Weekend Reading for Financial Planners (July 30-31)

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 July 30th/31st:

DoL's Rule On State Retirement Plans Arrives At OMB (Greg Iacurci, Investment News) - The Department of Labor has sent its final proposed rule on state-based retirement plans to the Office of Management and Budget (OMB) for review. Entitled "Savings Arrangements Established By States For Non-Governmental Employees", the rule is intended to clear the way for states to enact payroll-deduction savings programs for employees who don't have access to a retirement plan through the workplace, while minimizing the state's exposure to potential ERISA fiduciary liability. The rule comes as several states - including Illinois and Maryland - have recently passed laws to establish workplace automatic-enrollment IRAs, and another 30 states are in various stages of adopting similar programs (which will likely be expedited further as the new DoL rule comes to pass). This new DoL rule has been controversial in some circles, claiming that it allows states an unfair and uncompetitive way to avoid ERISA liability that isn't available in the private sector; on the other hand, the primary focus of the final rule is really just to grant states the ability to facilitate payroll deduction (including automatic enrollment) of deposits that would go directly to an individual's own IRA (not an employer retirement plan), such that the "arrangement" simply wouldn't be an ERISA plan in the first place (not for the state administering the program, nor the employer whose payroll deductions fund the IRA). The proposal still must receive its final approval from OMB, which is expected to come in about 45 days.

How An RIA Firm Can Comply With The New DoL Fiduciary Rule (RIA In A Box) - While the Department of Labor's fiduciary rule is widely expected to have more impact for broker-dealers than for registered investment adviser (RIA) firms, the reality is that RIAs are impacted as well, and the mere fact that an RIA was already a fiduciary under the Investment Advisers Act of 1940 is not an automatic safe harbor from the new regulations. Most RIA firms will likely qualify as a "Level Fee Fiduciary" (LFF) under the new rule - which applies if the only fee compensation received by the firm is level (a fixed percentage of the value of the assets, or a set [retainer] fee that does not vary with the particular investment recommendation - but even as an LFF, the RIA still has several operational requirements. The first is that the client must be given a written fiduciary statement - which may be incorporated into the RIA's advisory agreement, but that change to the agreement must actually be made. The second is that the firms must document why the advisor's arrangement is better than the prospective client's former investment/holding - in other words, justification for a 401(k) rollover, including any differences in fees, performance, and services, must actually be documented (as even a Level Fee Fiduciary has a fundamental conflict of interest in recommending an unmanaged 401(k) be rolled over to a managed IRA). And of course, the advisory firm's compensation itself must be fully reviewed to ensure that it actually is entirely level - for instance, charging different amounts for managing fixed income versus equities could run afoul of the rule - or the RIA will be required to comply with the far-more-onerous full Best Interests Contract, with additional policies and procedures, and disclosure requirements.

DoL Fiduciary Rule's 'Grandfathering' Exemption May Be Lost By Changing Firms (Greg Iacurci, Investment News) - Under the new DoL fiduciary rules, advisors who are receiving ongoing commissions (e.g., trails, or even certain commissions for additional contributions under an existing plan) may continue to receive such compensation without validating the recommendation as a fiduciary; this "grandfathering" provision for existing commissions effectively means only new investment recommendations with commissions will be subject to fiduciary scrutiny. However, several regulatory experts are raising the question of whether a registered representative who switches broker-dealers would lose the grandfathering status, as changing platforms would require clients to sign a new account opening agreement, which the DoL could interpret as a "new" investment recommendation, and therefore subject a prior recommendation to new fiduciary scrutiny for the first time. In turn, this could have a dramatic impact on the ability of reps to change broker-dealers once the DoL rule is effective - not only may some brokers struggle to validate prior recommendations under new fiduciary scrutiny, but broker-dealers themselves may not want to accept a broker's existing commission trails and be faced with accepting the new fiduciary liability that goes along with them (given that the new firm had no oversight of the original recommendation). On the other hand, given that this may be an "unintended consequence" of the DoL rule, it's possible that the DoL itself will issue subsequent guidance to clarify whether switching broker-dealers was (or was not) intended to trigger the fiduciary rule.

A Second Look At Third-Party Exams (Daniel Bernstein & Brian Hamburger, Wealth Management) - While there has been a lot of recent focus on the Department of Labor's fiduciary rule, a still-lingering issue is the concern that Registered Investment Adviser (RIA) firms are not being examined and overseen sufficient by the SEC, either, given the SEC's own estimates that it only examines the average advisor about once every 10 years. SEC Commission Chair Mary Jo White has made numerous public comments about increasing investment adviser exam frequency, and appears to be considering a proposal that would allow third-party firms to conduct regulatory examinations, given that Congress has continued to refuse the SEC's requests for a bigger budget to increase exams directly and a legislative proposal for RIAs to pay "User Fees" to the SEC (to fund more exams) hasn't gained momentum either. Exactly how a third-party examination process would be rolled out remains to be seen; Bernstein and Hamburger suggest that most likely, the third-party exams would not replace the SEC's efforts, but function more as a 'reconnaissance' function that could report problems to the SEC for further investigation, and could be done directly via SEC rulemaking and without Congressional approval (given Congress's gridlock). On the other hand, it's also not clear that more frequent examinations would actually do anything to protect the public, especially for the subset of RIAs that do not have custody of client assets and instead "merely" manage investments via a third-party independent custodian. Accordingly, Bernstein and Hamburger suggest that first, the SEC should do a proper analysis of what the ideal exam cycle should be, with an acknowledgement that different types of RIA business models (e.g., those that self-custody vs using third-party independent custodians) might represent different risks to consumers and therefore need require different exam cycles (along with different examiner competency requirements and examination scope). In addition, it's still unclear whether the SEC really needs more resources to increase and improve the RIA exam cycle, or if the SEC perhaps needs to re-allocate existing resources that are currently dedicated to (sometimes duplicative) B/D or registered investment company (i.e., mutual fund) exams instead.

How The Best Financial Advisers Build Trust (Craig Faulkner, Financial Planning) - While every parents tries to teach their children to tell the truth, when it comes to marketing in many industries, there's a long history of being less-than-forthright in communicating the costs and benefits of a particular product or service. In recent years, though, the trend has been towards embracing truly transparent marketing - as embodied in companies like Avis, with its famous "We're #2, We Try Harder" rental car campaign. To some extent, this is already required of financial advisors, given our disclosure obligations for legal compliance purposes; still, many financial advisors aren't entirely clear and transparent in their marketing materials. For instance, does the firm clearly state its target clientele and who it serves (i.e., including asset minimums?), its financial planning process and investment philosophy, and provide a clear detailing of the advisory firm's fees on its website? Faulkner notes that transparent marketing can extend even further, though, also trying to clearly show what happens behind the scenes at the advisory firm - for instance, including videos of everyday life at the office, or the advisor and team at an event together outside the office, which provides prospective clients a way to make a personal connection to the firm.

Tips For Dealing With Introverted And Extroverted Prospects (Dan Solin, Advisor Perspectives) - For most advisors meeting with prospective clients, the standard approach is some form of 'pitch' to persuade the prospect to entrust the advisor with their assets, under the presumption that the prospect wouldn't be there in the first place if he/she wasn't interested in hearing what the advisor had to offer. However, Solin notes that in practice, prospects may be more likely to do business with the advisor based on his/her perceived likeability, rather than merely based on a showing of technical expertise and competency. And the reality is that likeability is driven by the ability of the advisor to establish an emotional connection... a process that may be very different depending on whether the client is an introvert or an extrovert! For instance, extroverts tend to talk more, and can be prompted into a long conversation with relatively short open-ended questions like "Tell me about yourself", which the advisor should be wary about cutting off too early (or the extrovert may feel uncomfortable). On the other hand, introverts tend to be more reserved and reflective, which means they will do better with more direct questions like "Tell me how I can make this meeting as productive as possible for you?" The starting point, though, is for the advisor themselves to realize if they're an extrovert or an introverted advisor, as until you recognize your own style, it may be hard to perceive how you might need to communicate differently with a prospect (particularly one who is the opposite of your natural style!).

When You Do This, Clients Are 3X More Likely To Refer (Julie Littlechild, Absolute Engagement) - Having surveyed more than 1,000 investors who work with a financial advisor, Littlechild has found that clients are 3x more likely to refer when the advisor also works directly with one of the client's children. Of course, the caveat is that depending on the advisory firm, the client's children may not necessarily be the best fit for the advisor in the first place. Fortunately, though, Littlechild's research finds that almost any engagement with the children of clients increases the likelihood the client is a referrer, including not just meeting directly with the clients' children, but also sending information to the clients that they can share with their children, sending them articles or other resources to help them understand money, creating a 'basic' financial plan or budget for the children, or inviting the children to an educational event. And a follow-up survey question to clients whose kids are not served by their advisor suggests that as many as 1/3rd of clients might be interested in such a service. (Michael's Note: While it's not difficult to imagine the link between engaging with the children of clients, and those clients' likelihood of referring, it's also possible that clients who are already more likely to refer were simply more proactive in referring their children - which means that serving the children didn't make the person refer more, and instead that referral-oriented clients are more likely to 'persuade' their advisor to work with their children, even if it may not actually productive for the advisor to do so!)

