Weekend Reading for Financial Planners (June 22-23)

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.

(Editor's Note: Want to see what I'm reading through the week that didn't make the cut? Due to popular request, I've started a Tumblr page to highlight a longer list of articles that I scan each week that might be of interest. You can follow the Tumblr page here.)

Weekend reading for June 22nd/23rd:

Goldfarb’s CFP Board Sanction Shows Risk To Advisors - The big industry news this week was the CFP Board's announcement of a public letter of admonition against former Board president Alan Goldfarb, who abruptly resigned from the CFP Board leadership position last year after a complaint was filed against him regarding compensation disclosure and the CFP Board formed an internal committee to investigate the matter. The issue at hand was Goldfarb's description of his compensation on the FPA's "Find A Planner" website, where he had checked the "fee-only" box, and indicated in client communications that he was paid a salary from his parent company. However, that parent company also owned a broker-dealer, and Goldfarb himself owns a 1% interest in the company; as a result, even though Goldfarb says that the clients he served paid him only with fees, and that his salary was not impacted by any referrals to or profitability from the broker-dealer, the CFP Board's conclusion was that since he and his firm had an interest in the broker-dealer and clients who did business with those firms could ultimately accrue some (small amount of) commission-based revenue back to Goldfarb, that describing himself as "fee-only" was inappropriate. Perhaps the real story, though, is not just Goldfarb's sanction, but the question of how many other planners may not be appropriately characterizing their compensation, due to these kinds of complex business structures, especially for those who are involved in the hybrid RIA/broker-dealer environment. In addition, some (including Goldfarb himself) point out that perhaps the current compensation disclosure requirements tied to offerings like the FPA's "PlannerSearch" tool (where Goldfarb's compensation disclosure created an issue) may be insufficient to characterize the rising complexity of advisor business models.

First Timers - On Wealth Management, this article provides some great insights about how younger and newer advisors are building advisory firms today, in the world where cold calling is dead, and networking is on the rise. The article starts out with the story of young Arizona advisor Darin Shebesta, who after four years in a paraplanner role decided to go out on his own; although it took several months to get his first client, and a good year before he says he was really hitting his stride, Shebesta is now well underway, with 60 client households, including 25 for full financial planning, and some $9 million in AUM. Overall, the reality is clear that those starting a business from scratch need to be prepared to prospect and market with upwards of 75% of their time, and should "live and breathe" client acquisition for the first few years (which shouldn't be difficult as there won't be many clients yet!). Notwithstanding the pressure to grow, though, the article recommends against just meeting with everyone and asking for referrals immediately, and suggests instead a better way is to meet with contacts and potential referrers and simply ask them "if you were in my shoes, how would you approach it?" and then ask for introductions to other people to talk to for guidance and advice. For those with a sparse list of initial contacts, networking really becomes the key, especially since public seminars seem to be an increasingly inefficient and costly route; instead, join groups, from Business Networking Institute, to peer groups of complementary professions to find (comparable young) Centers of Influence. The key, however, is still not to be there to just troll for referrals, but instead to really engage with the group, become an involved member, and establish trusting relationships with fellow members who can become clients or referrers. Ideally, aim to join groups where you can establish a niche or already have some kind of affinity, where you can more clearly differentiate yourself.

How Specialist Advisors Earn Twice As Much - From Advisor Perspectives, practice management coach Dan Richards makes the fundamental point that in any profession - from medicine to dentistry to law to accounting - the average income for specialists is more than double that of generalists with the same years of experience, and the same conclusion appears to be emerging for advisors who specialize in a niche compared to those who remain generalists. The challenge, however, is that most planners start as generalists, and becoming a specialist with a niche can be difficult. Richards offers several tips about how to make this transition, and also debunks several myths, including the concern about abandoning existing clients or refusing referrals from those outside your new niche (you don't have to do this), concern about working with a group of entirely different/new clients (you don't have to; in fact, a great way to focus on a niche is to expand a satisfied "safe group" of clientele you already work with who fit within a niche!), and fear that focusing on a niche group entails completely departing from your current business approach (it's about refining, not necessarily abandoning and rebuilding from scratch). Richards emphasizes that ultimately your specialized niche should be a group that has a unique set of common needs; if you can't complete the sentence "I specialize in the unique needs of <name of group>, and as a result I have developed a particular expertise in..." then you're not focused enough. This could lead you towards people in a certain life stage (e.g., retirees), occupation (e.g., senior corporate executives, small business owners), or other unique circumstances (e.g., sudden wealth inheritors); you might end out with several potential types of groups/niches, and narrow it down further from there based on various criteria (and Richards suggests several questions to consider in selecting a group). Once you have a prospective niche chosen, start meeting with people in that niche, simply to go on a fact-finding mission and gather more information; this will help you both affirm if you're still happy with the niche choice, and begin to formulate ideas about how to refine the business to serve them.

