Weekend Reading For Financial Planners (July 27-28)

Schwab's Latest RIA Benchmarking Study Shows AUM Jump In 2023, Identifies Practices Of Top-Performing Firms

(Jennifer Lea Reed | Financial Advisor)

Following a challenging year for RIAs in 2022, when weak stock and bond market performance led to shrinking Assets Under Management (AUM) at many firms, 2023 offered an opportunity for firms to bounce back, not only as equities surged during the year and bonds saw modest gains, but also by reaping the benefits of marketing efforts to boost organic growth (i.e., assets from new clients and additional assets from existing clients), which can serve as a buffer against market drawdowns.

According to Charles Schwab's 2024 RIA Benchmarking Study, which surveyed 1,304 RIAs, average firm AUM grew by 17.9% in 2023 (compared to a 7.1% decrease in 2022). Notably, while a significant portion of these gains came from market appreciation, organic growth was a key contributor as well, with firms with less than $250M in AUM seeing 7.9% organic growth in AUM (and 19.4% higher AUM overall) and firms with more than $250M in AUM experiencing 4.9% organic growth (and 17.4% total AUM growth). Further, Schwab identified "top performing" firms (representing the top 20% of firms when 15 performance metrics were applied), which saw 12.2% organic growth and 23.9% overall AUM growth.

Looking under the hood, Schwab identified factors that separated its "top performing" RIAs from other firms. These included having a defined ideal client persona, client value proposition, and marketing plan. In addition, these top firms were more likely to solicit client feedback, and in the process gained 25% more assets from existing clients than other firms. In terms of specific marketing tactics, client referrals continue to be the largest driver of new client asset growth for firms, accounting for 67% of new clients and new client assets in 2023. To drive more client referrals, top-performing firms were more likely to send appreciation gifts to referring clients (with 56% doing so, compared to 38% of other firms), review the firm's full service offering with clients (59% to 47%), and ensure that clients know the firm's ideal target client (63% to 51%). Finally, amidst continued competition for advisor talent, top-performing firms were more likely to have a stronger employee value proposition, for example by having a defined mission statement, culture, and values (86% versus 68% for other firms), career path opportunities (80% versus 66%), as well as coaching or mentorship opportunities (70% versus 57%).

Ultimately, the key point is that RIAs saw AUM growth in 2023 not only due to market appreciation, but also thanks to their organic growth efforts to grow their client base and the percentage of their clients' assets that they manage. Further, using the benchmarking study data to take stock of the key practices that separate top-performing firms identified in the study from others (from narrowing in on an ideal client persona to creating a defined plan for driving client referrals), and considering how (and whether) they might fit within their own practice, could help firms continue their client and AUM growth through future bull and bear markets!

Size Of RIA M&A Deals Rising Amidst Steady Deal Flow

(Sam Bojarski | Citywire RIA)

Following a period of significant growth in RIA Mergers and Acquisitions (M&A) activity, 2023 saw a pullback in deal flow – with the number of RIA M&A transactions declining to 321 transactions from a record-high 340 in 2022, according to investment bank Echelon Partners – amid rising interest rates (that can increase the cost of financing deals) and other headwinds. Nonetheless, many market participants remained positive that underlying factors driving M&A activity (e.g., infusions of Private Equity [PE] capital into large buyers and a large number of retirements among RIA founders) would mean that deals could soon pick up.

According to a report from Fidelity, there were 54 RIA deals in the second quarter, an increase of 5 over the second quarter of 2023, with these deals accounting for $230.1 billion of client assets, triple the amount compared to the prior-year period. Further signaling that RIA M&A deals have grown larger in size, 36% of RIA transactions during the first half of 2024 involved firms that manage more than $1B in assets, up from 29% in 2023 and 27% in 2022. Similar to previous years, serial acquirors (often backed by PE capital) continue to drive deal flow, as 21 firms were responsible for 60% of RIA deals during the 12 months ending in June (Focus Financial Partners led the way with 16 transactions during this time period). Nonetheless, the first half of the year saw 17 first-time buyers (13 of which had PE backing), indicating there is room for (particularly well-capitalized?) firms to pursue an inorganic growth strategy through acquisitions.

Altogether, these data points suggest that many firms appear to be shaking off the headwinds that slowed M&A activity in 2023 and are continuing to pursue (often larger) deals, suggesting that owners of growing, sustainable firms who are considering a sale could receive strong offers, with larger firms (and the client base and advisor talent that comes with them) potentially being increasingly attractive (though some owners might find that positioning their firm for a sale could reduce their desire to actually sell it!).

