Weekend Reading For Financial Planners (June 29-30)

RIA Industry Hits Record Highs Of Firms, Clients, Study Finds

(Patrick Donachie | WealthManagement)

Historically, broker-dealers, and large wirehouses in particular, have led the way in terms of advisor headcount and Assets Under Management (AUM). Nonetheless, recent years have seen a shift toward the RIA model, both among advisors (as brokers break away to start their own independent firms and aspiring advisors seek positions that don't rely on an 'eat what you kill' approach) and consumers (who might be attracted to the differentiated service proposition they can experience working with an RIA that isn't manufacturing its own financial services products for sale).  

According to a recent study by the Investment Adviser Association and compliance firm COMPLY, SEC-registered RIAs saw growth on several levels in 2023, with the net number of RIAs increasing by 282 to a record high of 15,396 firms (notably, the number of RIAs has risen each year for more than a decade, while the numbers of broker-dealers have been shrinking during the same period), the assets managed by RIAs jumping by 12.6% (buoyed in part by strong equity market performance during the year), the total number of clients served by RIAs rising 3.5% to 64.1 million (further, these figures were stronger for the firms serving individual clients [as opposed to RIAs that advise institutions as well as funds and other pooled vehicles], with 12.8% growth in the number of clients and 15.1% growth in AUM), and the number of RIA employees growing 3.6% (passing the 1 million mark for the first time). In addition, the study found that RIAs continue to be relatively small businesses, with 58.3% of RIAs having AUM between $100 million and $1 billion and another 11% having AUM of less than $100 million, with the median SEC-registered RIA has 8 employees, $403.5 million in AUM, and 67 client households.    

The study also looked at state-registered RIAs, which totaled 16,296 for 2023 with $417.1 billion in AUM. These firms are more likely to be smaller, with an average AUM of $26 million (which makes sense given that firms typically have to register with the SEC once they hit $100 of regulatory assets under management). The study found that these firms are more likely to offer financial planning services compared to SEC-registered RIAs (with two-thirds doing so, compared to 44% of SEC-registered firms) and have an average of 2 non-clerical employees and 52 clients.

Altogether, the study indicates that while the largest RIAs tend to dominate in terms of total AUM (with 92% of client assets being managed at firms with more than $5 billion in AUM), the industry is robust across the size spectrum, with both smaller and mid-sized firms seeing growth (often pushing them into higher size brackets and/or from state to SEC registration) and remains attractive to new entrants, whether those moving over from other models or totally new firms. Nonetheless, given the equity market tailwinds experienced in 2023 boosted RIA performance, a focus on organic growth (i.e., winning new clients and/or managing more of current clients' assets), perhaps by showing the unique value a firm has to offer, would likely become more important in future leaner times for markets (and could be particularly important for relatively smaller firms that might not have the marketing budgets to compete with the largest RIAs?).

Dual Registrants Should Brace For Reg BI Crackdown, Former SEC Lawyers Say

(Tracey Longo | Financial Advisor)

The SEC's Regulation Best Interest, issued in June 2019 and implemented in June 2020, requires brokers to act in their clients' best interests when making an investment recommendation, by meeting 4 core obligations: disclosure, care, conflicts of interest, and compliance. While this represented a higher benchmark than the preceding "suitability" standard imposed by FINRA on its members, it fell short of a full fiduciary obligation (creating a gap between the obligations to customers of broker-dealer representatives and the clients of advisers at RIAs). Which has created ongoing questions about how dual-registrants in particular are expected to behave, since they may wear both "hats" at various times during the span of a client relationship, spending a portion of their time acting in their capacity as Reg-BI-based brokers and the rest as fiduciary investment advisers.

With this in mind, the SEC last year issued a risk alert related to dual registrants (who now exceed the number of solely registered broker-dealer representatives), outlining deficiencies uncovered during recent examinations, including how firms are disclosing to their clients the capacity in which an adviser is acting at any particular time, as well as related conflicts. For instance, the SEC noted that it found instances where broker-dealer registered representatives making investment recommendations were not disclosing to clients whether they were acting as a commission-based broker or a fee-based investment adviser at the time of the recommendation, creating the risk that the consumer doesn't actually understand which "hat" the advisor is wearing and its implications about whether or how much they should rely on his/her advice.

Amidst this background, former SEC lawyers recently highlighted that dual registrants could be particularly compelling targets for Reg BI enforcement, which could allow the SEC to "make side-by-side findings, one under the Investment Advisers Act and the other under the Exchange Act (Reg BI), with respect to the same conduct by dual-hatted representatives implicating both regulatory regimes", according to a client note by former SEC attorney Mark Schonfeld and other partners at the law firm Gibson Dunn. In particular, the SEC could focus on the conflicts and duty of care elements of the rule, with Cetera Chief Legal Officer Lisa Gok (also a former SEC attorney) suggesting that the SEC will look to see specific disclosures any time there is a financial conflict (and might conduct an industry-wide "sweep exam" in an effort to find violators). For instance, the regulator could want to see broker-dealers provide specific explanations to clients when a broker recommends a higher-paying product over an alternative. Which has drawn comparisons to the SEC's enforcement of its Share Class Disclosure Initiative around 12(b)-1 fees, under which ultimately more than 100 broker-dealers and dually registered firms have paid hundreds of millions of dollars of fines for failing to disclose to investors that there were less expensive mutual fund share classes available.

Ultimately, the key point is that hybrid advisory firms could be attractive targets for SEC enforcement actions given that they have duties relating to client care and managing conflicts of interest under both as a broker-dealer (under Reg BI) and as an investment adviser (under the Investment Advisers Act) and that their "dual-hatted" nature can be particularly confusing for their clients given the differences in standards of conduct depending on which hat is being worn at the time. Which could lead to clearer guidance for these firms and (if penalties are enforced) spur broker-dealers to live up to Reg BI's (as well as the RIA fiduciary) higher requirements… or alternatively may simply drive more financial advisors away from needing to contend with FINRA's overlapping regulations and "just" become standalone RIAs instead?  

IRS Audits Shift Focus From Ultra-Affluent Individuals To The 'Mere' High-Income

(Tracey Longo | Financial Advisor)

When it comes to auditing tax returns, the IRS often goes 'where the money is', targeting the highest income earners with the logic that the work required for these audits is likelier to uncover greater tax payment shortfalls than audits on those with less income. For instance, in 2020 then-Treasury Secretary Steven Mnuchin issued a directive calling for the IRS to audit at least 8% of individual tax returns from those with an Adjusted Gross Income (AGI) of more than $10 million annually (a percentage much higher than the overall audit rate).

Nonetheless, a report this month from the Treasury Inspector General For Tax Administration indicates that the IRS has ceased monitoring the 2020 directive, with the agency arguing that these audits had high "no-change rates" (i.e., no additional tax was owed) and shifting its focus to the larger pool of taxpayers with AGI of at least $400,000 (a floor established by a directive that additional funding the IRS received under the 2022 Inflation Reduction Act not go to increased audits of taxpayers below this income level). However, the Inspector General's report found that, overall, audits of those with at least $10 million of AGI were, in fact, more productive than those of individuals with lesser income. For instance, audits of the highest income individuals produced an average of $124,389 in taxes owed per return (or about $2,220 per hour of IRS employee work), compared to $31,000 per return (or $1,100 per hour of IRS employee work) for audits of individuals with income between $400,000 and $10 million. The report noted that part of the discrepancy between the IRS' claims and these findings could be differences between the performance of different IRS divisions, with the Small Business/Self-Employed Division performing better than the Large Business and International Division following the 2020 directive in terms of uncovering additional taxes owed.   

With these findings in mind, the Inspector General's Office recommended that the IRS include a separate category for taxpayers with at least $10 million of income when assessing the productivity of examinations and to identify the potential causes for the Large Business and International Division. In response, the IRS says that it has audit metrics for high-income individuals, though declined to set a specific target for those with at least $10 million of income, and that it will use enhanced data and analytics within the Large Business and International Division to select cases based on the highest risk of noncompliance.

Altogether, the report and the IRS' response suggest that while the IRS has been able to achieve stronger returns by auditing the highest-income individuals, those with at least $400,000 of income could increasingly come into the crosshairs for an audit (though notably, the Inspector General's report found that 63% of total audits last year were of those earning less than $200,000, indicating that relatively lower-income individuals are not immune from audits as well, even if they are less likely to be faced with one than those with higher incomes). Which highlights the value (in terms of avoided penalties) of accurate tax return preparation for financial planning clients, whether completed by the advisor themselves or working together with a dedicated tax professional!

5 Ways To 'Fix' A New Client's Portfolio

(Christine Benz | Morningstar)

While new clients tend to approach advisors with a wide range of pain points, a key area where advisors can add value is in ensuring that their portfolio reflects their goals and is invested in a tax-efficient manner. Which can start with an analysis of the client's current portfolio, identifying potential 'mistakes' and suggesting an alternative course of action.

One frequent feature of individual investors' portfolios is "portfolio sprawl", or having many (often redundant) holdings across several accounts (often built up as a result of starting a new 401(k) at each new job). This can often be rectified by rolling the disparate retirement accounts into a single IRA (or separate Traditional and Roth IRAs if they have Roth dollars) and creating a single asset allocation. Relatedly, a new client might be invested in individual stocks that are already represented in other parts of their portfolio (e.g., owning mega-cap tech stocks in addition to an S&P 500 fund), perhaps unintentionally creating a concentrated position that might need to be unwound (perhaps by selling the individual shares or by working around them through a direct indexing strategy). Further, while taking a 'hands off' approach to portfolio management can sometimes work to an investor's benefit (rather than tinkering with it and potentially buying high and selling low), some new clients might continue to hold mutual funds they bought many years ago that no longer provide the intended benefits, whether because of manager changes, extended underperformance, and/or higher fees than available alternatives.

More broadly, a new client's asset allocation (which they might have initially selected many years earlier) might not match their current goals. For instance, while an early- or mid-career employee might choose an aggressive asset allocation (which, over time, could skew even more aggressive if the investments post strong returns) that might not be as appropriate as they approach or enter retirement (and have to deal with sequence of return risk). Also, their portfolio might not have been constructed with asset location in mind, offering the advisor an opportunity to put different assets in different accounts (e.g., taxable versus tax-deferred) based on tax-related factors (e.g., how much income they generate).  

Ultimately, the key point is that advisors have several ways to improve the after-tax performance of client portfolios, from scanning for unintentionally concentrated positions to aligning their asset allocation with their goals. At the same time, doing so can come with challenges, from navigating the tax impact of adjusting the portfolio (e.g., possibly realizing capital gains on positions sold in taxable accounts) to potentially convincing clients to (perhaps gradually) part with long-held positions if they are not part of the advisor's recommendation (suggesting that adjusting the portfolio in some cases might be an ongoing, rather than a one-time process?).  

The Problem With Concentrated Funds

(Joe Wiggins | Behavioural Investment)

For some investors, investing in concentrated positions or funds could be a tempting proposition offering the promise of significant upside potential (compared to a more diversified asset allocation), particularly if they have high conviction in the company or sector they're investing in. At the same time, concentrated positions tend to come with greater risk, as worse-than-expected performance by the company or sector in question could lead to more dramatic losses than a diversified portfolio.

Wiggins comes down on the side of avoiding concentrated positions for 3 reasons. First, because investing is non-ergodic (i.e., an individual can have a dramatically different experience than a larger group engaging in the same activity over time). For instance, even if investing in concentrated positions led to higher average returns over time for the broad pool of investors, an individual investor could still find themselves facing massive losses if they took a concentrated position at the 'wrong' time (i.e., before a downturn). Second, while an investor in a concentrated position might have done significant research on the target company or sector, there is inherent randomness and unpredictability that cannot be reduced (e.g., unexpected changes in laws that affect the position). Finally, those investing in concentrated funds can face a misalignment of incentives with fund managers. For example, for the fund manager, the potential upside of an overly aggressive strategy (strong returns generating higher management fees) could outweigh the downside (the fund folds, and they have to start a new one or get a new job), whereas the potential downside for an investor (potentially losing all of their money invested in the fund) can be much greater.

In sum, while concentrated positions or funds can offer the promise of greater returns than a more diversified approach, they come with risks outside of the investor's control. Which does not necessarily suggest that they be avoided entirely, but rather that the size of these positions might need to be adjusted to meet an individual's risk tolerance and capacity to incur potentially steep losses?

How To Make Sure Your Personalized Portfolio Doesn't Backfire

(Philip Straehl | Morningstar)

An advisor creating a diversified portfolio for a client to reduce volatility might look at the various holdings within the client's investment accounts to ensure they meet the desired diversification goals (e.g., including a mix of asset classes with low or negative correlations). However, clients often have sources of wealth outside of their investment accounts that could impact the overall risk of their portfolio.

For instance, a working client might receive stock options as a part of their compensation package, which can create a concentrated position in their company's stock and the sector it is in. Which might lead their advisor to avoid investing in the company (or perhaps the sector overall) in the client's investment portfolio (e.g., by using a direct indexing strategy). However, concentration risk can go well beyond stock options to also include the client's human capital (i.e., the future earnings from their employer), which could also be at risk if their employer (or perhaps, even worse, the entire sector in which their company resides) fell on hard times. For instance, a hotel executive might have experienced a triple whammy during the early months of the COVID-19 pandemic, as their portfolio might have dropped along with the broader market, their options tumbled in value amidst a sharp drawdown in the leisure sector, and their job itself might have been in jeopardy. Which suggests that advisors could reduce the risk in client portfolios by taking into account their broader human capital.

In a recent study, Straehl and colleagues from Morningstar suggest a "Total Wealth" framework to personalize client portfolios that not only considers a client's overall human capital, but also extends beyond common risk mitigation approaches. Their research found that 'just' excluding the client's company or sector from their investment portfolio is not necessarily sufficient to reduce their human capital exposure. Rather, actively tilting the portfolio towards assets that are not exposed to the same economic drivers as the client's company or industry (potentially offering negative correlations to the client's human capital exposure) can provide better protection if the client's company experiences a negative shock.

In the end, in a world where risk is an inherent part of investing (and career earnings are not guaranteed), taking a more holistic approach could allow for greater risk mitigation for a client's overall wealth (and not just the performance of their investment portfolio). And for a client who is particularly exposed to a certain company or industry based on their skillset, this research suggests that a customized (and perhaps non-traditional?) asset allocation that addresses the correlations between the client's different sources of wealth could further mitigate the financial risks they face.  

Client Note-Taking: Frameworks And Tools For Advisors To Improve Client Conversations

(Michael Lecours | Nerd's Eye View)

Taking notes during client meetings can be a challenge for an advisor (particularly if they don't have a colleague there for note-taking support), as maintaining the flow of a good meeting and the rapport established through personal conversation is difficult when the advisor interrupts the rhythm of the dialogue by pausing to jot down some notes. Nevertheless, maintaining accurate client meeting notes is important for several reasons, including reminding both advisors and clients of the conversations and strategies discussed, creating records of action items that need follow-up attention, and potentially enabling a quick and easy resolution should the advisor be accused of wrongdoing.

The best method for an advisor to use to take effective notes is highly personal and will depend on the nature of the meeting. For instance, one consideration is whether to handwrite or type notes. As while studies have found students tend to remember lecture material better with handwritten notes (forcing them to think about material quickly as it is delivered and to summarize key points to simply keep up with the lecture) and that typing tends to be less thoughtful (as much of the information is simply transcribed verbatim), it may sometimes make more sense for advisors to type their meeting notes just to ensure the information is captured at all (further, typing notes is also more conducive for advisors to enter such notes, details, and follow-up action items directly into an advisor CRM system).

Regardless of the medium, there are several traditional frameworks for organized note-taking. Examples include the "Cornell Method", which divides the page into functional areas for notes during and after a meeting, with space to create an overall summary, and the "Charting Method", which organizes main points in a columnar format (useful for discussions bouncing back and forth between a few main topics). For advisors specifically, "Guided Notes" are customized templates useful for conducting meetings in a consistent, organized fashion. Tech tools are also available to help make note-taking easier and more efficient, with note-taking programs emerging as one of the first Artificial Intelligence (AI) use cases for advisors.

Ultimately, the key point is that, even though it may be difficult for advisors to take detailed notes during meetings, doing so can make life easier for the advisor down the line, whether in recalling what was discussed, crafting appropriate follow-up tasks, or maintaining records for legal purposes. And so, by developing excellent note-taking skills and habits (potentially with the assistance of available technology tools!), not only can advisors reduce the possibility that important details will ever be lost, they also can empower their teams to proactively provide the best client service experience with access to well-organized, detailed client information.

The Hottest AI Use Case For Advisors: Note-Taking Apps That Generate Action Items

(Charles Paikert | FamilyWealthReport)

While meeting with clients is a core part of an advisor's job responsibilities, the work involved with a client meeting doesn't end once the client leaves the office (or closes the Zoom window) and can include processing notes taken during the meeting (i.e., formatting and uploading them to the advisor's CRM) and creating follow-up tasks that came out of the meeting. Which can be a time-intensive task for the advisor (or lead them to hire a staff member who can support this function, among others).

However, amidst recent advances in Artificial Intelligence (AI) a variety of note-taking applications have emerged for advisors and the broader population. While the functions of these programs can vary, they typically are able to record client conversations (whether in person or virtual), transcribe them, and produce summaries, task lists, and compliance records that can be automatically loaded into the advisor's CRM, potentially saving an advisor many hours of work fulfilling these tasks (or reviewing an employee's work on them) over the course of a week, with tech consultant John O'Connell estimating that these apps could save advisors as much as 70% of the time needed to take and process notes manually.

While these note-taking programs offer significant time-savings possibilities for advisors, they are not without their potential downsides. To start, while voice-recognition and processing technologies have improved greatly in recent years, the program might not be able to fully understand everything that is said during a meeting (which could be particularly true for technical financial planning concepts). Further, clients might have privacy concerns given that the meeting (and the personal details discussed during it) will be recorded and possibly stored (and might not know what will be done with their data). With this in mind, due diligence on these program's capabilities and data security practices on the part of the advisor (e.g., by obtaining a Systems and Organization Controls 2 [SOC 2] report, a third-party assessment of the vendor's ability to securely manage data) could help mitigate these concerns.

Altogether, whileAI holds promise for advisors in several areas, note-taking applications might become the 'hottest' tools in the initial wave of advisor-facing software. With this in mind, interested advisors can not only consider which tool is best for their needs (i.e., choosing a tool that integrates with their CRM and/or one with enhanced security features), but also whether it can be used in accord with relevant compliance requirements!

Battle Of The Bots: Comparing And Ranking AI Notetaker Solutions For Advisors

(Kait Nortum and Monique Dutkowsky | XY Planning Network)

The explosion of AdvisorTech tools in recent years has allowed advisors to enhance the value they provide to clients. However, the large number of AdvisorTech categories and tools within them can make building a tech stack a time-consuming task (though resourcesand research studies are available to facilitate these decisions!).

One emerging AdvisorTech category is AI-enabled note-taking tools, which can (depending on the tool) record and store meetings, create meeting summaries, generate task lists, and integrate with the other tools in the advisor's tech stack. To help advisors narrow the options, Nortum and Dutkowsky evaluated popular AI note-taking tools on a range of criteria, including features, price, accuracy, security, and whether they are designed specifically for advisors. For instance, users who prefer an advisor-specific tool that is more likely to integrate with other software in their tech stack (so that meeting summaries and tasks are automatically uploaded to the advisor's CRM) might prefer options like FinMate AI (which they found to be the most accurate tool test), Jump(which was found to be best for customizations), or Zocks (which they found to be best for security). Looking beyond advisor-specific tools, they found that Grain provided the best overall value and had the best user experience, while Fireflies came with the best out-of-box features.

In sum, a wide range of AI-enabled note-taking tools are available for advisors, featuring a variety of features and price points, enabling advisors to choose the option that best meets their unique preferences (e.g., prioritizing security over the user interface or integrations over storage space)!

The Best Way To Get Things Done

(Nick Maggiulli | Of Dollars And Data)

One of the common features of modern professional life is having an ongoing list of tasks to complete each day or week. A problem, though, is how to prioritize the different tasks on the list, which might all seem important and time-sensitive (at least to the colleagues or clients who want you to complete them!).

With this in mind, an advisor could consider implementing a strategy to decide which tasks to work on first. At the simplest level, taking tasks on as they come in allows for fairness (as tasks are completed in the order received), though this can be slow (especially if a task that takes a long time comes in first) and doesn't prioritize the tasks based on their importance. An alternative to this could be to complete tasks based on their importance, which can ensure that priority tasks are completed first but can leave quicker tasks waiting to be finished. On the opposite end of the spectrum, one could first take on the tasks with the shortest processing time, allowing for more tasks to be completed (at the cost of prioritization). Another, perhaps superior, option, weighted shortest processing time, combines the features of the previous 2 strategies, assigning an importance weight to each task and dividing it by the time it will take to complete the task, creating a to-do list that reflects both the value of the task and how long it takes to get done (though this strategy can take time to organize).

At the same time, while implementing a personal task organization system can potentially boost efficiency and productivity, a key question to ask is whether all of the tasks on one's list actually need to be completed in the first place. Because while it might be satisfying to check off all of the items on a to-do list at the end of the day, the fastest way to get something done is to not have to do it in the first place. Further, one might find that the more efficiently they get things done, the more that might be put on their plate by colleagues or managers (reducing the amount of 'slack' in the system in case a crisis occurs). Which suggests that first getting a clear sense of one's goals and responsibilities can help narrow down the tasks they take on (and can then prioritize, perhaps using the weighted shortest processing time method).

Ultimately, the key point is that productivity is not just a matter of how much gets done, but also whether the most important tasks are accomplished. So while choosing a task management system is one part of the equation, the ability to prioritize what's important (and what needs to be done at all) can boost productivity further (and lead to less stress during the workday!).

Lazy Work, Good Work

(Morgan Housel | Collaborative Fund)

In centuries past, most work prioritized physical strength and dexterity over mental processing (with economist Robert Gordon estimating that in 1870, 46% of jobs were in agriculture and 35% were in crafts or manufacturing). However, work output today is more often the result of one's thoughts than one's physical tools, with 38% of jobs designated as "managers, officials, and professional" and another 41% of jobs sitting within the service sector.

Despite this dramatic shift in how we work, views of productivity often center around what can be 'seen' (e.g., time spent at the computer in the office). However, if much of today's work is based on how well one thinks, knowledge workers might be better off having time away from the desk. For instance, one study found that creative output can increase by 60% when walking compared to sitting. More anecdotally, you might think of how many good ideas have come to you in the shower or while just relaxing (as your brain isn't as cluttered with other tasks going on simultaneously).

In the end, in the modern age, time spent in the office does not necessarily equate with the quantity of quality of one's work. And given the creative boost that can come from stepping away from the desk, setting aside time to step back and just "think" could be one of the best (if counterintuitive) productivity tactics available!  

Why We Choose The Hard Way To Do Tedious Tasks

(Alicea Lieberman | Harvard Business Review)

Many professionals try to enter a "flow state" during the workday, where they can be completely focused on a single task or activity (as opposed to multitasking or thinking about the next task to be done). Nevertheless, while achieving a "flow state" can be a valuable practice for enjoyable activities or those that require significant mental bandwidth, staying 'locked in' to complete a task in a certain way can sometimes have its drawbacks, particularly if there is a better way it could be completed.

Lieberman and fellow researchers conducted a series of experiments to explore the idea of "entrenchment", or the tendency to continue to do things a certain way once those procedures have been mastered (even if a more efficient alternative is available). For instance, an individual who starts typing an email on their phone might continue to do so even if their computer is nearby (and would allow them to finish the email much faster). In their experiments, the researchers gave participants a tedious task and, after several rounds of completing it, offered some of them the opportunity to switch to a more enjoyable game. They found that once participants' mastered' the tedious task, they were often hesitant to switch to the game, even though it would almost certainly be more enjoyable.

To counteract entrenchment, Lieberman suggests that professionals find ways to find ways to avoid becoming overly engrossed in repetitive tasks that one has mastered. For instance, setting a timer can create a natural stopping point that could allow a worker to reflect on what task they're doing and whether taking a break or switching to another task might be more effective. In addition, recognizing and avoiding potentially entrenching activities (from social media scrolling to filling out forms) can help avoid an entrenchment spiral in the first place.

Ultimately, the key point is that while persistence often pays dividends, it is most effective when the task at hand not only is important, but also when the method being used to complete it is the most effective option available. Which suggests that financial advisors might benefit by taking a step back and considering whether the work methods and procedures that they have mastered over time are truly the most efficient and best use of their time or whether they have simply become comfortable with them (to the detriment of their productivity and, potentially, wellbeing)?

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We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog.