Weekend Reading for Financial Planners (Jun 24-25)

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 June 24th/25th:

CFP Board Proposes Tightening Fiduciary Requirements: 'Huge Step' or 'Double Standard'? (Ann Marsh, Financial Planning) - At the end of 2015, the CFP Board announced that it was forming a new Commission on Standards... a 12-person committee, with a diverse representation across the industry, that was tasked with updating the CFP Board's current Standards on Professional Conduct, which hadn't been changed since the last update went effective in 2008. This week, the Commission on Standards released the first draft of its new Proposed Code of Ethics and Standards of Conduct, which expands the scope of when a CFP professional must act as a fiduciary on behalf of clients to include not just when delivering financial planning or material elements of financial planning, but anytime the advisor provides "financial advice", which is broadly defined to include any time the CFP professional suggests that the client "take or refrain from taking a particular course of action" (which could include even a single product recommendation). Notably, though, the CFP Board will still allow CFP professionals to earn commissions – akin to the Department of Labor's fiduciary rule - as long as the advisor otherwise meets his/her fiduciary obligations with respect to the advice itself. And as a result, some critics are still raising the concern of whether the CFP Board's new standards will still leave open too many loopholes for broker-dealers offering particularly high-commission products. On the other hand, with the Department of Labor's fiduciary rule forcing substantial reform amongst broker-dealers anyway, including the rise of less conflicts T shares and clean shares, in practice efforts to comply with the DoL's fiduciary rule could reduce the conflicts that CFP professionals are exposed to, anyway. In the meantime, the CFP Board will be conducting a series of 8 open Town Halls for feedback on the proposed standards, and the release of the standards on June 20th marks the start of a 60-day public comment period, which will end on Monday August 21st, during which anyone can submit a comment on the proposed standards via the CFP Board's website here.

For SEC Fiduciary Rule, CFA Institute Says "Regulate Titles First" (Melanie Waddell, ThinkAdvisor) - As the SEC begins to consider its own fiduciary rulemaking process, it opened a Public Comment period on June 1st regarding "Standards of Conduct for Investment Advisers and Broker-Dealers", and the CFA Institute has suggested that the SEC can regain control of the fiduciary issue "by regulating the titles that those who provide personalized investment advice can use". Specifically, the CFA Institute suggests that "anyone wishing to refer to their title and/or activities as advisory in nature adhere to the Investment Advisers Act and the fiduciary duty implied by common law interpretation of the Act." Notably, the idea of regulating titles under the Investment Advisers Act is not new; in fact, the rule already expressly limits use of the term "investment counsel" (a popular title at the time the original law was written) to those who have registered as investment advisers. And in this dynamic, commission-based brokers would not be limited with regard to their activities or compensation – merely that commission-based brokers, who legally operate as salesperson representatives of their broker-dealer, would be required to refer to themselves as "salespersons".

New Nevada Law Imposes Fiduciary Duty On Brokers (Mark Schoeff, Investment News) - Notwithstanding all the debate at the Federal level about the Department of Labor's fiduciary rule, and whether the SEC should take up a similar fiduciary rulemaking process, the Nevada state legislature recently passed (and on June 5th, the Governor signed into law) Nevada Senate Bill 383, which will impose a fiduciary duty on all types of financial advisors in the state of Nevada, regardless of whether they are at a broker-dealer or registered investment adviser, and regardless of whether they are working with retirement accounts or other types of investments. The new rule would require financial advisors to disclose "any profit or commissions" they receive based on their recommendations, and must make a "diligent inquiry" about the client's financial situation; in addition, the Nevada state securities regulator is authorized to adopt further regulations regarding an advisor's fiduciary duties when operating in the state of Nevada. And with the new rule taking effect on July 1st, advisory firms with advisors in Nevada are scrambling to determine whether or how they must adopt their policies and procedures to accommodate the new fiduciary rule. In the meantime, the question arises as to whether Nevada's action presages more state fiduciary rules in the coming years, especially if the SEC continues to linger on adopting its own fiduciary rule.