How To Hire And Promote Rainmakers - In Financial Planning magazine, Deena Katz tackles an increasingly common challenge for many advisory firms: how to hire and promote rainmakers who can help bring in business to the firm, especially as many firms have been more focused in the past on hiring advisors who can simply serve clients well and provide client capacity, but didn't necessarily have any business development skills. Katz suggests that Daniel Pink's recent book "To Sell Is Human" (a book previously reviewed on this blog!) provides a good template for identifying the key "ABC" skillsets for sales success in today's environment: Attunement (to prospective client needs), Buoyancy (to handle prospect rejection), and Clarity (to focus on what people need and what needs to be done). Katz also cites research from advisor consultant Linda Stimac of RainmakerDNA, which finds that the best business develops have a prowess at helping clients make decisions, a strong self-approval (which helps them handle rejection and not seek client approval), good attention and ability to be present in the moment with clients, and financial acumen (you have to be able to talk numbers too!). One of the biggest issues that many face: missing the signs when clients really are ready to move forward. While these skills might be difficult to train towards as well, it can be done; at a minimum, though, be certain they're present in anyone you're looking at hiring for a rainmaker role!

Boomers Vs Gen X & Y: Mind The Gap - In Financial Planning magazine, industry commentator Bob Veres weighs in with his perspective on the current generation gap between younger Gen X and Gen Y advisors, and the baby boomer advisors they often work for. Notably, Veres challenges a lot of the classic criticisms about younger advisors, that they're unwilling to pay their dues, allergic to working long hours, or are just flat out unloyal; after all, when the baby boomers were young, they were viewed as being even less respectful of their parents' generation, as "long-haired bums with no morals or sense of responsibility!" Perhaps instead it's just about different perspective; Veres notes that today's younger workers may not mind putting in the hours, as much as they simply don't measure productivity by hours in the first place, and it's ironic that most boomers built their businesses by serving their peers and growing with them but have now increased their minimums to the point their younger hires can't follow the same track. More generally, Veres cites Malcolm Gladwell in proposing that perhaps the younger generations are simply more oriented towards networking and working with peers than the traditional hierarchical structure, and that too creates friction but doesn't necessarily mean younger advisors are "wrong" or ineffective. Ultimately, Veres suggests that perhaps the reality is simply that each generation will continue to complain that the newer one just doesn't measure up... until eventually, it has to, and it does, but on its own terms and with its own values.

Summer School: 4 Tips To Protect Your Tech - From Investment Advisor magazine, technology consultant Dan Skiles provides some four nice tips on technology updates you can focus on during the slower summer months. First of all, Skiles suggests that it's important to recognize that as consumers of all age groups adopt more of today's technology, with the ease of use of devices like iPads, your clients may be more confident using technology to conduct their affairs than you realize. Second, recognize that cloud technology really is taking over the desktop world; though the desktop isn't dead, and isn't going extinct in the near future, the trend is underway, and the majority of technology service companies building for advisors are now doing it in a cloud-based environment. It's also becoming increasingly viable to have hybridized solutions - part desktop, and part cloud - and there are cloud-based providers beginning to offer comprehensive solutions to turn a hybrid environment into a fully cloud-based one. Skiles' third technology tip is about security, not just of your servers from hackers, but also about the risk that hackers will attack your clients and send you fraudulent transfer requests on their behalf, so be certain you have some procedures in place to try to identify and prevent these risks from occurring. On a final note, Skiles points out that as the world of "apps" rises, more and more specialized tools are being built; as a result, don't just look for programs that build on existing software (like extensions for Microsoft Office), and be open to casting a wider net in looking for specialized solutions that may stand alone but can integrate with what you already use. The bottom line - a slower summer season is a great time to do a review of your own technology, and scout out some next steps.