Can New Portfolio-Risk Tools Improve Client Results Or Win New Business? (Bob Veres, Advisor Perspectives) - When it comes to determining a client's risk tolerance, Veres calls FinaMetrica the "gold standard" questionnaire, given its academic psychometric design and use in peer-reviewed studies. The challenge, however, is that while FinaMetrica may be effective at evaluating risk tolerance itself, advisors have complained that there's no quick and convenient way to map the FinaMetrica risk score to a particular portfolio (nor to evaluate its score in the context of the client's existing portfolio, and whether/how that portfolio might be modified). To fill the void, FinaMetrica is working on two new integrations with related portfolio risk analytics tools. The first is with RiXtrema, which has robust capabilities for doing scenario-based stress tests to evaluate a portfolio's diversification and downside risk exposure, and will now be able to relate those potential portfolio drawdowns directly to the client's (FinaMetrica) risk tolerance score. To do so, the client would simply go to RiXtrema's standalone "Portfolio Crash Test" site, enter their portfolio (or pull in the values using Quovo account aggregation), complete the FinaMetrica risk tolerance questionnaire (if not already done), and then compare the risk tolerance results with the portfolio's risk analysis; if the current portfolio is "out of whack" from the risk tolerance score, RiXtrema's tools can even provide recommendations (based on the advisor's buy list and what's already in the portfolio) to bring the portfolio in line (though the advisor would still have to evaluate the tax ramifications). Continuing the theme, competing portfolio risk analytics tool MacroRisk Analytics has also built out a FinaMetrica integration, housed at a standalone "Portfolio Risk Tools" site, which again allows the advisor to input a client's portfolio (though no Quovo account aggregation option), and then compare the portfolio to the client's risk tolerance score using a wide range of metrics (while RiXtrema focuses on drawdowns, MacroRisk also reports beta, down-market Beta, Sharpe ratio, Sortino ratio, and other quantitative measures). Again, slider tools then allow the portfolio to be modified to better match the client's risk tolerance, which can be commemorated in a final report provided to clients. For advisors who want to adopt the solutions, MacroRisk costs $900/year, while RiXtrema has subscriptions ranging from $150/month to $300/month, and both provide a 33% discount on FinaMetrica when you sign up together.

Maybe Negative Yields Are A Sign Of Prosperity (Tyler Cowen, Bloomberg View) - Over the past year, a growing number of government bonds around the world have begun to pay negative interest rates, and now there are over $500B of investment-grade corporate bonds with yields below zero as well. Some have raised the question of whether this is a sign of impending economic doom, with investors betting on a looming global deflationary event; others have attributed it to central bank bond purchases distorting natural bond market prices. But Cowen notes that on average, yields on Treasury Bonds have been falling for nearly 80 years now, due largely to their ever-improving safety and liquidity in the global marketplace, now functioning almost as a form of "money" with liquidity and safety comparable to cash. In this context, perhaps the reality is that longer-term bonds - including even some high-quality corporate bonds - are simply a reflection of the same trend, where yields are falling in part because investors have never felt safer and more confident than they do today. This would be significant, because it implies both that low or negative yields are not a cause for concern, but also because it implies that if growth picks up again, yields could actually fall further as investors just plow more of their excess wealth into these bonds for their implied safety. After all, within just a few years, global wealth is estimated to reach a whopping $369 trillion, and in that context $10 trillion of negative-yield bonds as "insurance" of a liquidity reserve is actually quite miniscule (with room to rise), particularly given how much risk remains in other forms of investments and asset classes. Or viewed another way, if we want to see bond yields improve, what we may need is not just better growth, but an improvement in the perceived safety of other risky assets, such that investors with such great global wealth don't still feel the need to hold so much in "safety" assets like government (and high quality corporate) bonds.

Active ETFs Produce Few Stars And Even Fewer Fans (Jeff Benjamin, Investment News) - With the ever-rising outflows of actively managed mutual funds (particularly in equities), asset managers have been increasingly launching actively managed exchange-traded funds instead. Yet while there are now 156 actively managed ETFs launched in the past 8 years (with 24 started this year alone), the category is still a mere $26B, or barely 1% of the overall ETF space. And amongst those, a very small number of active ETFs account for the overwhelming majority of the assets, including DoubleLine's Total Return Tactical ETF (TOTL) at $2.7B, PIMCO's Total Return Active ETF (BOND) at $2.6B, and PIMCO's Enhanced Short Maturity Active ETF (MINT) at $4.5B. In fact, the only other active ETFs to even crest $1B of AUM are the iShares Short Maturity Bond ETF (NEAR) at $2B, and the First Trust NOrth American Energy Infrastructure ETF (EMLP) at $1.3B (the latter being the only non-bond active ETF of any size). From the asset manager's perspective, active ETF growth is being slowed by the required transparency, which for an active manager that may move dollars incrementally over time, introduces the (legitimate) fear of other market participants front-running a fund's trades. Though at the same time, advisor adoption of active ETFs also appears to be slow, in part perhaps because (active or any) ETFs don't pay 12(b)-1 fees that are popular amongst advisor currently selling actively managed mutual funds, though ultimately the biggest challenge may simply be that advisors are more likely to actively manage ETFs themselves, and therefore aren't interested in paying for an actively managed ETF at all.