Don't Let Your Business Control Your Life (Angie Herbers, Investment Adviser) - Most stories of business focus on an owner/leader who just keeps climbing the mountain of success, navigating the occasional hurdle, until they reach the summit. Yet Herbers notes that such stories usually leave out the real challenges that crop up along the path for business owners – the setbacks, mistakes, failures, disappointments, fears, and self-doubts – that must be overcome to persevere. In fact, the biggest challenge for many is that the business itself can become all-consuming... because the business exists for the sole purpose of turning a profit, and will continue to demand more and more of the financial advisor owner (money, time, and effort) to feed its needs. So how do you fend off the threat, and keep a healthy balance to the advisor-business "relationship". Herbers suggests that it's crucial to establish your "core values" – and use those to draw the line on what you will or won't do in the business. For instance, your core values can guide who you will or won't work with as a client – if the client doesn't fit your core values, don't work with them. If a new offer and opportunity doesn't fit your core values, say "no" to it. In other words, when faced with the "Paradox of Success" – that more success brings more opportunities, making it harder to say "no" and causing you to lose your focus – your core values can be the filter that you use to determine when you should say yes, and when you should say "no" instead... while also keeping perspective on what's really important to you at the end of the day.

How The 'Michelangelo Phenomenon' Stops You From Achieving Your Goals (Julie Littlechild, Absolute Engagement) - Being an entrepreneur and business owner demands extraordinary focus and self-motivation. Yet the reality is that building a business is never ultimately a solo endeavor. Not only does a growing business itself ultimately require more people to support it, but even the most focused and self-motivated business owners will still face demons from time to time. In fact, Littlechild suggests one of the key traits of most successful business owners is that they don't actually just go at it alone – instead, they create a personal network around themselves, of people who support them, want to see them succeed, and encourage them to do so. However, the key point is that your support network must be people who actually support your success, which sometimes isn't the case. For instance, Littlechild cites the Michelangelo Phenomenon – a label for the research finding that interdependent individuals (e.g., married couples) tend to influence and "sculpt" one another over time, in ways that aren't necessarily supportive. An example would be a situation where you're all fired up about a big new opportunity in the business, arrive home excited to tell your spouse about it, and your spouse says "Well [sigh], sounds like you'll be working late then – I guess I'll deal with the kids." While this may be a very rational and genuine response, it can also limit your chances of success, sapping your (self-)motivation at a subconscious level. Of course, not everyone can and will necessarily be happy and supportive all the time. But the point remains that, in order to succeed, it's crucial to create a personal network of people – spouses, family, friends, and/or colleagues – who can be there to support you in your inevitable times of need. (Which is also why having a study group/Mastermind group is so popular as well!)

Be Obsessed About A Cohesive Leadership Team (Hoon Kang, Advisor Perspectives) - As an advisory firm grows, it becomes crucial to have not just a strong founder/owner leader, but an entire leadership team that drives the core areas of the business. However, Kang notes that in many firms, there is not a clear alignment in vision and direction amongst the partners/owners of the firm, and this lack of cohesion makes it nearly impossible for the leadership team to execute effectively. To illustrate the point, Kang pens a hypothetical "memo" from an employee (non-owner) CEO to the firm's owners, urging them to resolve the gaps and address key points, including: a leadership team must be productive, but capable of having "brutally honest" discussions in order to make good decisions on important issues; a cohesive leadership team must be willing to admit mistakes and weaknesses, and truly put the firm's priorities about personal ones (which first necessitates a clear understanding of which really are corporate vs personal interests); regular communication (i.e., regular meetings) are essential for a leadership team to ensure they remain on the same page; and gaps amongst the owner/partners must be worked through until resolved (e.g., if the firm has different views on who is the "ideal client" and what the long-term strategy for the firm is, those differences can't be allowed to fester). Of course, the reality is that people can and do form differences in views and perspective over time, so not all partners/owners will always be in perfect alignment; nonetheless, that means a key part of the process of executing a cohesive leadership team is regularly taking the steps that are necessary to come back into alignment about where the business is focusing.

Cash-Flow Analysis Conundrums (Mitch Anthony, Financial Advisor) - While a small subset of financial advisors spend time doing an in-depth analysis of client spending and cash flows, most don't... for the simple reason that most clients don't know what they're spending in the first place, which means either they can't provide the information to do an effective analysis, or in some cases they're living in ignorant bliss and may not even want to really know (and face) what they're spending. Yet Anthony suggests that little other planning work we do will really matter, if we don't first have a clear understanding of where the client really is right now – which requires getting a handle on their current cash flow spending. Not just to understand their financial situation itself, but also the kinds of financial habits that are embodied in the client's current spending. For instance, just as a doctor not only assesses your health but also your habits (e.g., do you eat healthy and work out), a good financial planner should look at a client's current financial situation but also their financial habits – such as whether the client has automated their saving, what kinds of monthly spending they do, how often they make large purchases (and how they decide on large purchases), their travel/entertainment habits, and their giving habits. Notably, the point isn't necessarily to go into depth about every line item of the household budget – especially not up front – but getting at least enough of a handle on the major categories of spending, and the underlying spending habits they represent, can provide crucial information and perspective on where a client's financial situation really stands.

