Weekend Reading For Financial Planners (July 8-9)

Advisor Satisfaction With Firms Hinges On Time Spent With Clients: J.D. Power

(Ryan Neal | InvestmentNews)

For many financial advisors, working directly with clients is one of the most rewarding parts of the job, particularly compared to compliance and administrative tasks. And while technology solutions have created greater back-office efficiencies for advisory firms, a recent survey suggests that some advisors still find that they do not have enough time to spend with clients.

According to a survey of more than 4,000 advisors by J.D. Power, 28% said they do not have enough time to spend with clients. These advisors reported spending an average of 41% more time each month than other advisors on “non-value-added” tasks, such as compliance and administrative duties. Further, the advisors reporting that they do not have enough time to spend with clients had Net Promoter Scores (a measure of advisor advocacy) that were significantly lower than their peers, suggesting less satisfaction with their firms. Together, these findings indicate (perhaps unsurprisingly) that advisors with less time to work with their clients are less satisfied with their jobs.

Notably, a separate recent survey indicates that another challenge many advisors face is having too many (non-ideal) clients to serve. According to the survey of 1,200 advisors by research and consulting firm Cerulli Associates, serving too many non-ideal clients (i.e., based on account sizes, needs, specialties, or engagement levels) was the most commonly cited challenge among respondents, with 64% identifying it as a major challenge and an additional 27% identifying it as a moderate challenge. The survey found that senior advisors serve about 160 clients on average, with 29% of senior advisors managing more than 200 clients, which could strain their ability to provide a high level of service (and perhaps the number of relationships they can maintain at once?).

In the end, these surveys suggest that because there are only so many hours in the workday, being able to spend more time with the (ideal) clients can boost an advisor’s satisfaction with their job and their productivity. And so, firms could consider not only consider ways to take some of the administrative work off of their advisors’ plates (perhaps by hiring additional back-office staff or by upgrading their tech stacks), but also ‘right-sizing’ their advisors’ client loads, perhaps by moving some clients to a different advisor or referring them out to another firm, in order to not only improve advisor satisfaction, but also to potentially provide a higher level of service to their (ideal target) clients!

Affluent Clients' Trust In Advisors Unshaken By 2022, Cerulli Says

(Jennifer Lea Reed | Financial Advisor)

Both the stock and bond markets saw poor performances in 2022, along with many client portfolios. During periods such as this, some advisors might worry that their clients could consider leaving the firm (even if their portfolio losses merely matched the broader market environment). But a recent survey suggests that clients appear to continue to have trust in their advisors.

According to a study from research and consulting firm Cerulli Associates conducted over the course of 2022, 72% of clients of independent advisors said they believe financial services firms put their best interests first, higher than the 61% reported by the broader pool of affluent investors surveyed. The study noted that this level of alignment between advisors and their clients is particularly important during periods of market stress, when clients might be tempted to make major changes to their portfolios (or, amid possible portfolio losses, question whether their advisor has their best interests at heart). For instance, the study found that 44% of respondents had reconsidered their overall portfolio plan in the prior 3 months, suggesting that advisors could play an important role in helping their clients better understand market volatility and how their portfolio is built to meet their goals.

Ultimately, the key point is that given the uncontrollable nature of investment markets, building a relationship of trust with clients is an important part of helping them avoid (potentially costly) changes to their portfolio. Further, by offering a slate of services tailored to their firm’s ideal target client (that go beyond portfolio construction), advisors can demonstrate ongoing value, no matter how markets are performing!

SEC Report On RIA Mandatory Arbitration Leaves Many Questions About Potential Investor Harm

(Mark Schoeff | InvestmentNews)

Investment advisory and broker-dealer firms often include arbitration clauses in their client agreements, which stipulate that any dispute between a client and the firm will be heard not in the court system, but through a third-party arbitrator who hears evidence from both sides and issues a (typically binding) ruling. The financial industry generally favors arbitration because it can be faster and less expensive than the court system; however, unlike a lawsuit heard in court, arbitration hearings do not become public record, which enables firms to save face if found guilty of wrongdoing and limits the ability of prior cases to become precedent for future plaintiffs. In theory, clients and the advisory firms they’re challenging might try to agree on whether a case will be heard in a court of law or via arbitration (as each weighs both the costs and whether they think they will receive a more favorable outcome in one forum or another), but in practice arbitration clauses are often mandatory with advisory firms, meaning that a client who signs a brokerage or advisory agreement containing the clause loses their right to ever take that firm to court in the event of a dispute. Even if the client believes that might have been the better forum to have their case heard.