An Intuitive Examination Of Downside Risk - From the Journal of Financial Planning, this article provides a great overview on some of the ways to measure portfolio risks and especially downside risk (beyond the common-but-not-terribly-effective measure of standard deviation), with a focus on semivariance and semideviation, and their applications using the Sortino ratio and the information ratio. Semivariance is addressed first, and is contrasted with standard deviation; with the latter, the measure is based on the total of all (squared) deviations of each data point from the average, while the former measures only the negative deviations (as in theory, investors don't mind variance that leads to positive results, just variance that leads to negative outcomes!), and in cases like Berkshire Hathaway this can make a big difference (as only 39% of Berkshire's variance is actually attributable to the negative variety, though with negatively skewed returns variance can understate risk, too!). Semivariance and semideviation (the latter is the square root of the former) is often applied by looking at the Sortino ratio, which is the excess return above the risk-free rate divided by the semideviation; essentially, it is a measure of excess return relative to downside risk, and is arguably superior to a Sharpe ratio, which simply measures excess return compared to total variance (which includes the "good" variance too!). Semideviation can also be applied to the information ratio - which measures the ratio of an active manager's excess return to his/her excess risk over a benchmark - by substituting in semideviation to the denominator and measuring an active manager's excess return relative to his/her downside excess risk compared to the benchmark. For those who aren't familiar with these downside risk measures, the article also provides a few examples of how they might be applied in analyzing particular investments.

What Advisors Need To Know About Health-Care Planning - On Advisor Perspectives, this article provides a  nice overview of some rules and details that advisors need to know about planning for retiree health care, as Medicare alone will not cover everything. After starting off with some general stats (the Federal government spends about 1/3rd of all receipts on healthcare including Medicare and Medicaid, while nearly half of high-net-worth Americans near retirement are "terrified" of what health-care costs could do to their plan), the author delves further into what clients are really exposed to. Health care costs can add up through retirement, and notably the cost varies significantly by location; most are covered by Medicare, getting Part A (hospital insurance), Part B (supplementary medical insurance), and Part D (prescription drug plan, which in recent years has been getting tweaked by the Affordable Care Act); the affluent often supplement this further with Medigap policies. Beyond health care, the author also notes risks of long-term care needs, where the percentage of people limited in their Activities of Daily Living tends to spike for those over age 85, and now 44% of those reaching age 65 are expected to enter a nursing home (though only 53% of them will stay for more than 1 year, and only 10% will stay more than 5 years). Long-term care insurance can help address this, but so far the reach is limited; only 264,000 individuals were receiving some type of long-term care insurance benefit payment at the end of 2012, but its estimated that more than 15 million family members and friends are providing help to their loved ones.

Investing In Future Generations: Evolution Of The Business Skills Trust - This Journal of Financial Planning article tackles the topic of Incentive Trusts (trusts that are designed to only distribute money in a manner that incentivizes good/desired behaviors), particularly those used in the context of transitioning a family business and preparing future family members to be financially responsible, in a world where only about 10% of family businesses survive the transition to a 3rd family generation. The author suggests that incentive trusts should be structured in a results-oriented manner - similar to the principles of a Results Oriented Work Environment (ROWE) - with the goal of not just incentivizing behavior directly, but trying to stir the trust beneficiary's intrinsic motivations instead. For instance, with a Financial Skills Trust the beneficiary could be required to go through a curriculum on financial literacy and responsible money management, and then trust distributions could be based on results like maintaining a certain minimum FICO score, a desired debt-to-equity ratio, or paying off credit cards monthly; similarly, the beneficiary might only receive trust support if he/she is otherwise living within his/her means, and managing trust assets responsibly (though since the point is the result, not the means, it's up to the beneficiary whether to accomplish this with an outside accountant and financial advisor, or independently and self-directed). In the business context, a Business Skills Trust could be comparably structured, that again would focus on business results that can be measured and achieved, but leave flexibility about how the beneficiaries (legitimately) attain the outcomes. Ultimately, the goal here is not to replace a family governance structure for the business, but simply to lubricate the wheels of family ownership transition.

