Weekend Reading for Financial Planners (Mar 12-13)

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth, which provides an evidence-based approach to private wealth management for near- and current retirees, and Buckingham Strategic Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors through the scaling phase of growth.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

Read all of Michael’s articles here.

Weekend reading for March 12th/13th:

Salesforce Launches Financial Services Cloud (Christopher Robbins, Financial Advisor) - This week, Salesforce announced the launch of its new financial-advisor-specific platform, the Financial Services Cloud. From the company's perspective, the key distinction is that while Salesforce has always been a Customer Relationship Management (CRM) system, the new version is built more centrally on really supporting the client relationship. As a result, the new Financial Services Cloud is designed to bring in integrated information from portfolio management, prospecting, account aggregation, and calendar scheduling into a single advisor interface, and even tracking progress towards financial planning "client life" goals. Initial integrations include account aggregation from Yodlee, document management from DocuSign, portfolio management through Orion, rebalancing via Advisor Software, prospecting via WealthEngine, compliance through Smarsh, and more. Pricing was announced at $150/user, which advisor tech guru Joel Bruckenstein notes will probably be more appealing to large advisory firms that can fully leverage the software at that price point, and in fact the most prominent RIA launch partner announced was mega-RIA United Capital, which announced it will be building its own specialized overlay on top of Financial Services Cloud to be available in the future as a private white label dashboard for other advisory firms.

Last-Minute IRA Contributors: 10 Mistakes to Avoid (Christine Benz, Morningstar) - The deadline for making the up-to-$5,500 2015 IRA contributions is looming next month, with a final due date this year of April 18th (pushed back due to the fact that April 15th is the Emancipation Day holiday for the District of Columbia and the 16th and 17th are over the weekend). Of course, the first issue is just clarifying which type(s) of IRA accounts the client can contribute to, with Roth IRA contributions phased out at $131,000 for individuals and $193,000 of AGI for married couples. Those above the Roth income limits can still make a traditional IRA contribution, though it may not be deductible if the contributor or his/her spouse are an active participant in an employer retirement plan. And a non-deductible IRA contribution can subsequently be converted into a Roth IRA as a form of "backdoor Roth IRA" contribution, though beware doing the conversion too quickly after the contribution. For those who have a choice between the two (either outright or through the back door), they must decide whether the traditional or Roth is better, which is driven primarily by when the tax break is most valuable (i.e., when tax rates will be lowest, with those subject to higher tax rates now going with the traditional and those expecting higher tax rates in the future to go Roth (or some possibly contributing partially to each to hedge their bets). In addition, don't forget the potential for a spousal IRA contribution as well, for single-earner families. And once the dollars are in the account, don't forget to actually invest them (or the contribution might sit in idle cash!), ideally in a manner that maximizes asset location benefits by sheltering higher-return tax-inefficient investments.

Retirement Health Care: What Are Your Options? (Darrow Kirkpatrick, Can I Retire Yet?) - Historically, one of the greatest challenges for those who wanted to retire "early" - i.e., before age 65 - was figuring out how to get health insurance coverage until becoming eligible for Medicare. But the passage of the Patient Protection and Affordable Care Act in 2009 - a/k/a "Obamacare" - changed that, by making it feasible for early retirees to get guaranteed access to health insurance without being subject to underwriting, which was crucial for those who had "pre-existing" health conditions by the time they wanted to retire. The additional good news for early retirees is that health insurance purchased via an exchange may even be eligible for a premium assistance tax credit, although planning for the credit is very complex as earning "too much" income can reduce the credit (or disqualify the insured from receiving any credit at all), while earning "too little" income can force the retiree to pay entirely out of pocket or have to rely on Medicaid. The overall targets are based on the Federal Poverty Level (FPL) thresholds; retirees need to earn at least 138% of the FPL in most states, and ideally no more than 250% of FPL to maximize the benefits (and staying between 250% and 400% of FPL to receive at least some credits). For those who don't want to use a policy from the health insurance exchanges (or perhaps cannot afford one, between the premiums and typically-high-deductibles), alternatives include Direct Primary Care plans (which cover routine primary care services for a flat monthly fee) for a lower cost, or "concierge medicine" plans for higher income individuals (although the quality and availability of concierge medicine providers varies greatly by location). Another option are faith-based health care ministries (at least in some areas with availability).

