, but failed to increase as income rose from there. Later, researcher Matthew Killingsworth took a new look at this question using a different data source (that allowed for more timely and specific responses from those surveyed) and found that there is no income plateau for day-to-day happiness. And more recently, Kahneman and Killingsworth teamed up for an ‘adversarial collaboration’ looking at this issue, finding that while larger incomes are in fact associated with ever-increasing levels of happiness, there are several caveats.

For instance, the researchers found that while individuals who are broadly happy did not see a plateau in their happiness as income rose, unhappy individual did experience this plateau (though unhappy low-income individuals saw significant happiness gains when their income increased). Which suggests that if an already high-income individual is unhappy with their current course in life, earning more money might not actually make them happier. In addition, Killingsworth previously found that so-called ‘time poverty’ (i.e., whether an individual has enough time to do what they are currently doing) was a small but significant negative mediator to the overall income-happiness correlation (e.g., an individual with more income who works 12 hours a day might be less happy than someone with less income but more free time). In addition, it is worth noting that the link between income and happiness was based on a logarithmic increase in income, meaning, for example, that a doubling of income would result in the same increase in overall life evaluation (e.g., an individual would get the same happiness bump moving from $50,000 to $100,000 of income as they would going from $100,000 to $200,000 of income).

Altogether, these findings suggest that the answer to the question of whether additional income leads to more happiness is a resounding, “it depends”. Though when it comes to financial advisors and the findings related to ‘time poverty’ specifically, these findings suggest that managing their time-money tradeoff (e.g., by considering adding staff or by outsourcing certain tasks to avoid falling into ‘time poverty’) could be an important part of improving advisors’ overall wellbeing!

The Fundamental Logic Of Annuities With Lifetime Income

(Wade Pfau | Advisor Perspectives)

For financial advisors working with pre-retirees and retired clients, creating and managing their retirement income plans is typically an important part of their value proposition; from the timing of claiming Social Security benefits to managing sequence of returns risk, there are many factors for advisors and their clients to consider. Another of these is choosing an appropriate asset allocation for the client, often a mix of stocks (which are meant to provide potential upside) and bonds (which can serve as an income-generating ballast with less risk than stocks).

But Pfau suggests that income annuities (which make regular payments during an individual’s remaining lifetime) could play an important role in the retirement income equation as well. He notes that such annuities can help mitigate several types of risk, including longevity risk (because the payments are ‘guaranteed’ to last throughout the client’s lifetime) and sequence risk (because the payments are fixed and not based on future market returns).

Pfau argues that income annuities could be particularly attractive as a replacement for the bond portion of a client’s portfolio. Because not only do income annuities offer bond-like income (as the insurance company selling the annuity will invest the principal in bonds itself), but also offers a form of ‘longevity insurance’ that bonds and bond funds cannot necessarily offer. Which means that annuity payments can be larger than income generated from bonds because they include ‘mortality credits’ (i.e., the leftover dollars from annuity buyers who do not live very long) on top of ‘just’ the bond interest alone.

In sum, Pfau concludes that income annuities are superior to bonds as part of the fixed income allocation when it comes to generating income in retirement, finding that the ‘efficient frontier’ asset allocation for a client is a combination of stocks (which provide potential upside and can preserve assets for those with legacy interests) and income annuities, with no allocation to bonds at all. Which suggests that financial advisors can help clients determine their preferred retirement income style and consider whether and how income annuities might help clients achieve their goals (e.g., by using more assets to buy an income annuity if they prioritize stable lifetime income or fewer assets if they want to pursue more upside and/or leave a larger legacy bequest), especially as insurance companies increasingly begin to offer no-commission “advisory” versions of income annuities through their ‘Outsourced Insurance Desk’ (OID) platforms.

Annuities And Institutional Best Practices: A Good Fit?

(Chamberlain, Dayton, Richter-Gordon, and Trone | 401K Specialist)

Before passage of the SECURE Act in late 2019, less than 10% of 401(k) plans offered an annuity option, in large part due to fears of the potential liability plan sponsors faced if the annuity carrier ran into financial problems that jeopardized the carrier’s ability to meet its obligations. In order to mitigate this risk (and, with the encouragement of the insurance industry, provide more lifetime income options for plan participants), the SECURE Act included a Fiduciary Safe Harbor for plan sponsors picking an annuity company (which greatly limits the sponsor’s liability as long as they review “the financial capability of [an] insurer to satisfy its obligations” and determine that “at the time of the selection, the insurer is financially capable of satisfying its obligations under the guaranteed retirement income contract”).

Of course, overcoming liability concerns is just 1 step for plan sponsors in adding annuity options to their 401(k) plans. The authors suggest that plan sponsors first consider the ‘why’ of including annuity options to the plan, including whether their participants would benefit from the addition of guaranteed income solutions. Then, sponsors can compare different carriers based on creditworthiness, product types offered (e.g. immediate and/or deferred annuity options), available riders (e.g., ‘ratchets’ to mitigate inflation risk), and costs to find the best options for their participants.

In the end, given the breadth of carriers and product offerings in the annuity market, the authors note that plan sponsors (who are unlikely to be experts in annuities themselves) can look to outside experts to help them evaluate the available options to determine which carriers and products to offer in their plan (and whether to include them in the first place). Which presents a (potentially profitable) opportunity for advisors to step in and help these employers manage their responsibilities in crafting a menu of investment options for their plan participants!

