Weekend Reading for Financial Planners (June 19-20)

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.

Goldman Sachs Enters RIA Custody Business By Landing Flagship RIA Relationship (Andrew Welsch, Barron's) - When Goldman Sachs last year acquired Folio Institutional and its 150-employee RIA custody business last year, the rumor was that Goldman was preparing to launch a more direct RIA custody challenger to Schwabitrade and Fidelity and the ongoing consolidation of RIA custodians, particularly in the world of "breakaway brokers" that might be more willing to trust the storied Wall Street firm and its brand over a more "retail"-affiliated RIA custodian. And now, Goldman Sachs has announced its first large-scale custody relationship with an RIA, as $23B RIA Steward Partners has agreed to begin using Goldman Sachs' new RIA custody offering. Which makes sense, as Steward has been active in the world of recruiting wirehouse advisors into the independent channel - given its own roots as a Morgan Stanley breakaway nearly a decade ago - and a Goldman RIA custodial relationship allows the company to position a Goldman custodial offering as an appealing destination for wirehouse breakaways. Notably, though, Steward is not necessarily abandoning its existing RIA custodial relationships; instead, it announced that the firm is adding its own multi-custodial technology tools to support Goldman Sachs in addition to its other relationships (which also included adding Raymond James as an RIA custodian last month), positioning Goldman Sachs as 'one of several' RIA custodians that a larger RIA might use (recognizing what are still the ongoing challenges and hassles of mass repapering when advisors consider moving existing clients to a new RIA custodian, rather than simply adding the next new clients to a new custodial relationship).

SEC Plans More Changes To Accredited Investor Definition (Melanie Waddell, ThinkAdvisor) - According to its just-released "Regulatory Flexibility Agenda", the SEC has announced that it is considering some further adjustments to the Accredited Investor rules, notwithstanding the fact that the SEC just expanded the definition already last summer to allow more investors to qualify by meeting certain knowledge or experience requirements (including having a Series 65 license), rather than 'just' the historical income or net worth thresholds. In its new discussion of "Exempt Offerings", the SEC indicated that its primary focus is to consider an increase to those income and net worth requirements, which were not adjusted for inflation in last summer's updates (despite those thresholds having originated several decades ago) and would effectively place further limits on who can participate in private offerings. At the same time, though, some SEC commissioners have suggested that the Accredited Investor requirements actually need more exceptions, not higher limits, noting, for instance, that "an entrepreneur who is plugged into a network of financially sophisticated people should be able to go to those people for funding, even if they are not wealthy enough to meet our financial thresholds" and suggesting that more educational credentials could be used as a basis for Accredited Investor status in the future. Ultimately, though, the SEC did note that the latest proposal is simply a "pre-rule" - i.e., not an actual new rule being proposed, but a signal that the SEC intends to gather public comment on the issue, and that a new rule proposal may subsequently follow (ostensibly not until 2022 or beyond).

DoL To Redefine 'Fiduciary' In New Rule (Melanie Waddell, ThinkAdvisor) - In its announcement of planned rulemaking this month, the Department of Labor announced its own plans to amend the regulatory definition of the term "fiduciary" to one that would "more appropriately define when persons who render investment advice for a fee to employee benefit plans and IRAs are fiduciaries". In its announcement, the DoL specifically noted that it would "take into account practices of investment advisers, and the expectations of plan officials and participants, and IRA owners who receive investment advice", in a signal that the DoL may be considering an approach that would look more directly to how advisors hold out to consumers and the expectations they create (i.e., "title regulation"), rather than just their compensation itself. Though at the same time, the DoL also noted that the ways advisors are compensated can also subject advisors to "harmful conflicts of interest" that may be further scrutinized. Ultimately, a new rule would likely revise the so-called "five-part rule" that is currently used to determine who is deemed a fiduciary under ERISA - which had previously been updated under President Obama's DoL fiduciary rule, but was vacated by the courts and subsequently rolled back under the Trump administration - with a proposed rule that would provide more stringent consumer protections anticipated to arrive by December for a public comment period (suggesting that a final rule itself would likely not be implemented until 2022 at the earliest).

