Weekend Reading for Financial Planners (Jun 4-5)

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.

Nine Groups File Lawsuit To Strike Down 'Capricious' DOL Fiduciary Rule (Greg Iacurci, Investment News) - As was expected, anti-fiduciary opponents filed a lawsuit against the Department of Labor in the continued effort to stop the implementation of a fiduciary rule for advisors working with retirement investors. The lawsuit is being spearheaded by the U.S. Chamber of Commerce, and is joined by SIFMA (representing the securities industry) and FSI (representing broker-dealers) as well. The legal filing, U.S. Chamber of Commerce v. Thomas E. Perez, alleges that the Department of Labor exceeded its authority, acted in an "arbitrary and capricious" manner in issuing the rule and without gathering sufficient input from relevant parties, and had a flawed cost-benefit analysis of the rule, which if found true by the courts would be a reason for the rule to be struck down. In addition, the lawsuit also specifically challenges the DoL's ability to force financial institutions to remain exposed to a class action lawsuit under the Best Interests Contract Exemption, and the DoL's efforts to supersede existing regulation of annuities by including fixed-indexed annuities under the Best Interests Contract, and even suggests that the DoL fiduciary rule violates company's first amendment rights to talk about their products and services by limiting those discussions to only be done in a fiduciary context. And a second similar lawsuit was filed today by the National Association of Fixed Annuities (NAFA), again contesting the DoL's authority to extend fiduciary to the sale of fixed indexed annuities. Notwithstanding the depth and breadth of the legal compliants, though, experts are already noting that the anti-fiduciary lawsuit seems weak, given that Congress clearly gave the Department of Labor the right to define fiduciary duty and prohibited transactions under ERISA and for IRAs, and recognizing that courts generally defer to regulators in their domain, especially given the lengthy comment period and input process that the DoL followed in issuing the rule over the span of nearly 6 years. Even if the lawsuit doesn't strike down the DoL fiduciary rule, though, it's possible that implementation could be delayed by at least a few months beyond the original April 10, 2017 date. Notably, the anti-fiduciary lawsuit is being spearheaded by Eugene Scalia, son of the late Supreme Court Justice Antonin Scalia, who did just recently lead the lawsuit by MetLife against the Financial Stability Oversight Council that successfully got the government to remove the "Systemically Important Financial Institution" (SIFI) label from MetLife.

Legal Battle Erupts Between Bill Winterberg And Joel Bruckenstein, And T3s Profits Get Dragged Into Court Of RIA Opinion (Lisa Shidler, RIABiz) - Last month, advisor tech guru Bill Winterberg filed a lawsuit against fellow advisor tech guru Joel Bruckenstein, alleging that Bruckenstein never paid him his 50% share of what are claimed to have been $458,000 of profits from the recent T3 Enterprise technology conference from last November. In the lawsuit, Winterberg claims that the split was based on an oral agreement with Bruckenstein where they would co-produce the conference and "evenly split the profits generated" after Dave Drucker (Bruckenstein's former partner in the T3 conferences) retired at the end of 2014. However, Bruckenstein claims that he separately bought out Dave Drucker's 50% share of the conference business (which dates back to 2005), that he owns the entire business, and that Winterberg was simply engaged as a contractor and did not have an ownership share or entitlement to the profits. Also at issue is the amount of the profits itself, which Winterberg claims were $458,000 based on an accounting of the T3 Enterprise conferences for the past 3 years, but Bruckenstein counters is a "grossly inflated" estimate. Ultimately, the courts will decide on the nature of the Bruckenstein/Winterberg agreement, whether a split of the profits should or should not have happened, and what the profits actually were, but the visibility of the T3 profits that has come from the lawsuit has also begun to raise questions from tech vendors, who pay substantial sponsorship fees to speak and advertise at the "famously no-frills event" and may or may not balk in the future at the cost of sponsorship (depending on whether the conference really is as profitable as Winterberg claims it to be). On the other hand, strategic consultant Tim Welsh notes that the T3 conference is unique precisely because it is a pay-to-play offering, that allows tech vendors to buy in and speak/present on whatever they wish - whether it's industry trends or their latest product features - and that the opportunity for vendors to have full control over their session is what makes the conference so popular, and has allowed the T3 conference to successfully charge what it does.