The Perfect Retirement Investment Nobody Wants

(Peter Coy | The New York Times)

Retirees face many financial risks, including longevity risk (i.e., the chances that they will outlive their available resources) as well as the risk of requiring an extended period of (costly) long-term care that could deplete their assets (and perhaps leave a spouse with limited resources to support their lifestyle needs). And while there are products available to address each of these needs separately (annuities and Long-Term Care [LTC] insurance, respectively), only a slice of the population has purchased one or both of these products.

To help better protect consumers (in a way that would be profitable for insurance companies), researchers in 2001 proposed a hybrid product (combining LTC insurance with an annuity) that would potentially mitigate both of these risks. Consumers would potentially benefit from having both longevity and LTC risks covered at a lower cost (as the researchers found that insurance companies could charge premiums that were 3-5% less than purchasing an annuity and LTC policy separately). Further, the researchers found that this hybrid policy would be less risky for insurance companies because these 2 risks would cancel out: a healthy retiree might receive more annuity payments than the average individual, but might not need as many LTC benefits, while a retiree who became sick early on could need to tap the LTC benefits but might die earlier than other participants and therefore not receive as many annuity payments (and while some retirees might draw on both sides of the hybrid policy, the authors concluded that these cases would be relatively rare).

Despite these findings, insurance companies have yet to introduce this type of hybrid product. Some observers suggest this is because consumers tend not to ‘like’ annuities (which require individuals to give up a large chunk of money up front) and LTC insurance (which can come with hefty ongoing premiums) separately, that a hybrid option might be equally unattractive, despite its potential ability to mitigate longevity and LTC risk. Which means that in the absence of such a product, advisors can add value by helping clients determine whether an annuity, LTC insurance, or both might be appropriate ways to address their exposures to longevity risk and potential LTC costs.

Fooled By Fanatics

(The Rational Walk)

Those who have reached the peak of their chosen fields can often make what they do look easy. Whether it is an NBA player effortlessly making a jump shot or a musician gracefully playing an instrument, it can be easy to think that you could do the same, perhaps with a little practice.

However, in reality, the highest achievers are often ‘fanatics’ when it comes to their craft. For instance, the NBA player has probably taken tens of thousands of shots in practice that led to their ‘effortless’ 3-pointer during the game. And the musician almost certainly did not just pick up the instrument and start playing, but rather went through hours and hours of instruction and rehearsals. A similar phenomenon can be seen in the investing world as well; for example, Warren Buffett has shown a knack for picking profitable investments during his career, making him one of the richest people in the world. But he did not just start making successful stock picks one day; rather, he has spent decades evaluating companies and poring over investment filings, developing the skills needed to be an effective investor.

Ultimately, the key point is that while those who have achieved the greatest success in a particular area can make their talents look effortless, they are often the result of ‘fanatical’ levels of dedication to improving their skills (and perhaps a dose of luck in the genetic lottery). Which means that those who want to reach peak performance, whether in the professional world or in a hobby, will likely need to put in the sweat equity to reach their goals!

If You're So Rich, Why Are You Desperate?

(Nick Maggiulli | Of Dollars And Data)

Pretend for a moment that you had a net worth of $1 billion. You might imagine yourself traveling to exotic locales, or perhaps spending quality time with family or mastering a new skill. In this scenario you probably would not plan to focus your time getting into online arguments or promoting a new product. But as anyone who spends time on social media knows, many billionaires are doing just that.

Given that these individuals no longer need to work to support their (luxurious) lifestyles, Maggiulli asks why they are so desperate for attention and your business. He suggests the reason is that while they have enough money to meet any material needs, they continuously pursue more in an attempt to gain attention, status, or respect (e.g., trying to move up or at least avoiding *gasp* dropping down the Forbes Billionaires list). Which is a signal for aspiring billionaires (or even millionaires) that while money can solve a lot of problems, it does not automatically confer a sense of purpose and fulfillment.

This phenomenon ultimately leads to the question of why building wealth is important in the first place. For many, wealth provides a level of freedom, whether it is the freedom to choose their career, when to retire, or even simply where they want to live. Because in the end, those who leverage their wealth to give themselves more time to do what they want might have more freedom than billionaires who spend their limited time trying to build an ever-larger net worth for its own sake!

Lucky In Life

(Michael Batnick | The Irrelevant Investor)

For those who feel like they are successful, it can be tempting to attribute this success entirely to their hard work and determination. For instance, they might have studied hard in high school to get into a good college, did several internships during college to land their first full-time job, and have put in many hours in the office to grow in their career. But while hard work is no doubt important, luck (good, bad, or both) often plays an important role in shaping one’s career as well.

For Batnick, luck (both good and bad) played a major role leading him to his current position as a managing partner of RIA Ritholtz Wealth Management. On the bad side, he graduated from college into the teeth of the Great Recession, limiting the number of finance jobs available to him. He started out working in insurance sales, with little success. But while he was toiling in that job, good luck struck when his father connected him with a financial advisor who was willing to meet with Batnick and introduce him to the world of investment management. While that connection did not directly lead to a job in finance (which were still few and far between in the wake of the financial crisis), it did inspire him to build his education in the world of investments and pursue the CFA designation. Eventually, Batnick’s luck would finally turn positive again when he had a chance meeting with now-Ritholtz CEO Josh Brown on a train platform after Batnick left a basketball game early, which eventually led to a job opportunity at the firm (if the game had been closer, he might never have met Brown and started his career at Ritholtz!).

Altogether, Batnick’s example shows how luck can play an important role in shaping a career, whether it is the bad luck of entering the professional world during an economic crisis or the good luck of a fortuitous chance encounter. Which suggests that individuals could consider how luck has played a role in their own career success and perhaps ‘pay it forward’ by seeking to provide others with the type of opportunities they received themselves!

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