Embracing The Subscription Fee Model Gives Clients More Options (Marianne Caswell, Financial Planning) - The monthly subscription model has entered one industry after another over the past decade, exemplified by companies from Apple to Netflix to Spotify, as well as the rise of monthly subscription fees for concierge medicine to Amazon offering monthly deliveries of common goods, and now the subscription fee model appears to be coming for financial planning as well. From the consumer end, the appeal of the subscription model is that it better fits the consumer's own household cash flow to be able to afford the fee (compared to a 'lump sum' annual or project fee payment that they may not have the available cash flow to pay), and allows the consumer to have access to the financial advisor whenever they need them (akin to how we pay ongoing insurance premiums every month not because we want to see the doctor every month, but simply because we want to know we can access medical services whenever we do need them). For advisors, a subscription fee model provides a payment mechanism to get paid for the increasingly common non-portfolio (or beyond-the-portfolio) services that advisors are providing (from 'get-organized' meetings to more complex estate and business planning needs), helps to drive client engagement over the hourly model (as once clients are paying on an ongoing basis, they're implicitly encouraged to engage and get the most out of the dollars they're paying), and makes it easier for the advisory firm to tier its services to varying client types that may have different needs (than the traditional AUM client).

Rising Retention Rates For Retainer Fees Reach Parity With AUM Fees (Michael Thrasher, RIA Intel) - The financial advisor world is increasingly experimenting with 'alternative' fee models, given both the ongoing competitive pressures on the AUM model, and rising consumer interest in non-AUM alternatives, with one recent J.D. Power survey showing that 73% of Millennials said they preferred a recurring fixed-fee or subscription model. Yet for many advisory firms, the concern of adopting fixed-fee/retainer models is that the AUM model - and the associated portfolio management services - are very "sticky" and associated with especially high client retention rates (that have historically hovered around 95%). But recent research from Herbers & Company finds that the retention rate in the retainer model has been closing the gap, from 85% nearly a decade ago, to 97.7% in 2020... such that last year, retainer-fee advisors actually had higher retention rates through the pandemic than advisors on the AUM model. In fact, Herbers suggests that advisory firms may be undervaluing the subscription model - not unlike how the industry undervalued the AUM model in the 2000s before its rapid rise in the past decade - creating opportunities both to roll out a subscription model to existing clients (which Herbers finds in practice rarely cannibalizes AUM clients because different clients have different preferences for services and the associated pricing model in the first place), and/or to even acquire firms operating on the retainer model that may be "undervalued" in the marketplace and a good opportunity for growth-oriented firms that can capitalize on the strong lifetime client value of the new high-retention-rate recurring-revenue model.

Why Advisers Need Minimum Fees (Jim Stackpool, Certainty Advice Group) - It has long been a standard in financial planning to offer one or several meetings upfront with prospects before they become clients, in an effort to get to know them and demonstrate value and try to get them as clients in the first place; in fact, some firms go so far as to provide the entire financial planning process upfront at little or no cost, in the hopes of getting the client onboard (and to compensate the advisor) for the subsequent implementation phase. However, while the reality is that such an approach really can drive a lot of prospects to become clients, the approach can also be extremely time intensive... which, as an advisory firm grows, can become counter-productive, limiting the capacity of the advisor to grow the business, and/or potentially burning them out with a high volume of 'unpaid' hours (which in turn just puts even more pressure on getting those prospects to become clients to recover the cost of the time spent in nurturing them for free). And Stackpool notes that ironically, the tendency is especially common amongst the best and most 'giving' of advisors... who may become too giving to the detriment of their own business. So what's the alternative? To institute a minimum advisory fee, which may result in slightly fewer prospects becoming clients (as not all will be willing to pay), but in turn can actually make the advisor's time more efficient by ensuring they're only spending their time with prospects who are willing to pay. And for those situations where the advisor really may want to help the prospective client, but that prospect really can't afford to pay, there's still room to provide the services on a pro-bono basis... but with a minimum fee, it's more straightforward for the advisor to recognize who really is a pro-bono client, and handle the situation accordingly (e.g., by limiting their pro-bono clients to no more than 10% of their total client base, to be certain it's not cumbersome for the overall business).