Why You're Going To Be Paying A Lot More Overtime (Kimberly Weisul, Inc) - Last month, President Obama announced an overhaul to the rules on overtime pay, which is expected to have a sweeping effect on small businesses, including many financial advisory firms. Under the old rules, workers classified as "EAP" - executive, administrative, and professional employees - only had to be paid overtime for working more than 40 hours per week if they made less than $23,660 in base pay. With the change, which will take effect on December 1st, EAP employees will have to be paid overtime unless their base pay is at least $47,500/year. This means a broad range of professional employees who were making between $23,660 and $47,500 didn't have to be paid overtime in the past, but will after December 1st, which potentially includes the paraplanner and associate planners in many advisory firms. Overall, the change is expected to boost the number of salaried workers eligible for overtime from just 7% up to 35% (though to put it in context, 62% of salaried workers were eligible for overtime 40 years ago!). Notably, the rule does not apply to businesses with less than $500,000 of revenue, unless the employees are involved in interstate commerce (which means it could still apply for small advisory firms that have clients in multiple states). Going forward, though, this means firms that are affected will either need to convert staff earning between $23,660 and $47,500 to hourly independent contractors, give them a raise up to a base salary of $47,500 so they're not eligible for overtime, limit their hours to 40 hours/week, or pay them overtime under the new rules.

Who Are The Best Clients For A Niche Practice? (Carolyn McClanahan, Financial Planning) - One of the most common suggestions in today's environment for advisors to improve their business is to develop a niche, usually by picking a particular profession like doctors, airline pilots, teachers, or tech employees. The opportunity is to simplify the marketing of the business, the differentiation of its specialized services, and the efficiency to deliver them. But McClanahan raises the question of whether defining a niche based on a profession is a wise path. As a former physician herself, she had a natural opportunity to work with physicians, but recognized early on that one of the reasons she left medicine was that there were so many doctors she didn't like to work with... which means if "physicians" would be her niche, at a minimum the field would need to be narrowed further. Over time, McClanahan found that her ideal clients were those who previously had been do-it-yourselfers, who recognized that their lives were becoming too complicated, and wanted a professional to whom those tasks could now be delegated (and therefore would value a holistic advisor). Though as she began to focus on this personality type, she also realized that it was broader than just physicians, or business owners, or executives, or other typical profession-based niches; in other words, the personality type itself became the niche, which transcends the traditional lines of professions, but still allows her firm to focus on working with those clients that she feels they can work with the best.

Unbilled Cash Complicated By DoL Rule (Dan Jamieson, Financial Advisor) - Under the new DoL fiduciary rules, advisors who can earn variable (i.e., different) compensation on different types of financial services products or recommendations for retirement investors are subject to new disclosure and oversight scrutiny under the Best Interests Contract Exemption. However, if the advisor has discretion over the retirement investments, variable compensation is a conflict of interest that can't just be disclosed away; it's an outright prohibited transaction. In practice, this creates a new complication for at least some RIAs that can shift clients in and out of cash positions as a part of their management process, but aren't billing for any cash holdings (a recent advisory firm trend as clients sometimes push back on paying advisory fees on zero-yield cash allocations). The problem, simply put, is that if firms are paid less on cash positions than on stocks and bonds, they have a fundamental conflict of interest and incentive to minimize cash and invest in other holdings instead, which is viewed as an untenable conflict of interest under the new DoL rules. The alternative is that advisors will have to either bill a consistent fee across the whole portfolio - perhaps adopting a slightly lower blended fee that includes the invested assets and the cash - or instead shift the cash out entirely and put it in a non-managed account instead (which is permissible, but means the client will have to specifically authorize the transfer to reallocate the cash back into the portfolio later). Notably, this issue also exists for any advisory firms that have different fee schedules for the equity allocation vs the fixed income allocation (e.g., charging less on the bonds given their lower yields) if the firm has discretion over all of those assets (and again would need to adopt a consistent fee schedule across all investment/account types to avoid the prohibited transaction rules). Alternatively, firms can adopt a retainer fee model instead, which by definition is the same fee regardless of how the client portfolios are invested, and would therefore also avoid the prohibited transaction rules and qualify under the Level Fee Fiduciary exemption.