When Doing Good Is Bad - Practice management consultant Angie Herbers takes a look at the problem behavior of "financial enabling," such as giving away money someone can't afford, giving money to someone when it's not really in their long-term interests, having trouble saying no to money requests, or even outright sacrificing one's own financial well-being for the sake of others, such as when parents support adult children at high personal cost rather than pushing those children to learn to support themselves. Yet Herbers notes that while we as planners often tackle these issues with clients, the reality is that it's also prevalent in small businesses - including advisory firms - between the owners and their employees. As a result, Herbers notes that when employees ask for more money, it's almost never actually about the money, but advisory firm owners often capitulate to the money request and in the process enable the underlying problem behaviors rather than addressing them. For instance, is the "more money" request really just masking a problem employee living a lifestyle beyond his/her means, or redirecting pressure from a spouse about how much time is being spent at work ("if you're going to work that much, you should ask to get paid more for it!"), simply not liking the job ("if I got paid more, maybe I could tolerate this job longer"), lack of motivation to do the job, the firm is overly dependent on the employee (such that the employee feels entitled, or feels he/she has leverage to demand more), and emotionally driven major life events. The key distinction here is that, as with clients who have problem financial behaviors, the real solution is to try to deal with the underlying problem - helping the employee become happier and more motivated, or helping to connect the company to the employee's spouse, or helping the employee transition to a more affordable lifestyle - rather than just fighting about whether the employee does or doesn't deserve the raise. Especially since, if the underlying problem isn't resolved, a current "more money" request is likely to just enable the behavior to continue, and therefore is unlikely to be the last request.

Do Incentives Really Motivate People? - In Investment Advisor magazine, Pershing CEO Mark Tibergien looks at the topic of motivation, and the fact that we have a tendency to throw compensation and potential bonuses to influence problems that often won't really be solved by incentives. While it's certainly true that badly designed incentives make spur bad behavior, and that aligning financial incentives with the desired behavior can help, it's not a cure-all; ultimately, incentives may make it in someone's financial interests to choose to do A over B, but it doesn't motivate them to do it. After all, if financial incentives alone were key, there wouldn't be so many hard-working people employed in nonprofits and charitable organizations, who maintain their motivation despite some often harsh or outright dangerous conditions. In fact, there are many modestly compensated jobs with highly motivated workers, including teachers, social workers, military personnel, and clergy. Instead, Tibergien suggests that we look at Clayton Christensen's "How Will You Measure Your Life?" book, which discusses motivation theory, and the simple idea that ultimately people do things because they want to, not just because they get paid to. In this framework, while poor compensation (and work conditions and job security) can be demotivating, good compensation is not necessarily motivating. That's why the best business developers may get paid well, but in the end they're also simply driven by a fierce desire to win and a strong fear of losing that internally motivates them. The bottom line from Tibergien's perspective is that while having reasonable compensation and incentives matters, the real key is about effective and active management of employees and creating an environment in which motivated people can flourish; don't just throw money at the problem.

Not Your Values - In Morningstar Advisor, financial planner Carl Richards makes the important point that planners need to be highly cognizant not to confound what's important to the planner, and what's important to their client; as Richards states, "the line between our values and their values is an important one to keep clear." Otherwise, we risk imposing our values on our client's money. For instance, Richards cites an example of a conversation he had with a financial journalist who publicly claimed that being a stay-at-home Mom is bad financial planning with numbers to prove it, while Richards' own wife has numbers that disagree as she places a high value on some of the mental intangibles of being able to stay home with her children. Certainly, there is a financial risk to his family's approach, but they have made a decision that the personal rewards outweigh the risk, and ultimately that is the family's decision, not the advisor's. The potential problem crops up in many other areas as well, from the advisor who worked his/her way through public university and has concerns about the client who wants to fully pay for a child's Ivy League education, or the advisor who regularly contributes to charity and criticizes the client for not being more giving as well, or the advisor who was raised to believe home ownership is a wise investment and discourages clients from being renters. As Richards notes, there's nothing wrong with having an opinion, but be very cautious when it comes to value decisions and weighing trade-offs; the planner's job is to help clients understand those trade-offs, but not to judge them or impose our own values on the situation.

I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!