Following a request from the House Committee on Appropriations (and calls from a variety of consumer and investor advocacy groups) for the SEC to collect data on this issue, the regulator in late June published a report assessing the state of RIA mandatory arbitration clauses. To start, the report found that 61% of SEC-registered RIAs have mandatory arbitration clauses, with the vast majority using private arbitration forums to hear claims (which can be more costly than the dispute resolution fora used by other firm types, such as the system run by FINRA for adjudicating customer and registered representatives’ claims against brokerages). However, given the relatively opaque nature of arbitration proceedings and limited reporting requirements (e.g., RIAs only have to report arbitration claims if they deem them to be “material” to the operation of their firms, a lower standard than non-fiduciary brokers, which are required to report all customer disputes, arbitration cases, and outcomes), questions remain about the number of RIA arbitration cases, where they are heard, the costs for claimants, and the amount of damages that are awarded and actually paid.

Altogether, while RIAs often differentiate themselves from other advisory firm models on transparency grounds (e.g., in how and how much clients pay in fees), the SEC report demonstrates that the ubiquitous presence of mandatory arbitration clauses and the lack of data surrounding them is an area of relative opacity for RIAs. And while it is unclear whether Congress or the SEC will take action to regulate the use of these clauses, firms can consider on their own whether the potential benefits of using them (e.g., costs to the firm and speed of resolution) outweigh the potential to turn off prospective and current clients (at least those who are aware of their use?).

The RIA M&A Market Has Been Hot – But Buyers Are Still Walking Away

(Holly Deaton | RIAIntel)

The pace of RIA Mergers and Acquisitions (M&A) depends on a variety of factors, from the ability of acquiring firms to finance deals to the number of firms interesting in selling and alignment between the 2 sides in terms of valuing the firms considering a sale. And a recent study shows that while several factors drove a heightened pace of M&A activity between 2020 and 2023, there were still areas of misalignment between buyers and sellers that led to the breakdown of potential deals.

According to Fidelity’s 2023 M&A Valuation Study, 492 RIA deals were reported between January 2020 and March 2023, up from 146 between 2017 and 2019, signaling brisk interest in dealmaking. Further, the size of deals increased as well, with the median assets under management of acquired firms increasing from $250 million previously to $400 million in the more recent period. Among acquiring firms surveyed, the top reason driving interest in deals was acquiring top advisor talent (cited by 90% of firms, up slightly from 87% during the previous study), followed by an interest in entering a new geographic market (63%, down from 78%) and growing their share of assets (50%, down from 52%), suggesting that the current competition for advisor talent is playing a central role in driving buyer interest. For owners of selling firms, the top reason for pursuing a sale was to reduce operating duties and focus on client needs (77%, up from 57%), achieve full or partial liquidity for the owners (70%, up from 61%) and the lack of a viable succession plan (40%, down from 43%), suggesting that many sellers are more interested in spending time directly with clients rather than working ‘on’ their business.

Notably, buyers reported walking away from 52% of evaluated deals, with a misalignment of valuation expectations (cited by 87% of respondents) being the top reason for doing so, followed by a lack of cultural fit between the firms (73%) and differences in vision such as growth plans or client experience (50%). Regarding the perception that sellers were overvaluing their firms, 83% of buyers thought sellers were using unrealistic comparison multiples in large sales, 77% thought sellers had a lack of understanding of valuation drivers, and 47% said sellers were too close to their business to see weaknesses. Which together suggest that potential sellers could consider getting an independent appraisal of their firm’s value to get a better idea of what their firm might actually be worth.

In sum, while the pace of RIA M&A activity has been hot leading up to 2023, there is no guarantee that a given deal will be consummated. And given the potential for higher interest rates and other factors to reduce buyers’ ability to complete deals in the near future, aligning expectations between buyers and sellers, both in terms of valuation and how the combined firm will look after a deal is completed, could be more important than ever!