The Dark Side Of Becoming An RIA Owner (Dave Grant, Financial Planning) - In this article, Grant shares his own deeply personal story as an advisor who went out on his own to launch an independent RIA, and found that struggles with his business began to lead to an outright struggle with depression. Grant had some initial success for the first two years, bringing on new clients and fueled by the excitement of starting his own firm and having control over every aspects - which was exhausting to handle but energizing to tackle. But after the initial burst of energy, exhaustion began to set in, and for the past nine months the client roster has begun to outright decline, leading to a depression that has only made the situation harder to break out from. Yet as Grant notes, there is sadly no discussion about the challenges of failure in the advisory industry, despite a known-to-be-very-high failure/attrition rate amongst financial advisors. And the situation can be even more challenging as an advisor who's an introvert, since working alone can help support creativity but also leave fewer options for peer/social support. Grant even notes that ironically, because the industry is so focused on positivity, he felt uncomfortable discussing his negativity and challenges with his mentor. For Grant, the path out began with forming a study group of fellow startup advisory firm owners, who shared their own struggles - which often included similar challenges given the inevitable ups and downs of entrepreneurship - and provided mutual support. Though notably, even if the business can grow and the income challenges are resolved, Grant notes that depression can take a long time to resolve, and in the meantime he has begun to practice some daily meditation, take frequent (daily) walks, and continue to talk openly about his challenges (both with his study group, and now in this article). The bottom line, though, is that if you're an advisor who is facing your own struggles with the business, or even depression, recognize that you're not alone, and there are others you can talk to for help!

Is 4.5% Still Safe? (Bill Bengen, Financial Advisor) - In recent years, the so-called "safe withdrawal rate" has faced significant criticism, as no longer being a viable framework to evaluate retirement income sustainability. Notably, Bengen (who authored both this article, and the original "4% rule" research over 20 years ago) points out that what seems like a "safe" withdrawal rate can change over time. Before the 1960s retiree came along, the "safe" withdrawal rate would have been 5.27% (based on a 1937 Great Depression retiree holding 35% large-cap, 20% small cap, and 45% government bonds), as it wasn't until the late 1960s retiree that had to take a withdrawal rate as "low" as 4.5%. (Notably, Bengen himself uses a 4.5% withdrawal rate that includes small cap stocks, not the original 4% withdrawal rate that only included large cap stocks.) So it remains theoretically possible that a new lower-return future could produce a new lower safe withdrawal rate. Accordingly, Bengen tests the more recent scenarios of a year-2000 and year-2008 retiree, to see how their retirees would be holding up using a 4.5% initial withdrawal rate that has previously been dubbed "safe". And in fact, Bengen finds that a year 2000 retiree would be doing just fine by the end of 2015, with a current withdrawal rate up to "just" 5.4%, which is actually still rather safe given the retiree would already be half way through retirement (and this spending level is a whopping 60% below the "danger threshold" of the worst case historical market scenario). In turn, a 2008 retiree is actually in even better shape; despite the severity of the 2008-2009 market decline, the rebound has been so strong that the retiree's withdrawal rate today would actually be at 4.4%, below the starting withdrawal rate of 2008, with an even shorter time horizon remaining. Ultimately, this still doesn't unequivocally mean the 4.5% initial withdrawal rate will always be "safe", but the safe withdrawal rate results of the 2000 and 2008 retiree only seem to bolster the case for how safe it really is.

Understanding Medicare Traps For The Unwary (David Cordell & Tom Langdon, Journal of Financial Planning) - As clients approach age 65, they are faced with a number of decisions about Medicare, and failing to act in a timely manner can actually be quite costly later. In the past, the process was more straightforward, in part because age 65 was both full retirement age for Social Security and Medicare; however, it today's environment, full retirement age is 66 (and heading to age 67), while Medicare eligibility still kicks in at age 65. Thus, even for those who plan to claim Social Security at full retirement age, they will need to handle their first initial enrollment period for Medicare, which begins three months before their 65th birthday, including both Medicare Part A (for hospital insurance), and Parts B (physician and outpatient services) and D (prescription drug coverage). And the reason all this matters is that if someone does not sign up for Part B and Part D coverage by the end of the initial enrollment period (which closes 3 months after turning age 65), coming back to sign up later will result in a Part B premium increase of 10% per year for each year of deferring past age 65 (and a 12% per year increase for Part D premiums). Notably, there is an exception to the premium penalty for anyone who continues to work past age 65 and is covered by an employer group health insurance plan (as long as the person enrolls in Medicare within 8 months of whenever they do retire and that coverage ends). On the other hand, it's important to recognize that the trigger date for Medicare enrollment for the continuing worker is 8 moths after employment ends, not after prior coverage ends - so if the retiree gets COBRA continuation coverage, or retiree health coverage, and chooses to wait on Medicare because of this other health insurance coverage, going back to sign up for Medicare will trigger the premium penalty again. Fortunately, there's nothing wrong with getting Medicare coverage and coverage through the former employer (either via COBRA or a retiree policy), though notably some retiree policies actually require it and failing to enroll in Medicare not only results in higher Medicare premiums but could even result in denied health insurance claims from the prior employer's retiree health plan as well!

Understanding Social Security's Long-Term Fiscal Outlook (Stephen Goss, The Actuary) - While Social Security faces substantial financial challenges in the coming years, they were not unanticipated; in fact, the driving forces are demographic shifts that have long been known and understood. The starting point is to understand that financially, Social Security is financed by revenues that come in from payroll taxes, which go into a Social Security trust fund (which is invested in government bonds), and payments to retirees are then made from the trust fund. However, because the Social Security program has no borrowing authority, the trust fund must maintain a positive balance; if/when it ever goes to zero, Social Security payouts to retirees are limited to just the revenue that is coming in from payroll taxes. For the past several decades, payroll taxes brought in more than enough though - accumulating more than 3.5x the amount necessary to pay annual benefits - and only since 2009 has even reached the point where a portion of the Social Security trust fund balance must be used to pay benefits. However, given the ongoing rise of baby boomer retirees, and more generally the fact that there are fewer workers for every retiree than there was in the past (due primarily to a significant decline in the fertility rate since 1965), the need to supplement Social Security retiree benefits with trust fund liquidations will accelerate, until by 2034 it will be depleted. At that time, though, the majority of benefits will actually still be paid - from current payroll taxes - resulting in about 79% of benefits still being paid going forward from that point. Nonetheless, to remedy this shortfall for the rest of the decade, Social Security needs to be adjusted, either with a roughly 25% benefit reduction, a 33% increase in payroll tax rates, or some combination of the two. Notably, the Social Security program actually has faced similar challenges in the past - the last was in 1983, when changes were implemented that are still phasing in (including the increase in the Social Security full retirement age from 65 to 67). Which is important to recognize, because if we do in fact make changes to benefits and payroll taxes again, current Federal budget projections may actually be overstating the impact of future shortfalls, which are currently presumed to be covered by increases in Federal debt, rather than the (arguably more likely) changes to benefits and/or payroll taxes instead.

Stop Helping Those Who Don't Want To Be Helped (Josh Brown, LinkedIn Pulse) - A recent study from ScottTrade finds that the "do-it-yourselfer" who doesn't engage with an advisor are actually on the decline (falling from 66% to 61% in just the past year), while the number of "validators" who want to make their own decision but access an advisor as a sounding board for support jumped from 21% to 25%. While some would view this as an opportunity for a growing segment of consumers that advisors might serve, Brown suggests that advisors should avoid these kinds of clients; after all, lawyers call the shots on legal strategy, and doctors are in charge of diagnosis and treatment, so why should professional financial advisors operate any differently. In addition, it's difficult to build a scalable and sustainable business if there's no certainty that a "validator" is actually going to take the advice and implement it. Accordingly, advisors from Ric Edelman to Nick Murray regularly suggest that advisors should adopt a "take it or leave it" approach to their advice for clients, and the famous advisor and author William Bernstein says that investors seeking his services actually have to write a letter to him explaining why they should be accepted as a client. The point here is not about being a "snob" or elitist advisor, but simply that "validators" are more likely to be seeking out someone who is just an order-taker and not actually a real advisor... so if you do want to be a real advisor, you should focus on those who are willing and ready to actually (fully) engage your help.