Why News Junkies Are So Glum About Politics, Economics, and Everything Else (Derek Thompson, The Atlantic) - The quintessential rule of journalism is that ordinary events are not newsworthy, while notable oddities deserve what may be disproportionate coverage. Yet given the influence of the media, the implications are subtle but profound - if journalists disproportionately report on extreme events, they can guide the attitudes of both the public and experts to misjudge and overestimate the likelihood of those events (a phenomenon known as the "availability bias"). In other words, if the press only reports on extreme bad news, it can make the world seem more terrible than it actually is. For instance, one study recently found that greater media-driven awareness of market volatility and crashes appears to be driving people to grossly overestimate the likelihood of a 1987-style Black Monday market crash. Similarly, the reality is that since 9/11, fewer than 100 people have died in jihadist attacks in the U.S., which is the same as the number of deaths from automobile accidents every day, yet many Americans feel that terrorism is far more of a menace than a six-car-pileup. And when the press starts to cover a topic that was rarely written about in the past, it can create even greater distortions - for instance, media coverage of gun violence has increased in recent years, particularly when it comes to police shootings of black men and the deaths of police officers, yet the true reality is that police fatalities were about 60% higher 30 years ago and homicide rates have been falling for two decades. Which means ironically, as futurist Ray Kurzweil recently put it, the problem is not that the world is getting worse, but that our access to information about the world is getting better, and the introduction of that newly accessible information is distorting our perception of reality.

Which Financial Advice Topics Are Positively Associated with Financial Satisfaction? (Jing Jian Xiao & Nilton Porto, Journal of Financial Planning) - The 2012 National Financial Capability Study surveyed more than 25,000 people nationwide, and asked people about both their financial satisfaction, and whether they have recently asked for advice from a financial professional in the areas of debt, savings/investments, taking out a mortgage, insurance, or tax planning. Given this data set, Xiao and Potro analyzed whether access to and working with a financial professional actually resulted in higher financial satisfaction (i.e., was there a perceived benefit to receiving the advice). The results revealed that advice on debt counseling, mortgage/loans, or insurance, all resulted in lower financial satisfaction, but that advice regarding investments and taxes was positively associated with financial satisfaction, and holistic advice including both investment or tax advice and the others led to neutral or positive financial satisfaction. Of course, it's not entirely clear whether the negative association was debt, mortgages, and insurance was caused by the financial advisor, or if the simple reality is that those tend to be more negative topics in the first place (such that spending time on them in any context leads to more negative financial associations). Nonetheless, the results imply that advisors who do have to consult around one of these "negative" topics (debt/mortgage/insurance) may be well-served to also pair it with a positive one (investments or tax planning) as well, and more generally suggest that holistic financial advice can be a positive, even when discussing negative or challenging topics, and that clients will likely feel financial satisfaction when discussing 'typical' financial planning topics like investing/saving and tax planning.

Is Your Attitude Towards Work Killing Your Retirement Dreams? (Tim Maurer) - If you ask someone "do you have a generally positive or negative impression of the word 'retirement'", there are a surprising range of responses. Maurer notes there do seem to be some generational consistencies - baby boomers generally have a positive view of retirement (likely impacted by decades of financial services marketing to them about "a utopian post-career existence"), while Millennials have a largely negative view (imagining early buffet dinners in rural Florida, and an American dream that feels unavailable to them given student loan debt loads). Yet Maurer points out that perhaps the even more concerning dynamic is that fewer than 1-in-5 of the Gen X or Boomer generations say the thing that motivates them to get up in the morning is going to a job that fulfills them - which suggests that perhaps the reason older generations are more eager to retire is that their work itself is more unfulfilling. Which is concerning, because those who don't find their work fulfilling may also be less likely to progress in their career track, therefore failing to improve their earnings and savings potential, and causing retirement to feel even further away. Conversely, the irony is that those who enjoy their work the most, and may therefore be most engaged with their job, and most likely to get raises, are the ones who are so happy that they're not even interested in retiring in the first place (even though they may be the most able to afford it). All of which suggests that perhaps trying to solve for the "can you retire" or "will you retire" puzzle is actually the wrong challenge, because the better path is trying to figure to shift from the unhappy-work vicious work (where you want to retire but can't) to the happy-work virtuous circle instead (where you may not want to retire, but at least you'll have good enough career growth and earnings to be able to if you want!).

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!

In the meantime, if you're interested in more news and information regarding advisor technology I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!