Avoiding Costly M&A Mistakes While Driving Inorganic Growth

(Adam Malamed | WealthMangement)

Growth-minded advisory firms have many options to increase their assets under management. Often, advisors look to spur organic growth, whether through marketing campaigns to attract new clients or a push to bring more assets of current clients under the firm’s umbrella. Alternatively, for firms looking to bring on new assets quickly, acquiring another firm could be an attractive option. However, just as owners of growing firms face challenges moving from a solo operation to running a business, embarking on an acquisition can pose a new challenge. And given the high financial stakes of deals, there is significant pressure to get a deal ‘right’, from valuing the selling firm to ensuring a smooth integration after the deal is completed.

Firms contemplating an acquisition can first consider the big picture of doing a deal by asking themselves whether the acquisition will add to the existing strengths of the business or fill a vital gap that the firm’s current capabilities cannot address (and if the answer to both of these is no, the firm might want to reconsider the transaction). Next, acquiring firms can consider the valuation of the selling target and review their financing options (particularly in the elevated interest rate environment) to ensure that the deal makes financial sense. Acquiring firms can also prepare for the integration process once the deal is completed (e.g., by considering how long the selling advisor will stay in the picture, how client relationships will be managed, and what changes to portfolios might need to be made) to bring the selling firm’s staff and clients onboard with minimal disruption to the acquiring firm’s current clients and team members.

Overall, it is important for firm owners looking to make an acquisition not only to consider the financial costs (and benefits of a deal), but also the time costs required to conduct proper due diligence before the deal and to integrate the 2 firms after the deal is completed. Which suggests that while an acquisition can be a quicker way to grow client assets compared to organic growth strategies, it can still involve a significant time commitment for a firm owner to ensure that the deal ends up being in the long-run interest of their firm!

To Hike Or Not To Hike: How RIA Buyers Handle Fees For Acquired Clients

(Andrew Foerch | Citywire RIA)

After an RIA acquisition is completed, there are many factors to consider in the process of integrating the 2 firms, from bringing new staff members on board to transferring client information and accounts to the acquirer’s platform. Another key decision for the acquiring firm is whether (and, if so, how) to change the fees currently being charged to clients of the acquired firm. Because while at least some of the clients of the acquired firm might be paying a fee that is less than they would pay on the buyer’s fee schedule, some firms might be hesitant to increase their fee and risk the client leaving amid the transition.

One option for acquirers is to allow legacy clients of the acquired firm to remain on their current fee schedule permanently. Given that having their previous firm be sold can be a stressful time for clients (from possibly having to ‘repaper’ to transfer assets to the acquirer’s custodian to potentially being transitioned to a new advisor), keeping the fee schedule steady can remove one point of tension from the process. Another option is to keep the fee scheduled steady for the acquired clients for a certain period of time (e.g., 1 or 3 years), before making any changes. This can give the clients time to get used to the newly combined firm and the (potentially higher) level of service it offers before being confronted with a  fee hike. Still other firms might be willing to risk losing some clients and make changes to fees soon after the deal is completed to ensure all firm clients are on the same fee schedule (though this approach has become rarer in recent years).

In the end, a potential change to the fees charged to clients of an acquired firm is a key element that can be negotiated in a deal between the buyer and seller during the negotiation process. Though ultimately, it is up to the acquiring firm to demonstrate to its newly acquired clients that it is providing a level of value that will make them want to stay with the combined firm, whether or not their fees are adjusted!

Don't Worry Too Much About IRMAA

(James Dahle | The White Coat Investor)

While some of the benefits for clients of working with a financial advisor are qualitative (e.g., the peace of mind knowing that they are on a sustainable financial path), retirement income planning (particularly as it relates to taxes) can be a way for financial advisors to show how they are saving their clients hard dollars on an annual basis. And when it comes to retired clients who are on Medicare, one area where advisors can potentially help save their clients money is on the Income-Related Monthly Adjustment Amount (IRMAA), a surcharge on Medicare Part B and Part D premiums for individuals whose income exceeds certain levels.