Roth Vs. Traditional 401(k): Study Finds A Clear Winner (Demetria Gallegos, Wall Street Journal) - Mathematically, the decision about whether it's better to contribute to a Roth vs Traditional retirement account is determined primarily by a comparison of current versus future tax rates, where it's better to pay your taxes when the rate will be lowest (which means those with low current tax rates contribute to a Roth, and those with lower future tax rates should contribute to a traditional). However, that comparison only holds true when individuals are otherwise working with the exact same amount of pre-tax income in either case (either contributing to the traditional IRA and getting the tax deduction, or paying the taxes upfront and contributing the remainder to a Roth IRA). Which is important, because a recent research study from behavioral economist John Beshears and colleagues at Harvard Business School finds that in practice, this is not actually how individuals behave. Instead, savers tended to save at the exact same rate regardless of whether they were contributing to a Roth versus Traditional account (in the case of the study, Roth vs Traditional 401(k) plans). Which means the savers implicitly saved more with the Roth-style account, as they were actually contributing to the account and paid the tax obligation for doing so (with outside dollars). The driving factor seems to be the fact that when savers consider how much to save, they tend to just use relatively simple rules of thumb, such as "save X% of income", and don't tax-adjust the amount of their savings (and instead simply adapt their household spending to the amount of remaining dollars available). Which means those who save with Roth accounts – and maintain the same savings percentage – effectively end up saving more of their total pre-tax income, given both the Roth savings itself, and the front-loading of the tax burden that also gets paid in the process.

Tightwads And Spenders: Predicting Financial Conflict In Couple Relationships (Sonya Britt, Jeffrey Hill, Ashley LeBaron, Derek Lawson, & Roy Bean, Journal of Financial Planning) - Financial problems are consistently reported as a top stressor for Americans, both as individuals, and especially amongst couples (which in turn can lead to marital disputes or outright divorce). Drawing on data from the Flourishing Families Project, the researchers evaluated whether and how marital conflict tended to emerge, based on whether each member of the couple was either a "spender" or a "tightwad" or a "good money manager" (which was measured by partner perception). The results revealed that the top predictors of financial conflict for both husbands and wives were when one spouse thought the other was too "spendy" – leading to conflict from both members of the couple (both concern about the spendy spouse, and concern of the spouse for feeling judged as too spendy). Notably, "traditional" couples financial dynamics were also evident – both husbands and wives reported greater financial conflict if the husband's income was low, and wives were 11 times more likely to report financial conflict when their husbands viewed them as spenders. Notably, though, perceptions of husbands or wives as "tightwads" was not predictive of financial conflict. Overall, though, the results suggest that open-ended questions about a couple's financial habits and spending behaviors may provide useful indicators and clues about a couple's potential financial stress and conflict.

Increasing Transparency For The Life Insurance Industry (Bob Veres, Financial Planning) - In 1985, the insurance industry took in just over $12B in cash value and term life insurance premiums. By 2007, new premiums reached an all-time high of $18B, but that was primarily because people simply buy larger life insurance policies (for higher premiums) given the impact of inflation on income, wealth, and required death benefits. When measured in terms of the number of policies sold, new life insurance sales have actually declined from 17 million policies in 1985 to fewer than 10 million today. And in the meantime, mutual fund sales have exploded from $68B of new money flowing in 1985, to a whopping $1 trillion in 2007 (including both mutual funds and ETFs), and the fund industry overall has exploded from $495B to $17T in the past 31 years. Veres suggests that a driving force for this difference is that in the 1980s, the mutual fund industry began its slow but steady transition from commission-based distribution to no-load products (purchased directly by consumers, or via fee-compensated advisors), along with greater transparency regarding costs. In recent years, though, the insurance and annuity industry seems to be becoming increasingly cognizant of this trend, leading to the launch of a growing number of fee-based (no-commission) annuity products, though the launch of no-load insurance products has been slower. Veres notes that the greater pressure for transparency on insurance seems to be coming, though, and a new software solution called Assurance has recently launched specifically to analyze (and attempt to provide greater transparency for) life insurance policy illustrations. Drawing on data from WinFlex (the insurance industry's comprehensive database of life insurance policy data), the Assurance software aims to illustrate, and compare-and-contrast, life insurance policy illustrations. Although notably, Assurance cannot illustrate dividends (which for a participating policy from a mutual insurance company, can have a very material long-term impact). And the software still can't capture the risk that the insurance company itself might change (i.e., raise) the cost-of-insurance (COI) charges for a policy in the later years after it's issued. Nonetheless, Veres suggests that initially, no-commission fiduciary advisors may find Assurance useful, especially to analyze potential policy replacements (e.g., whether it's better to replace an old policy with a new no-load version). But ultimately, Assurance could help to spur the growth of no-load insurance products themselves, similar to how the transparency and analytics tools of Morningstar ultimately helped to reshape the mutual fund industry as well. (Interested advisors can check out Assurance in further detail on their website here.)