Off-Channel Communications Now Advisors' Top Compliance Concern: Survey

(Melanie Waddell | ThinkAdvisor)

In decades past, advisor-client communication largely entailed in-person meetings and phone calls. But today, advances in technology have brought a range of new options, from email to text messages. While convenient, a wider array of communications methods can create a headache for firm compliance officers charged with tracking advisor-client communication subject to relevant regulations (with the Securities and Exchange Commission [SEC] issuing more than $3 billion in fines for employees' use of unapproved communications channels, such as text messages sent from personal phones).

According to a survey of compliance professionals at 595 investment advisers conducted by the Investment Adviser Association, ACA Group, and Yuter Compliance Consulting, electronic communications surveillance/off-channel communications was identified by 59% of survey respondents as the "hottest" compliance topic, supplanting advertising/marketing (with the SEC's 'new' marketing rule likely driving interest), which took the top spot last year. Other key focus areas for compliance professionals included cybersecurity, private funds, conflicts of interest, and vendor due diligence (which largely line up with the SEC's latest examination priorities).

Amongst respondents, 83% reported that they are currently undergoing an SEC exam or have been examined within the last 5 years. Notably, they reported that the top examiner focus areas in recent exams were books and records (cited by 58% of those surveyed), advertising and marketing (57%) and conflicts of interest (50%). To help prepare for exams, 65% of those surveyed said they have conducted or intend to conduct a mock exam (and 85% of those who had done one said it prepared them for an actual exam and identified issues and best practice enhancements).

In the end, compliance professionals have a variety of ways to ensure that their firms remain in compliance with relevant regulations, including mock exams, using best practices for annual compliance reviews, crafting an annual compliance calendar, and, when it comes to communications archiving, using available AdvisorTech tools to make the job easier (though they will still have to ensure firm employees aren't using unauthorized communications methods that can't be tracked!).

How Does Inflation Impact Retirement?

(Nick Maggiulli | Of Dollars And Data)

When it comes to helping clients entering retirement increase the chances that their portfolio will sustain their spending needs throughout their lifetimes, financial advisors are often focused on sequence of return risk (i.e., if early returns are too low for too long, ongoing withdrawals can deplete the portfolio before the 'good' returns finally arrive). Nonetheless, inflation, and specifically the timing of different inflationary regimes, can also play an important role in determining the sustainability of a client's retirement income plan.

For instance, the 1970s saw multiple years with double-digit inflation, driving prices higher for retirees, potentially requiring them to pull more money out of their portfolios. An open question, though, is how the experience of a retiree going through this period would differ depending on when they retired. To test this, Maggiulli looks at hypothetical individuals who retired in 1954 (who would experience the high-inflation period at the tail end of a 30-year retirement), 1964 (and faced higher inflation in the middle of their retirement), and 1974 (starting their retirement with high inflation) and who followed the "4% rule" (i.e., withdrawing 4% of the initial value of their portfolio in the first year and adjusting this amount for inflation in subsequent years, while maintaining a rebalanced portfolio of 60% stocks and 40% bonds). He finds that while all 3 groups were able to finish a 30-year retirement without depleting their portfolio, they end up with somewhat different terminal portfolio values, based in part on the portfolio returns experienced during their respective periods (e.g., the 1964 retiree ends up worst off in part because they experienced 3 major bear markets during the first 10 years of retirement).

Notably, this calculus changes significantly if a larger withdrawal rate is assumed. For instance, an individual using a 6% inflation-adjusted withdrawal rate and who retired in either 1964 or 1974 would have exhausted their portfolio before the end of the 30-year retirement period (while a 1954 retiree, who experienced the high-inflation period at the end of their retirement, saw their portfolio balance triple over the course of their retirement!).

In the end, while a financial advisor might not recommend that a client take a fixed withdrawal rate over the course of their retirement, the differing experiences of retirees depending on the timing of inflationary periods during their retirement suggests that inflation could be considered (alongside portfolio returns) when it comes to crafting a sustainable retirement income plan. Further, while it can be challenging to predict future inflation or market returns, clients have more control over their spending, suggesting that those who can maintain a flexible spending approach (i.e., cutting back on spending where possible during periods of poor market performance or not adjusting their spending fully to account for inflation) could increase the chances that their portfolio lasts throughout their retirement.

How Near-Retirees React To Inflation

(Jean-Pierre Aubry and Laura Quinby | Center for Retirement Research at Boston College)

The years leading up to an individual's planned retirement are filled with important financial decisions, from choosing a specific date to retire to determining how much they might be able to spend in retirement (which leads many of these individuals to start working with a financial advisor!). While many near-retirees today might not have been considering inflation as a factor in their calculations, given that it had remained at relatively low levels for many years, the inflation spike experienced in the past few years might have thrown a wrench in some retirees' plans.