But Dahle suggests that while IRMAA surcharges might be a nuisance, those subject to them might not want to spend too much time worrying about the surcharges because they represent a relatively small percentage of an individual’s or couple’s income. For instance, married clients who have reached the first IRMAA tier (greater than $194,000 of Modified Adjusted Gross Income [MAGI] for those who file joint tax returns) would have to pay a total of $1,874.40 in IRMAA surcharges per year, representing less than 1% of their AGI (which notably does not include non-taxable sources of income such as qualified Roth distributions). Similarly, those in the highest tier of IRMAA surcharges (single filers with income of at least $500,000 or joint filers with income of at least $750,000) would only pay 1% to 2% of their AGI each year (e.g., married couples in this tier would pay a combined $11,328 in surcharges per year).

That said, there are areas where an advisor could add value to their clients by paying attention to IRMAA thresholds. For instance, an advisor recommending that their client engage in Roth conversions or capital gains harvesting could weigh the benefits of these strategies against the costs of moving into a (higher) IRMAA tier, especially if they’re very close to a threshold (as each of the 4 surcharge tiers are “cliff” thresholds, meaning that even $1 of income past the threshold results in the entire [higher] surcharge amount being applied). Another potential way for advisors to add value is to recognize when clients have a “life-changing” event that leads to a reduction of income (e.g., retirement, death of a spouse). Because while IRMAA surcharges are typically calculated based on ‘prior-prior’ year income (e.g., charges paid in 2023 are based on the client’s AGI in 2021), individuals can apply (typically by using Form SSA-44) to have their IRMAA surcharges reduced to reflect substantial changes in income if one or more listed “life changing” events occurred since the prior-prior year.

Ultimately, the key point is that relative to the income levels it takes to hit IRMAA thresholds in the first place, IRMAA is really just the equivalent of a modest income surtax. Nonetheless, there are potential opportunities for advisors to add value by helping clients in certain scenarios (e.g., if they are very close to the next surcharge tier threshold, or experience a “life-changing” event that leads to a reduction of income) to reduce (or eliminate) the Medicare surcharges they are required to pay!

IRS Warns Of Tax Scams That Target Wealthy

(Jeff Stimpson | Financial Advisor)

Every year, the IRS releases its “Dirty Dozen” list of tax scams to help consumers be aware of the latest tactics scammers are using to abuse the tax system (and potentially defraud consumers who sometimes pay for help or advice to implement these not-actually-valid tax scams). This year, scams on the list include everything from email-based “phishing” and text-based “smishing” attacks that are used for identity theft, to fake charities that take advantage of the public’s generosity. In addition, the IRS also highlighted 2 schemes aimed specifically at high-income tax filers: misused Charitable Remainder Annuity Trusts (CRATs), and monetized installment sales.

CRATs are irrevocable trusts that let individuals donate assets to trust, and pay a specific dollar amount back to the donor each year (for the remainder of their life, or for a specific time period), and then donate the remainder to a charity. Which can be a valuable tool for charitably inclined individuals. However, the IRS warned that these can be misused, often at the behest of a promoter or ‘advisor’. For example, an individual might transfer appreciated assets with a fair market value in excess of its basis to the CRAT, but then wrongly claim that the transfer of the property to the CRAT results in an increase in basis to fair market value as if the property had been sold to the trust (it doesn’t, the cost basis is supposed to carry over to the trust). If the CRAT then sells the property but does not recognize the gain (due to the incorrectly claimed step-up in basis), promoters then encourage the purchase of a single premium annuity with the proceeds from the sale of the property, and tell the taxpayer to (incorrectly) treat the remaining payment as an excluded portion representing a return of investment for which no tax is due. When in reality the trust should have recognized a gain on the sale of the property, and the donor should then have allocated those capital gains to trust distributions (under the standard rules for taxation of distributions from a Charitable Remainder Trust), plus any ordinary income associated with the annuity payments themselves.

In another scam, promoters seek out taxpayers looking to defer the recognition of gain upon the sale of appreciated property by facilitating a purported monetized installment sale in exchange for a fee. This involves an intermediary purchasing appreciated property from a seller in exchange for an installment note that typically provides for payment of interest only, with principal being paid at the end of the term, allowing the seller to get the majority of the proceeds from the sale but improperly delaying the recognition of gain on the appreciated property until the final payment on the installment note, often years later. Instead, the reality is that if the seller receives the proceeds of the sale, installment gains should be recognized as the proceeds/payments are received.