Neither ETF Nor Mutual Fund, Behold the Exchange-Traded Managed Fund (Ron DeLegge, ThinkAdvisor) - Two weeks ago, the first Exchange-Traded Mutual Fund (ETMF) launched on the Nasdaq. Sponsored by Eaton Vance, the Stock NextShares (ticker EVSTC) will mimic the holdings of the Eaton Vance Large-Cap Core Research fund managed by Charles Gaffney, but in "ETF" form. The key distinction of the ETMF over the ETF, though, is the fact that the new ETMF will not reveal its daily holdings (in order to preserve confidentiality of what the fund manager is buying and selling, to avoid front-running), and instead investment positions will only be revealed on a quarterly basis (similar to other mutual funds). However, the ETMF wrapper itself will still trade like an ETF, which means an investor who wants to sell shares simply sells them in the secondary market to other investors, which avoids forcing the underlying fund to engage in sales (that potentially trigger capital gains for the remaining shareholders) just to meet redemptions. Of course, the lack of daily transparency makes it problematic for the normal process of authorized participants to arbitrage the public pricing of an ETMF to its intrinsic NAV the way it is done for a fully transparent ETF; as a result, ETMF shares will still only trade based on the day's closing NAV price, and intra-day trading will be priced relative to NAV (for instance, a price might be marked as "NAV + $0.01").  Because of the complexity in executing such trades, for now the Eaton Vance ETMF will only trade through Folio Investing and Folio Institutional, though if the offering is successful - i.e., it gathers assets, and trading runs smoothly - it is expected that other asset managers will follow suit, and trading availability will expand to other exchanges and platforms. In the meantime, Eaton Vance has registered a total of 18 NextShares funds, and beyond the Stock NextShares there will be offerings in categories from fixed income to absolute return and multi-asset class, with the next set of funds (for municipal bonds and global equity income) expected at the end of March.

What You Don’t Want to Hear About Dividend Stocks (Meb Faber, Meb Faber Research) - There is extensive research showing that dividends are a very material component of long-term returns, and to support the benefits of investing into high-dividend stocks. However, Faber notes that while dividend-paying stocks may be appealing from a pure investment perspective, they can be very inhospitable from an after-tax returns perspective, due to the ongoing tax drag of dividend taxation itself (at least, where the stocks are not held in a tax-sheltered retirement account). Fortunately in today's environment the tax drag is less severe, due to the favorable tax rates on qualified dividends, but for much of their history - and potentially in the future? - dividends have been taxed as ordinary income, and at rates as high as 90% at one point in the past. Accordingly, Faber tries to assess if there's a way to produce similar return results to a high-dividend strategy, but without necessarily buying the 'tax-inefficient' high-dividend stocks themselves. And as the results reveal, a strategy that specifically focuses on value stocks (as measured by a combination of price-to-earnings, price-to-sales, price-to-book, and EBITDA-to-EV) dramatically outperforms a high-dividend strategy over the past 20 years (even as the dividend strategy beats the market as well). Of course, many of the "value" stocks also happened to be high-paying dividend stocks as well, but by focusing on value first, the stocks that were high-dividend because they were poorly-priced "bad" companies were eliminated. In addition, the lower dividend yield actually resulted in significantly better after-tax returns as well, adding between 0.3% and 1.5% per year to after-tax returns. And Faber notes that this strategy isn't necessarily new; in practice, it's effectively what Warren Buffet has done with Berkshire Hathaway, creating a 'roll-up' value company that generates appealing returns, but without any dividend drag along the way (as Berkshire has only ever paid one dividend, for $0.10, in 1967). And ultimately, Faber notes that the potential for value-outperforming-dividend stocks may be even better from here, as high-dividend stocks appear to have elevated valuations (selling at a value premium, instead of their usual value discount), likely driven by the investor search for yield in today's low-interest-rate environment.

A Fresh, and Cheap(er) Approach To Digital Marketing (Joel Bruckenstein, Financial Planning) - In the past, financial advisor drip marketing strategies usually entailed hiring an outside firm to private label a canned printed newsletter, which the provider would then physically mail to the advisor's prospect list (for an additional fee). In today's world, a growing number of e-newsletters and digital content providers are becoming available, but the quality of the content varies greatly, and it's not always delivered in a manner where advisors can actually track whether the recipients are reading the content and sharing it. A new player in the space to fill this void is Financial Media Exchange (FMeX), which provides a combination of content distribution via e-newsletters (tagging prospects and clients into groups with keywords for more targeted distribution) and also social media, branding (for advisors to white-label the content), a "robust" library of written content (over 5,000 articles licensed from established financial publishers) along with FINRA-approved videos, editorially selected top content (from FMeX's own editorial board), and (for an additional fee) the opportunity to subscribe to premium third-party content from Morningstar. The service also provides analytics to understand whether readers are opening the messages and viewing them. And notably, FMeX is priced at only $395/year, which is significantly cheaper than competitors like MarketingPro (at $825/year plus a $295 initiation fee) or FMG Suite (which starts at $170 per month). Yet even at the cheaper price point, Bruckenstein notes that at the recent T3 advisor conference, the 'buzz' was that FMeX is better and more comprehensive than other alternatives. One significant caveat, though, is that FMeX lacks integrations with advisor CRM platforms like Salesforce and Redtail, so advisors must import contact lists manually via CSV files (though an API to share contact information is "in the works"), and as a new company the FMeX feature set is likely to expand further going forward.

With Vest Platform, Everyone Can Have Options (Christopher Robbins, Financial Advisor) - Amongst advisors, adoption of options strategies has been relatively low, but a new start-up - first backed by start-up accelerator Y Combinator, and now supported by the Chicago Board Options Exchange (CBOE) - is trying to make it easier for advisors to use them. The company, called Vest Financial, allows advisors to manage options by targeting how much risk they want to take in the portfolio in terms of the downside protection to buy and whether they want to cover the cost by giving up some upside potential as well (with the software performing all the behind-the-scenes calculations of what the option strategy would cost). Advisors who want to deploy client assets on the platform will pay a 0.5% annualized platform fee, though there are no separate commissions to pay on the options trades. Eventually, the company aims to partner with an index provider to offer a packaged version as a UIT, mutual fund, or ETF, and evolve into a full service asset management firm.

How To Read Your Client's Poker Face (Joel Bruckenstein, Financial Planning) - While most technology developments for financial advisors are in 'core' parts of the advisor technology stack like portfolio account or CRM software, Bruckenstein notes a potential new entrant: facial recognition and emotion analytics software tools like nViso. For instance, one New Zealand bank has been using nViso's EmotionScan software to track how users respond to a series of eight simple financial scenarios; the software tracks the movements of 43 facial muscles to analyze facial expressions, and assesses whether the user is annoyed, happy, surprised, fearful, sad, or showing distaste/disgust, which is then reported back to the user. The idea is that by gathering this insight, both the user and the financial services provider can have a better understanding of the individual's emotional connection to money and various financial issues, and therefore be better prepared to deal with them (including how the person feels about financial advisors in the first place). For instance, perhaps the individual says Retirement is a priority, but emotionally they react most strongly to cash flow issues, suggesting that there are issues there to be addressed as well. Ultimately, it remains to be seen what will be done with the software and where else it might be applied - perhaps a better version of risk tolerance software? - but for now, you can even try it out for yourself at a sample site that nViso created, called the Emotion Advisor.

Small And Capable (Joel Bruckenstein, Financial Advisor) - Advisors are typically most familiar with the "big" RIA custodians like Schwab, Fidelity, TD Ameritrade, Pershing, and major broker-dealers that support hybrid RIAs like LPL and Raymond James. However, Bruckenstein notes that there are several other less-well-known RIA custodians, many of whom are especially friendly to newer start-up RIAs. For instance, TradePMR has built its own advisor workstation platform called Fusion, and has been particularly popular among small- to medium-sized breakaway brokers. The software supports not only trading and performance reporting, but has CRM capabilities to handle investment-related workflows, and an "intelligence" feature that captures information clients fill out in account applications and other documents and automatically populates it into the CRM system (and even adds a reminder note to the advisor's calendar!). And at the upcoming TradePMR conference Synergy 2016, the company is expected to release its next generation platform as well, called Earnwise, which will include a web-based responsive design to function across all devices, a new client portal (which initially will just show TradePMR accounts but eventually will include aggregation of outside accounts as well), and robo-advisor capabilities (via embed codes that advisors can include on their own websites to deliver TradePMR functionality). Another 'lesser-known' RIA custodian platform is Shareholders Service Group (SSG), which rather than building its own technology tools from scratch has partnered with Pershing to provide their NetX360 platform to advisors (which itself received a major update in 2015, and is also customized specifically for SSG's RIA firms). SSG facilitates relationships to the entire advisor technology stack as well, including CRM providers like Junxure Cloud, Laser App to manage account paperwork, Vestorly for content marketing, and Wealth Access for PFM solutions, along with MoneyGuidePro financial planning software and Black Diamond portfolio performance reporting. The third in the 'smaller' RIA custodian category is Scottrade Advisor Services, which in the past 2 years went through a significant internal restructuring but is now refocused on building out a growing range of technology partnerships (now numbering a whopping 69 third-party vendor relationships, albeit only with a few like Laser App, MoneyGuidePro, and Redtail including deep integrations). In 2016, Scottrade plans to roll out an open API that should make it easier for more third-party integrations to the platform.

Why Don’t Investors Stay True to Their Principles? Think Self-Deception (Stephen Wendel, ThinkAdvisor) - The conventional view of investing is to pick a strategy and stick with it, yet the reality is that investors - and sometimes even advisors - will stray from their investment principles over time, from chasing returns to getting caught up in fads or running scared when the markets turn. Wendel suggests that most commonly, this occurs because we manage to deceive ourselves into thinking we're not "really" breaking our own rules - for instance, saying to ourselves "it's ok to bend the rules a bit" by claiming it's an unusual circumstance. Except, of course, the whole point of guiding principles to is avoid being swayed by what seem - at least at the time - as 'unusual circumstances'! Notably, the behavioral research finds that we can only do this to a limited extent, before we recognize that we're no longer just within the "fudge factor" range, and have really materially deviated from the original course of action. Nonetheless, rather material deviations from our own planned behavior can still occur, even as we rationalize what we've done to maintain the self image that we ("generally") still do the right thing. In fact, the desire to 'cheat' and stray from our principles is so strong that research finds we are actually prone to cheat when given the chance, albeit deviating by just little enough to still otherwise maintain our self-image as an honest person. And notably, we generally don't recognize we're doing it even as it occurs! So what's the solution? Wendel provides three tips: 1) have regular reminders (e.g., at the beginning of each review meeting) about the goals being pursued and the agreed upon path (so if you stray you'll be more cognizant of it); 2) remove room for the fudge factor by being clear about what will be measured (e.g., if the focus is to minimize fees, be certain to regularly look at those fees); and 3) "de-normalize" clients who may be distracted by what their peers are doing (and think THAT is normal) by reminding them of more appropriate role models (e.g., if they're value investors, remind them what Warren Buffett is doing that their friends are not).

Abundance (Josh Brown, Reformed Broker) - Brown notes that our world is experiencing a unique form of abundance these days, from unlimited music to $9/month, to unlimited movies and TV shows for $13/month, and unlimited news and journalism for $0/month (free, online!). The immense hours we spend on social media (Facebook, Twitter, Snapchat) is free as well. And it's not just digital goods, but physical ones too, as oil prices have plummeted, natural gas supplies are overflowing, and industrial metals like copper and iron ore are bidless. But in the aggregate, this is not healthy for the economy, and Brown suggests that much of this abundance is built on the back of malinvestment, leading to scenarios where companies just burn cash by selling a service for far less than it costs to provide it, done solely because the availability of easy money means there's a good chance someone else will buy the company anyway. The abundance is also leading to broad cultural fractures; there's no more "pop culture" with #1 songs, #1 movies, and #1 TV shows, but instead 50 different subcultures, from television to politics (where fringe candidates are succeeding because there are no "mainstream" candidates anymore). So what's the solution? Brown suggests that we need a washout - a recession that purges the excesses from the system, and forces the businesses of money-losing abundance out before they do harm to the real economy that is struggling to compete.

Is Passive Investment Actively Hurting the Economy? (James Ledbetter, New Yorker) - For most of the 20th century, anyone who wanted to invest in the stock market had to buy individual stocks, but in 1975 Jack Bogle introduced the first indexed mutual fund, and since 2000 the amount of money in index mutual funds has exploded (with the advent of ETFs just accelerating the trend) to as much as 20% of all stocks now owned by index funds. The question arises, though, about whether at some point there are so many passive investors, that markets will begin to behave in fundamentally different ways than they have in the past, where the flow of dollars was driven by the supply of and demand for, and the management performance and growth potential, of the individual companies themselves. Recently, some business school professors tried to tackle this question, looking at the effects of passive investing on commodities and the companies that rely heavily on commodities, and found that the flow of passive dollars there does appear to be distorting the normal market signals for the true economic demand for raw commodities. And the concern is that it could ultimately span into the stock market in the aggregate as well, where the flow of dollars to indexing naturally props up the most valuable companies (given cap-weighted indexing) and holds the least valuable companies down, making them "stuck" at their current weightings even if the underlying fundamentals have changed. And one study suggests that companies themselves may be adjusting their behavior in recognition of this, finding that banks whose shares are often packaged into index funds tend to offer higher fees and rates for their services (since their inclusion in the index 'assures' them access to capital). Another study found a similar effect in the airline industry, as airlines now have extremely concentrated ownership amongst a subset of passive index funds, potentially reducing the competitive pressures on the airline stock prices and indirectly resulting in higher prices for travelers. Ultimately, one solution to this is simply to adjust how stocks are indexed to not be cap-weighted (an indirect argument for fundamental indexing as the norm, as it would ensure the underlying economic fundamentals of the stocks remain relevant), although the question arises as to whether concentrated ownership should even be addressed as an anti-trust issue. Of course, few are disputing the investor benefits of low-cost indexing itself, so the issue is not about index investing per se, but how to ensure it does not distort the underlying economy, especially if indexing just continues to grow from here.

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!

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. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!