6 Ways to Help Clients Avoid Medicare’s IRMAA Surcharges in Retirement (Phil Lubinski, ThinkAdvisor) - The Medicare Income-Related Monthly Adjustment Amount (IRMAA) was established in 2003 as a way to shore up projected Medicare deficits by applying a 'surcharge' to Medicare Part B premiums (and subsequently, on Medicare Part D premiums) for higher-income households. And the potential increase is not trivial, as Medicare premiums in 2021 jump 40% (from $148.50/month to $207.90/month) once income exceeds $88,000 (for individuals, or $176,000 for married couples), and can more-than-triple to $504.90/month for the highest income households (individuals with income over $500,000, or married couples in excess of $750,000). Since 2020, the IRMAA income thresholds are now indexed for inflation, but with a rising stock market and rising wealth, more and more retirees are still facing the potential to exceed the thresholds (especially once Required Minimum Distributions begin at age 72). So what can advisors do to plan around the IRMAA brackets? Lubinski offers up several suggestions, including: beware the 'traditional' strategy of spending down non-qualified accounts first and allowing pre-tax retirement accounts to just keep compounding, or the concentrated withdrawals in the later years can blast retirees into the IRMAA brackets with no way to come back down (instead, consider drawing more evenly across pre-tax, taxable, and tax-free Roth buckets); consider partial Roth conversions to winnow down the size of IRAs before RMDs begin; use RMDs for charitable contributions (via the Qualified Charitable Distribution or QCD rules) so the income never hits the tax return in the first place (and thus can't boost income for IRMAA purposes); consider tapping home equity via a reverse mortgage to manage/minimize the taxable liquidation of accounts (as dollars drawn out from a reverse mortgage are received as a loan and not taxable income); and don't forget the potential to tap any permanent life insurance the client may have purchased in the past, which can also be borrowed against without a taxable event to generate retirement cash flows without crossing IRMAA thresholds (just be cautious not to over-borrow against the policy and trigger a taxable lapse in the future!).

The Valid and Not-So-Valid Reasons for Rejecting Annuities (Joe Tomlinson, Advisor Perspectives) - Economics research on retirement optimization has long shown that a lifetime immediate annuity can improve the efficiency of retirement income... yet in practice, the great "Annuity Puzzle" is that consumers still rarely purchase them (and fiduciary advisors often oppose them). Of course, in many cases, there really are valid reasons to not use an annuity, including those who simply don't have enough wealth to purchase an annuity, or need more liquidity than an immediate lifetime annuity would provide with 'just' its ongoing monthly income payments, or simply have enough guaranteed income already from their Social Security payments or pensions to cover their (essential) needs. Alternatively, some households are so affluent that they just don't need the income guarantees that annuities provide, and instead can afford to take the 'risk' of remaining invested in volatile markets and the long-term upside that can still provide. And in some cases, the retiree is in poor health and isn't actually planning for a long retirement in the first place (which both makes the lifetime annuity inappropriate given the elevated risk of death, and often not necessary because a shorter life expectancy means current retirement savings may be more than sufficient). In the aggregate, Tomlinson suggests that these constraints alone may eliminate as many as 80% of households from annuity consideration. On the other hand, Tomlinson also notes a number of reasons that are often used to opposed annuities that may not be so appropriate, including opposition to high-fees/high-commissions (which in practice are coming down or being eliminated with the rise of fee-based annuities), a fear of losing assets currently in managed accounts (but in the end, a client who annuitizes and can make it through retirement in any form, is better than a client whose keeps assets in their investment accounts... until they end out spending it down to $0 anyway!?), a fear of lost liquidity (in practice, partial annuitization is often also quite effectively, especially when using a deferred income annuity or a QLAC in a retirement account), or waiting for better rates (yes, interest rates are low, but annuitization still provides a boost in the form of mortality credits over the interest rates in any environment, and, in practice, waiting for rates to rise amounts to trying to "market time" interest rates... which as the past decade has shown, is just as hard to do as timing the stock market itself?).

Retirees Often Discover They're More Prepared Than They Anticipated? (Brett Arends, Marketwatch) - One consumer survey after another for years has signaled that a significant number of consumers are concerned they won't be financially OK in retirement, with Gallup showing just 53% feel that they're on track and prepared, which is down slightly from 20 years ago (when in 2001, 59% of workers said they expected to be OK in retirement). Yet in the end, Gallup also finds that 80% of households that are actually retired report they are doing just fine... suggesting that our fear of the leap into retirement is a bigger gap than our actual ability to adapt to a retirement life when the time comes. The phenomenon appears to be tied at least in part to Daniel Gilbert's research on what's known as the "end of history" illusion - that we're simply not very good at projecting our interests and preferences (including our retirement happiness) in the distant future, and in the end change and adapt far more than we ever anticipate along the way (such that the gap doesn't turn out to be as bad as we feared). In addition, the so-called "happiness curve" throughout life is known to be U-shaped (such that we're happier when we're young, our happiness declines into our early 50s, and then rises again thereafter)... which means our gloominess about retirement preparedness may be less about actually being unprepared, and more than we're just being asked at a time of life that's already more challenging! And of course, there's simply the phenomenon of "hedonic adaptation" - where we adjust our expectations to our current reality quickly - which on the one hand leads up to the "keeping up with the Joneses" phenomenon (that no matter what we have, we may continue to want more because we see someone else who has more), but also means we can often adapt our expectations down relatively quickly if there is a retirement gap, and become satisfied with what we do have in retirement relatively quickly once we're actually there?