Given that many financial planning clients could be attractive targets for these scams – especially for those holding long-term appreciated assets, where the scams are focused on (incorrectly) trying to defer or avoid large gains – advisors can add value for their clients by helping them recognize such that offers really are “too good to be true”. Further, the IRS’s notice can serve as a reminder for advisors who (legitimately) use CRATs or installment sales with their clients to ensure they are structured and executed appropriately in accordance with the relevant tax laws!

How You Can Grab A 0% (Capital Gains) Tax Rate

(Laura Saunders | The Wall Street Journal)

In the United States, different types of income are taxed at different rates. For example, the tax brackets for ordinary income are different than the rates paid on long-term capital gains and qualified dividends, with these latter sources of income getting preferential treatment. In fact, while the lowest tax bracket on ordinary income is 10%, long-term capital gains and qualified dividends can be taxed at a 0% rate depending on a taxpayers’ circumstances! Nonetheless, given other tax strategies available, financial advisors can help their clients determine whether taking advantage of this 0% bracket is the best course of action given their particular circumstances.

Currently, the 0% long-term capital gains tax rate is available to taxpayers with taxable income up to , the upper thresholds of the 12% ordinary-income tax bracket, which is currently $44,625 for single filers and $89,250 for married filers filing jointly. Which means, for example, a couple with $50,000 of other taxable income could realize up to $39,250 in long-term capital gains without having to pay any (federal income) tax on those capital gains proceeds! Which not only allows for the opportunity to sell appreciated investments “tax free” for retirement withdrawal purposes, but if not needed for spending the investor could also just buy back the investments that were sold and get a ‘free’ step-up in basis (a tactic known as capital gains harvesting), as the “wash sale” rules only apply to selling an investment for a loss then buying it back (not selling for a gain and buying it back… even if that gain was harvested because it’s ‘tax-free’ at 0% rates!).

Given the potential benefits of the 0% long-term capital gains tax rate, though, it is important to recognize how this income interacts with other sources of income and tax strategies an advisor might implement. When it comes to the ‘stacking’ of income, ordinary income comes first, and long-term capital gains (and qualified dividends) come second and stack on top (any available deductions are applied against ordinary income first). This means that if taxable ordinary income reaches $44,625 (for single filers), there is no more ‘room’ in the 0% long-term capital gains bracket and any further gains will be taxed at 15% (until they reach the 20% bracket threshold); in turn, it also means that if there is only $10,000 of “room” left (e.g., taxable income was previously $34,625) and the investor has a larger $25,000 long-term capital gain, the first $10,000 that falls under the threshold gets the 0% rate, but any additional capital gains that land above the threshold are still taxed at 15%). Notably, because ordinary income not only includes earned income, but also the proceeds of Roth conversions, Required Minimum Distributions (RMDs), and other income sources, it is important for advisors to consider these additional sources of income when determining how much ‘room’ might be left in the 0% bracket and whether they want to recommend certain ordinary income-generating strategies (e.g., Roth conversions) instead.

Ultimately, the key point is that the 0% long-term capital gains tax rate can be a valuable tool for clients in a variety of situations, from retirees who have not yet reached their begin date for RMDs to working-age individuals who have an unusually low-income year due to a layoff or other circumstance. And it’s not just about getting the tax benefit as investments are sold for rebalancing or portfolio changes or for retirement spending purposes… it can also be a proactive capital gains harvesting strategy to get an ongoing step-up in basis for clients any year they’re in one of the bottom 2 tax brackets. Though advisors still have to weigh whether another tax-saving strategy (e.g., partial Roth conversions) might be more important given the client’s individual situation!

Your Brain Has Tricked You Into Thinking Everything Is Worse

(Adam Mastroianni | The New York Times)

For many people, looking back on their childhood or early adult years brings back fond memories, not only of their own experiences but of the world around them. But when thinking about the state of the world today, the things that come to mind might be significantly more negative, whether it is thinking about the latest ‘scandals’ reported on the news or the person who cut you off driving to work in the morning.