To assess the impact of the recent surge in inflation, Aubry and Quinby conducted a study of near-retirees and retirees to see how they changed their spending and savings habits in response. To start, they asked about near-retirees' perception of their income growth compared to inflation, with 53% of respondents indicating their income had risen, but less than inflation, 35% reporting that their income kept pace with inflation, and 11% saying their income went up by more than the inflation rate (a strong majority also assessed that their investment performance lagged the inflation rate as well). Amidst this environment, 65% of near-retirees said they had changed their savings rate since 2021 (with an average decline in annual savings of $1,128, or 2% of their income), though those who said they changed their savings because of inflation decreased their savings by an average of $4,065, or 4% of their income. Further, 44% of respondents said they changed their withdrawals from their savings, taking out an average of $2,519 ($3,620 for the 23% of respondents who said they did so because of inflation).

Nonetheless, while many near-retirees dipped into their savings and saw their investment returns lag inflation during this period, only 4% indicated they changed their retirement age because of inflation (though those that did delayed it by an average of 4 years). Overall, 34% of respondents said they changed their retirement age this period, on average accelerating their retirement by 2 years, suggesting that some might have chosen to retire at a time when their wealth might have been lower than it would be had they chosen to continue to work (where they might have benefited from wages adjusted higher to account for inflation), potentially leading to a reduced amount of sustainable retirement income.

Altogether, this study indicates that near-retirees are vulnerable to inflation as they approach their anticipated retirement, as it can potentially lead them to reduce their savings and potentially pull money out of their accounts in their final working years (potentially their last chance to save before drawing down their accounts in retirement). Which further demonstrates the value that advisors working with clients in this situation can provide, including showing them scenarios of how different choices in an inflationary environment (e.g., shifting their retirement date or cutting back their spending) could impact their lifestyle in retirement!

How Sequence-Of-Inflation Risk Impacts Retirees

(Justin Fitzpatrick | Nerd's Eye View)

In decades past, when financial plans often relied on constant investment return projections derived from straight-line appreciation and time-value of money calculations, financial advisors began acknowledging and accounting for the variable and uncertain nature of investment returns. And by turning to tools that incorporated historical or Monte Carlo simulations, advisors were able to examine the potential impact of sequence-of-return risk on an investor's portfolio, modeling those risks across hundreds or thousands of scenarios into a client's personal retirement plan and refining the design of realistically sustainable spending strategies for the client. But despite recognizing the impact of investment variability and sequence of return risk on a financial plan, advisors do not necessarily incorporate the same historical trends for inflation in their clients' financial plans, often modeling it as a static rate.

However, the high variability of inflation over the last several decades – with the high rates of the early 1980s dipping down to the lows in the late 2000s (even in just the last decade, the US has seen both mild deflation in 2015 and inflation of over 9% in 2022) – makes a strong case for treating inflation as uncertain and variable in financial planning. Sequence-of-inflation risk can substantially impact a financial plan and failing to consider this risk can lead advisors to overestimate sustainable spending and underestimate risk in retirement. Though most plans are affected at least somewhat by inflation risk, certain factors make accounting for it especially important. If inflation is expected to be high or especially variable or uncertain, or a plan has substantial not-adjusted-for-inflation cash flows (as found in many pensions), a higher bond allocation (that can suffer in real terms during inflationary periods), or a higher probability of success (>70%), failing to consider the variability of inflation and sequence-of-inflation risk will likely distort plan results and make them less dependable. In these situations, modeling variable inflation can help reveal risk that isn't otherwise apparent when inflation is kept constant. By exploring high-inflation, low-inflation, and mixed-inflation scenarios, advisors have the flexibility of customizing advice that can more holistically balance a client's spending goals with their risk tolerance.

Ultimately, the key point is that inflation is far from a static factor and is just as variable and uncertain as the other key aspects of the plan. And when its variability is not accounted for, the quality and resilience of the advice in a client's financial plan can potentially suffer, especially for those with lower portfolio returns and higher probability-of-success expectations. But by accounting for inflation's variability, and acknowledging the sequence-of-inflation risk that clients are faced with, advisors can leverage multiple scenarios to create a robust plan and ensure they are offering the best recommendations for their clients!

Show, Don't Tell: How To Boost Advisor Confidence Around Complex Topics

(David Blanchett and Ross Riskin | ThinkAdvisor)

Being an effective financial advisor requires knowledge of a wide range of planning-related topics, from investments to taxes to estate planning. And while an advisor might be confident in their general knowledge in these areas, given the varied complex strategies, products, and laws that apply to each, they might not feel as sure of themselves when getting deep into the details (and might have a tough time verbally relaying information about them to clients).