Getting The Goalposts To Stop Moving (Morgan Housel, Collaborative Fund) - For many households, the biggest financial challenge is not actually to save and invest and accumulate wealth... it's that their expectations about their lifestyle grow faster than the wealth itself, such that even as their income and net worth grows, their life satisfaction does not. A case-in-point example was the prosperity that emerged in the US in the 1950s, where the median income from a job made it possible for a household to survive with a single-earner and support a spouse and three children (along with a modest house and two cars). Yet by any absolute measure, the 1950s were not better than today. Adjusted for inflation, median family income in 1955 was $29,000, and was up to $63,000 in 2018, with median inflation-adjusted wages up more than 50% since then. Similarly, while healthcare costs have exploded over the past 20 years, in 1950 half of Americans didn't even have health insurance, and 2/3rds lacked "surgical insurance" to cover a major health incident, such that nearly 4X as many Americans died before their 5th birthday as they do today. And in the 1950s, 47% of men aged 65+ were still working because they simply couldn't afford retirement, compared to "just" 23% today (and back then, work was much more physically demanding, too!). Which also helps to explain why, despite the negativity about the current outlook in the US, so many have (and still) come to the US as the land of opportunity; relative to conditions elsewhere, the US often still seems far better by comparison. Which helps to emphasize how our judgments about the current state of affairs are so often a function of what we're comparing to, and not necessarily the actual conditions that exist. Leading Warren Buffett to once quip to a group of college students that they all lived better today than John D. Rockefeller did... "I mean you’re warm in winter and cool in summer and can watch the World Series on TV. You can do anything in the world. You literally live better than Rockefeller. His unparalleled fortune couldn’t buy what we now take for granted!" The key point, though, is simply to recognize that our satisfaction in life often is not driven by the absolute level of our conditions, but our conditions relative to our expectations. Which means on the one hand getting clearer on what it is you actually need to enjoy life (because comparing to others will always make something else seem better), but also that often the key to being happy isn't about getting "more" but in just managing our expectations so when we grow and do get more, we can enjoy what we've actually achieved.

If You’re Still Worried, You Aren’t Wealthy (Ben Carlson, A Wealth Of Common Sense) - Despite the so-common pursuit of "wealth", there is surprisingly little consensus on what it actually means to be wealthy, as some equate wealth to the money in the bank or the investment portfolio, others judge it based on the possessions they can buy, and still others that tie the definition of wealth to income rather than assets. Yet Carlson notes that in the end, what we consider to be a "rich life" really depends on our relationship with money and what we decide matters to us most... which means wealth is as much a function of our mindset and expectations as the financial matter itself. In fact, some recent headlines have highlighted how the sudden wealth from markets (and crypto) is now being associated with rising stress in Millennials, and sometimes those who have accumulated significant wealth (often by focusing heavily on their futures) still find themselves full of anxiety about their future (despite the wealth they've accumulated to provide for it). To some extent, getting comfortable with this dynamic is simply recognizing that there are things that we can control and things that we can't, and that we'll be happier when we focus more on what we can. Though, ultimately, Carlson suggests that perhaps the best definition of wealth is simply the person who gets to the point where they feel their current lifestyle is secure enough to be managed to the extent it can be controlled; or stated more simply, when you're comfortable with what you've got and are confident you can handle whatever uncontrollable thing comes next without needing to worry about it?

The Best Investment Of All: The People You Love The Most (Ron Lieber, New York Times) - As the post-pandemic economic recovery helps to rebuild financial lives, and many households that were able to weather the storm (and keep their jobs throughout) actually find themselves in a better financial situation than before, the reality is that it's the relationships that money can't buy that still matter the most when times get difficult. In fact, as we re-emerge from the pandemic, for many the greatest excitement and opportunity is being able to return to a life of greater social interaction with our friends and family. And in many communities, it was the shared support during these difficult times that helped people get through, whether finding support after a layoff or in the face of a family health issue or other challenges. Accordingly, as the pandemic subsides and travel resumes, arguably one of the best ways to (re-)build our bonds is to spend our money in ways that give us back our time with others - for instance, covering the cost to fly to meet up with friends (if you can afford to do so more than they can), or even paying for a rental house to bring friends and/or family together. Alternatively, for families that have been a little too pent up together during the pandemic, arguably one of the best investments to make could actually be spending money to get some time apart - e.g., giving a family member an opportunity to take their own individual journey and refresh themselves. Either way, though, the key is simply to recognize that while money can support friendship and social relationships (by providing for the time and/or access we need to get to and connect with one another), actual investments into relationships are not a function of money, they're about investing the time.

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 Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.