How Technology Hijacks People's Minds (Tristan Harris, Medium) - The virtue of technology is that it can allow us to do things far more efficiently, but as Harris points out, technology can also exploit our minds' weaknesses in ways that may or may not always be ethical (and Harris is an expert on the subject, as Google's "Design Ethicist"). For instance, Western culture in particular is heavily focused on the ideas of individual choice and freedom, and consumers typically appreciate it when technology tools give them "choices", but fail to recognize that what they're choosing from may actually be a very limited menu that was designed by the company offering the choice - which means in some cases, the "free choice" is actually an illusion altogether, because any of the choices will still be a win for the company. For instance, a supermarket that gives a wide choice of toothpastes, but in reality they're all different alternatives from the same manufacturer; or in the context of technology, a group of friends looking up a bar on Yelp, trying to choose between the available listings, and failing to recognize that the Yelp listings themselves may still only be a small subset of the available choices in the area and that the menu with the most choices isn't necessarily the menu that is the most empowering to make good choices. Another challenge is how we get addicted to things; we are most stimulated by intermittent variable rewards, which is why slot machines make more money off us than baseball, movies, and theme parks combined (seriously), and is why we so compulsively pull out our phones to check them all the time (for the "slot machine" variable reward of a new email, new post, or new notification). And the problem just gets worse because we also have a "Fear Of Missing Something Important" (FOMSI), which makes us even more obsessed with checking our technology devices (even though ironically we can feel better by turning off the notifications so we don't see what we might have missed out on!). Other technology dynamics that impact us heavily include: our need for social approval (which is why we're so obsessed with getting Likes, Followers, and Comments on social media platforms); our desire for and need to fulfill social reciprocity (when someone tags/communicates to us on social media, we feel compelled to respond, even if it drives to an unhealthy level of use); creating "infinite scrolling" features that take away our awareness of when we should have reached "the end" and stopped an activity; and interrupting notifications (which companies use because we really are more likely to feel like it's urgent and respond). The ultimate point - many of these items actually fulfill our own social needs and desires, so they're not necessarily "bad", per se, but technology companies often exploit these in a manner that maximizes their value (e.g., because the company profits when you visit and use their website more), rather than doing so in a manner that minimizes the stress on the user (all of us). Is it time for a technology user's "Bill of Rights"?

The Time Is Now For Young Advisers (Ali Malito, Investment News) - Last year there were about 36,000 new adviser "trainees" (with less than three years of experience), but almost 30,000 advisers who started in the past 5 years left the business in 2015 as well. As a result, the net number of new financial advisors every year is fairly low, and not enough to offset the wave of baby boomer advisers who are retiring, leading to a declining headcount in total advisors (which fell from 325,000 in 2008 to just 285,000 by 2014). The problem of young advisor attrition seems to be a combination of firms that struggle to put their new advisors to productive use, the challenges of business development for young advisors, and the impact of having limited experience both from the firm's perspective and the client's (e.g., the client who says their young advisor can't relate to the challenges they're having with college funding for their kids because the advisor isn't old enough to have kids of his/her own). The problem is amplified by the fact that few CFP educational programs teach the relationship management and networking skills that are necessary to build empathy with clients and get new ones. Fortunately, though, the industry is coming up with solutions, which often includes putting younger advisors onto teams with experience advisors, stepping up on training programs, and helping young advisors establish study groups with peers and find mentors. Membership associations are also helping to fill the void, with both the FPA's NexGen group and NAPFA's Genesis, as well as standalone organizations like the XY Planning Network. Nonetheless, many young advisors still go through multiple job changes in their early years, trying to find a firm and role that are the right fit for their interests and skills.

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.