With this in mind, Blanchett and Riskin explored whether the use of visual aids could boost advisor confidence in their knowledge of certain topics. The researchers surveyed more than 2,000 financial professionals and had them rate their self-confidence in tax and estate planning concepts. They then showed participants a visual explaining how a Charitable Remainder Annuity Trust (CRAT) works, including the flow of money involved when implementing the strategy, the tax impacts, and considerations for when using one might be appropriate. After seeing the graphic, a strong majority of those who indicated they were "not confident" in their knowledge of estate and tax planning indicated that their confidence had increased, with a smaller percentage those who said they were "somewhat confident" seeing gains as well.

Altogether, this research suggests that the use of visual aids can be helpful, not only for those who tend to learn better from visuals, but also to explain complex topics more clearly than can be done through the written word alone. Which could apply not only when training newer advisors (or refreshing a seasoned advisor's own knowledge!), but also to boost client engagement when providing deliverables or explaining potentially confusing planning topics or strategies!

Why Doesn't Advice Work Better?

(Dynomight Internet Newsletter)

Humans are often (perhaps a little too) generous with providing friends and loved ones with advice on a range of topics. And while the advice-giver might think that it is a no-brainer that the recipient act on it, this advice often goes ignored. In the financial planning context, an advisor might recommend that the client take a certain action, only to have them not heed it (or perhaps stall on making a decision until the next meeting). While this might be frustrating on the advisor's part, it could also serve as an opportunity for reflection on why the advice wasn't taken and acted on.

To start, the different lived experiences of an advisor and their client can lead to different views of a piece of advice. For instance, a client with certain money scripts (i.e., messages and lessons we learn about money while we're growing up) might be hesitant to take an action that's in contrast with their ingrained attitudes towards money. Alternatively, while a financial advisor will have seen a wide range of circumstances occur across their client base (e.g., a client who experienced a long-term disability or their company shutting down), a client who has not faced these might assume that these issues might not happen to them. In addition, advisors can encounter the "Curse of Knowledge," which says that teaching something that an 'expert' know really well can sometimes be really difficult because, as a 'knower', they don't remember what it is like to be a learner (which suggests that clients who don't understand what's being explained might be less inclined to act on the advice). Further, if many pieces of advice and action items are being given at once, a client might feel overwhelmed and avoid taking on any of them.

In the end, while there are many impediments to advice (financial or otherwise) being accepted and acted upon, financial advisors can take steps to increase the likelihood that their clients will do so, from gaining a solid understanding of what makes a client 'tick' (to craft their messaging in an appropriate manner), to presenting recommendations in a clear, structured way that maximizes client engagement, which could ultimately lead to them being more willing to accept and implement (or give their advisor the go-ahead to do so) the advice being given!

The Problem With Behavioral Nudges

(Evan Polman and Sam Maglio | The Wall Street Journal)

In recent years, the idea of behavioral 'nudges', using psychological tactics to steer people to making certain decisions (with little to no action required on their part), has gained in popularity. For instance, many companies (in an effort to boost their employees' retirement savings) have started automatically enrolling new employees in their 401(k) program, sometimes at a certain contribution level (typically, employees can opt out of the contributions, but doing so would require action on their part).

While nudges can be used effectively to get individuals to do a certain one-time task, an important question is whether those who are 'nudged' will follow through on the actions they have (semi-wittingly) chosen over the long run. For example, in a series of experiments, Polman and Maglio found that individuals who were 'nudged' into a decision (e.g., by being given a default option or by being encouraged to choose a 'middle ground' among 3 options) were less likely to follow through on it compared to those who made the same decision but weren't nudged. To explain these findings, the authors suggest that individuals might feel disconnected from their choices (and engage less with them) when the decision takes less conscious effort (which can be the case when being 'nudged').

Altogether, these results suggest that while nudges might be a good first step to get individuals to make a certain decision, they might need additional motivation to follow through with the action in the long run. For financial advisors, this could mean using "transparent nudges" that educate clients on the decision being made and force them to have some level of conscious thought about the nudge so that they truly understand how their financial plan recommendations are, in point of fact, designed to support their financial goals!

The AI Revolution Is Already Losing Steam

(Christopher Mims | The Wall Street Journal)

Artificial Intelligence (AI) has become a buzzword over the past couple of years thanks to the development of ChatGPT and other AI tools that can provide both information and seemingly creative responses to user prompts. The rise of AI also has led to some optimistic expectations for the field, from companies receiving lofty valuations to predictions that it will represent a revolution in worker productivity (while potentially eliminating many jobs in the process).