Why Wall Street Hasn't Been Celebrating This Bull Market (Josh Brown, Reformed Broker) - The stock market has rallied to more than triple its value from the bear market lows 8 years ago, yet the public refuses to get excited about it, and Wall Street itself doesn't seem very exuberant these days either. In part, this is because one of the most lucrative segments of money management – hedge funds – continues to struggle, as the profit opportunities get narrower, more and more shut down, and most of the rest are increasingly relying on computers programmed by quants (rather than "traditional" human analysts). And computers don't have high-profile parties and talk about how successful they are, the way that hedge fund managers did in the past. And in the world of actively managed mutual funds, it's arguably even worse, as mutual funds continue to experience net outflows despite the bull market, and there are virtually no high-profile equity fund managers left (as contrasted with Peter Lynch and the celebrated fund managers of old). Nor are the investment bankers happy, either – as technology and automation are coming to the IPO process as well, and fewer and fewer investors seem to be directly pursuing IPO investments either way. So how is it that there can be such a raging bull market, and the entire investment industry isn't celebrating? Brown suggests the answer is very simple: Vanguard. Because it's Vanguard that has absolutely dominated in this bull market cycle, and attracted the majority of all flows for the entire industry, combined. And while passive fund investing isn't quite the majority yet, Brown suggests that at this point, it's up to about 35% passive... and the other 65% are just terrified. That's what happens when there's a raging bull market, and virtually the entire asset management industry hasn't gotten to participate this time around.

Wall Street's Self-Regulator Blocks Public Scrutiny Of Firms With Tainted Brokers (Benjamin Lesser & Elizabeth Dilts, Reuters) - FINRA is the brokerage industry's self-regulatory organization, charged by Congress to protect investors from unscrupulous brokers. And because all broker-dealers are subject to FINRA oversight, and report disciplinary events into FINRA's Central Registration Depository (CRD) system, FINRA is best positioned to enforce its rules against problem brokers, and the problem broker-dealers that house them. Except as long as it's not illegal to hire problematic brokers, FINRA has stated that it doesn't have the power to prevent their hire – or to limit the hiring practices of a subset of broker-dealers who are known to house a disproportionate number of brokers with concerning disciplinary history. In fact, even though only 9% of brokers industry-wide have a problematic disciplinary FINRA flag on their CRD record, there are 48 broker-dealers, housing about 4,600 brokers (and billions of dollars of investor funds), where more than 30% of all their brokers have FINRA flags. Furthermore, even though FINRA reportedly is now tracking up to 90 broker-dealers that are deemed to pose the highest risk of investors, FINRA has determined that it can't even name those firms publicly, as FINRA itself is concerned that doing so could violate rules of fairness and due process (which even "problem" broker-dealers are entitled to). Of course, the consumer marketplace itself could potentially sort this out, simply by drawing on the publicly available CRD data on BrokerCheck... except those records are only available one at a time, and not in bulk (and current industry data on problem broker-dealers only became available when a Columbia University Law School DataLab wrote some computer code to extract all the records from the BrokerCheck website, one at a time). As a result, there is a rising scrutiny on FINRA itself, whether the organization is even capable of executing its self-regulatory mandate of the brokerage industry, and/or whether it may at least be time to substantively reform FINRA, and the 3,800 broker firms and 630,000 brokers its tasked with overseeing. And in the meantime, state securities regulators are increasingly taking an active role in oversight of broker-dealers operating in their state, raising the question of whether broker-dealer oversight itself might increasingly shift away from FINRA and down to the states in coming years.

I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of 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 as well.