In a recent paper, Mastroianni and co-author Daniel Gilbert reviewed survey data to study this phenomenon and found that across many countries, individuals tend to believe that humans are less kind, honest, and ethical today than they were in the past. At the same time, when looking at survey data over time asking individuals about the current state of ‘morality’ (e.g., whether they were treated with respect the day before), the answers do not change meaningfully over the years (i.e., respondents rated ‘today’s’ level of morality the same in 2002 as they did in 2020). This demonstrates an incongruency: while the assessed ‘current’ level of morality does not tend to change from year to year, individuals assess that it has declined significantly over time!

Mastroianni suggests 2 psychological phenomena could combine to cause this result. First, “biased exposure” is the tendency for individuals to encounter and pay attention to negative information about others (e.g., front page headlines about a recent scandal). Second, “biased memory” explains how the negativity of negative information fades faster than the positivity of positive information (e.g., while you might remember many of the details of a fun trip you went on many years ago, the memory of a bad performance review at an old job might fade over time). Together, these can create an illusion of decline in that bad things happening today will be top-of-mind while negative news from the past will often fade away in your memory.

Advisors might recognize this tendency when clients come to them worried about the latest ‘scary’ financial headlines, assuming that the market environment is significantly more perilous today than it was in previous years. Which could create an opportunity for advisors, not necessarily to remind clients how ‘bad’ things were in the past, but rather how market fluctuations are common and how the client’s portfolio and financial plan are aligned to meet their goals!

Burnout Is The Echo Of Self-Judgment

(Lawrence Yeo | More To That)

Burnout is common in modern society, whether it is the result of an individual working well into the night for an extended period or a parent trying to juggle professional and personal responsibilities. Typically, burnout is viewed as the result of external forces weighing down on an individual (e.g., a boss assigning a project with a short deadline), leading to distress. But Yeo argues that the main driver of burnout actually comes from within our own minds.

Yeo suggests that individuals have an “inner critic” that judges their performance and often says they are not “good enough”. He argues that in the modern era, productivity is seen as a virtue, and that individuals often push themselves to be more productive to demonstrate how valuable they are to others and to themselves. Because individuals often associate productivity with their job, it can be tempting to push oneself harder at work to not only demonstrate their value to others but to provide value to oneself (e.g., in the form off money earned from work), both of which have no limit. Yeo describes this dynamic as “self-exploitation”, which, if left unchecked, can lead to burnout.

To overcome this cycle of pressuring oneself to always be doing ‘more’, Yeo suggests that it is important for individuals to recognize that their identity goes well beyond their work (e.g., to their relationships with family members and friends) and that they have intrinsic value beyond what they produce. In sum, while there is infinite potential ‘work’ that could be done, it is impossible to do everything and that, in reality, you don’t need to in order to be a person of value!

How To Escape A Funk

(Darnell Mayberry | Money Talks)

Financial advisors often help their clients set financial goals and create a plan that can help them reach these targets. But while the path to reaching these goals might seem linear (e.g., an ever-increasing net worth based on average expected investment returns), the path is typically not so straight given the potential obstacles along the way (e.g., a market downturn or a lost job). And while it can be easy to recognize conceptually that the path to achieving a goal (financial or otherwise) will not be straight, in real-time, these bumps in the road can be frustrating.

Mayberry recently found himself in a funk as he contemplated his personal goals, which include living a healthier lifestyle and seeing progress with his finances. While he wished he could see linear progress in these areas, the reality is that advances can be slow and halting and the process is not always pleasant. For instance, on one particular night it seemed to him like all of his neighbors were getting food delivered, which tempted him to do so himself. However, this would have hindered his progress toward both of his goals, and so he decided to cook for himself instead. At the same time, avoiding temptation contributed to his “funk”, where he just felt tired of continuing to make sacrifices without the benefit of seeing immediate ‘results’ (as the calories and money saved could pay off down the line but cannot necessarily be experienced immediately). To get out of this “funk”, he reminded himself of his goals and the slow-and-steady progress that he has experienced as well as the why of his goals.

Ultimately, the key point is that there will usually be bumps on the road toward achieving any goal. Whether they are setbacks on the way to meeting financial goals or the sacrifices required to reach health goals, it is important to recognize that while progress is not linear, perseverance (perhaps aided by support and guidance from a financial advisor or other relevant professional) can eventually lead to success!

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