However, there are starting to be signs that AI's momentum might be slowing down. To start, while the initial release of ChatGPT amazed many observers with its capabilities, the tool (and other large language models like it) have only seen incremental progress since as AI companies try to find new "training data" to improve its capabilities (to the point now where some are using information generated by one AI model to train another, which might not be as effective as using real-world text). Further, the plateauing of the capabilities of early AI models means that others can catch up, which could ultimately lead to a commoditization of AI (leaving only a few 'winners', perhaps those with the greatest funding, such as Microsoft or Google, still standing in the end).

Another challenge facing the AI industry is the cost of running these systems, which require both significant amounts of processing power (through their own servers or cloud services) and energy to run. Which means that AI companies will need to find new ways to generate revenue not only to cover these costs, but also to turn a profit (to ultimately justify the high valuations some of them have received). Because while many individuals have tried out the free services offered by ChatGPT and other tools, a smaller percentage (about a third of companies, according to one survey) have been willing to pay for at least one AI tool.

Ultimately, the key point is that while AI has introduced new capabilities to a variety of fields (including financial planning), it remains to be seen whether it will end up being the disruptive force that some observers have suggested (though, while AI is unlikely to replace financial advisors, it could make them more efficient!).

7 Everyday Problems AI Can Help Solve

(Alexandra Samuel | The Wall Street Journal)

Discussions about the potential changes AI could make in the workplace sometimes teeter on the hyperbolic ("it will eliminate X% of jobs in the next 5 years!"). While the long-run effects of AI remain to be seen, current models and applications offer a variety of seemingly less revolutionary opportunities for financial advisors and other workers to boost their efficiency.

To start, several tools have emerged to support notetaking during meetings, whether an internal team discussion or a client meeting. Which can allow attendees to remain focused on the topic at hand rather than also having to take notes to commemorate the meeting (or provide those who are unable to attend a quick summary of what they missed). Next, AI tools like Superhuman and Shortwave can be used to speed the process of managing emails by analyzing the senders and content of incoming emails to organize an inbox by message type and priority (the programs can also draft message replies). On the subject of email drafting, AI tools like ChatGPT and others can also be used to adjust an email for tone (e.g., if you think your email might come off as angry, the AI can rewrite it to take a more constructive tone). In addition, AI tools also can be helpful for summarizing information. For instance, an individual might ask an AI tool to summarize a long article that seems interesting or analyze a spreadsheet containing a multitude of data points. They can also be helpful when brainstorming ideas, whether it is finding topics to write about for a firm's blog or creative text for social media posts.

In sum, while AI has yet to fully 'disrupt' many fields (including financial advice), the current wave of AI applications provides advisors with opportunities to make their days more efficient, suggesting that the ultimate impact of these tools might not be to replace financial advisors, but to help them increase their productivity by streamlining more of the middle and back office tasks and processes!

The AI Summer

(Benedict Evans)

When ChatGPT burst onto the scene in late 2022, users flocked to try out the tool, which 'magically' could respond to user prompts in seemingly creative and insightful ways. With 100 million users trying out ChatGPT in just the first 2 months alone, investors and developers flocked to the AI space in an attempt to create the 'next big thing' in AI.

However, recent trends suggest that instead of a quick rise to profitability, AI might have to go through similar processes and waits as did previous technological advances (e.g., retail commerce or smartphones). For instance, while well over 100 million users have tried ChatGPT (and even more have heard about it), data from the Reuters Institute indicate that a strong majority of users across several countries use it weekly or less (with a significant portion having only used it once or twice), suggesting that many users would not be willing to pay for it or similar generative AI tools. Further, data from Google Trends appears to show a negative correlation between search traffic for ChatGPT and school holidays (suggesting that students, rather than workers at well-financed companies, might make up a not-insignificant portion of ChatGPT users). And while generative AI tools have drawn interest from several business sectors (e.g. software, customer service, marketing), others have shown less interest in it (e.g., finance, sales, HR, and legal), according to data from Bain. Further, among those that are interested in leveraging AI tools, many are still developing or piloting applications (or paying consulting fees to understand how they might use AI), with a smaller percentage actually deploying them.

In the end, while generative AI tools seemingly emerged like a bolt of lightning, the road to profitability might take more time than many initially suspected as companies try to find product-market fits. Which suggests that, in the world of financial advice, while some AdvisorTech tools have started to incorporate AI into their capabilities, many companies might still be feeling out both what advisors are looking for in AI-enabled software (and what they're willing to pay for!) and what is possible given the current generation of AI tools' capabilities and shortcomings.

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

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog.