Weekend Reading for Financial Planners (Mar 14-15)

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 14th/15th:

5 Things Regulators Want to Know About the Way You Do Business (Kenneth Corbin, Financial Planning) - At the beginning of the year, both the SEC and FINRA provide guidance on what they currently view as the greatest areas of concern for their auditors/examiners, and this year the key areas include: retirement rollovers, and whether advisors are rolling over employer retirement plans into IRAs "just" to gather assets and/or to fund "complex" products, even if keeping the funds in the plan may have been better (e.g., lower cost, better asset protection) for the client; cybersecurity, after receiving only minimal attention as recently as last year, has leapt forward to become a central "marketwide risk" issue for 2015, with greater scrutiny than ever on how both large and small firms are protecting client data and defending against potential wire fraud; fee selection in situations where advisors have multiple fee structures available and whether clients are being steered to the "right" one, including both dual registered advisors who must justify why clients are placed into an AUM fee arrangement and not a brokerage account (or risk a charge of "reverse churning"), and also RIAs who have multiple fee options and must be able to justify why clients got one solution and not another; big branch offices and whether advisors located far from the home office might be operating too far outside supervision (an issue that could potentially crop up for RIAs with multiple office locations as well); and repeat offenders, where FINRA and the SEC are taking an especially close look at any advisory firms who hire an advisor with existing compliance violations on their record.

The True Value Of Your Practice (Matt Matrisian, Financial Advisor) - Matrisian notes that the common rule-of-thumb approach to value a practice is flawed in that it implicitly assumes each advisory firm is operated the same way, even though the metric fails to adjust for the fact that firms can arrive at similar revenue by drastically different means (e.g., by serving lots of "small" clients or relatively few "large" ones, by charging a low fee per client for a simple investment service versus a higher fee for each client to receive in-depth financial planning, etc.). Instead, advisors should really look at their practice based on the free cash flows that it generates, and its valuation should be based on the discounted present value of its future cash flows, which accounts for both its (projected) revenue and its (projected) expenses. Valuing a business by its projected free cash flows also gives an opportunity to adjust for the cost of replacing the founder's services in working with clients as well - a critical factor from the buyer's perspective. In addition, a proper valuation - that appropriately accounts for the cash flows that will be generated over time - also provides a more effective means for managing the value of the business as well; by just looking at revenue, advisory firm owners may miss the fact that strategies which add as much expense as they do revenue are not actually enhancing the value of the firm, and the economic value of effectively scaling a business becomes clearer when the firm's value is measured based on (discounted) future cash flows.

How United Capital's Unconventional Rolling Up Of A $2B RIA Reveals How Close The Roll-Up Model Is To Extinction (Lisa Shidler, RIABiz) - Popular "roll-up" firm United Capital launched itself to the $10B AUM threshold with years of serial acquisitions, but its most recent deal represented a notable departure, picking up a 23-person $2B AUM advisory practice within a bank through what was essentially a giant "tuck-in" hire of the entire business while writing only a limited-sized acquisition check to the bank they were acquired from. While the incoming partners of the acquired practice will receive shares of United Capital, the lack of a large cash purchase price - especially when the firm had options to get a big check from other potential acquirers - marks a notable shift in the mergers-and-acquisition environment for advisory firms. In fact, according to FA Insight, the pace of acquisitions involving roll-up or "aggregator" firms has actually been slowing since 2006, and made up only 22% of the major deals announced last year, while the pace of RIAs merging in other RIAs has been accelerating. Overall, advisor M&A consultants suggest the lines are blurring between aggregators and roll-ups targeting RIAs, RIAs themselves becoming the acquirers, and some large aggregators functioning increasingly like giant RIAs. Nonetheless, the pace overall appears to be accelerating, with the total number of $100M+ RIA acquisitions up 66% in the first two months of 2015 over the prior year.

How to Take Over a $1 Billion Practice (Jane Rusoff, Research Magazine) - In the wirehouse environment, mergers and acquisitions are thriving, though often without the public headlines of independent RIA transactions. One recent study estimated that while amongst RIAs there are 2.6 acquisitions for every 10 advisors, within wirehouses it's more than double, or a whopping 5.9 acquisitions per 10 advisors. In the wirehouse context, though, the transaction functionally isn't a "sale" but more of a "retirement" program where the wirehouse facilitates some payment to the exiting advisor, some financing for the acquiring advisor, and a transition plan to help clients shift to and be retained by the new advisor. Nonetheless, "deals" within wirehouses can still be quite generous; under a new Morgan Stanley program, the top advisors can exit their practice with an upfront payment of 50% of trailing 12-months' gross revenue, plus an ongoing payment of a percentage of revenue for 5 years (in one deal, the payment was as high as 70% of revenue in the first year after the deal, declining from there). While internal wirehouse deals can be started by introductions from the wirehouse itself, in many/most cases the advisors get to know each other through events and committees within the firm, form a relationship, and decide to work with the wirehouse to get the transition done (and financed).

Going Independent? Final Launch Stages (Shirl Penney, On Wall Street) - For an advisory firm breaking away to independence, one of the biggest transitions to manage is not the clients themselves, but where the advisor(s) will meet with them, and advisors who have always relied on the wirehouse's branch offices may find themselves for the first time ever negotiating for office space. Considerations include not only where the office will be located (or even "if" you'll have an office outside of your home, depending on your clientele!), but how big does it need to be, given both the size of your current team, and your expectations for growth and hiring. Other considerations include the need for conference rooms (and how many?), a reception area, whether you'll have "hospitality" space for client events, and the furniture you'll need to fit out the space. If you're moving into an unfinished office space, you'll also need to plan out the office layout as well; Penney notes that furniture companies often include office planning as a part of their services. After furniture the office needs to be set up for internet and telephone, and once that's done it's time to set up the hardware like computers and servers, copiers and printers, etc., for which Penney strongly recommends IT outsourcing firms to make sure everything is done correctly. And of course, Penney also notes the importance of budgeting for the expense of an office - including setup the first time - as a part of the transition process, and an advisor going independent should have a plan for how books and accounting will be managed going forward as well.

Why Do You Exist? (Mark Tibergien, Investment Advisor) - In this article, Tibergien reviews the popular Simon Sinek book "Start With Why" and the idea that "people don't buy what you do, but why you do it." Yet Tibergien notes that in the advisor context, few can effectively answer the question "why do you believe your business exists?" without resorting to answers about what they do but not actually why they do it. The issue is important not only because "starting with why" may more effectively connect with clients, but also because it's an effective differentiator from other advisors, and can help to persuade clients not to just do it themselves. Yet the irony is that as a 'helping profession', many financial advisors actually do have a compelling "why" statement, from helping individuals make an impact with their investments, to building wealth to spread wealth, or helping people take control of their personal financial lives. It just needs to be articulated.

Stay in Your Lane (Angie Herbers, Investment Advisor) - The phrase "stay in your [own] lane" is often used to suggest someone should mind their own business or stay focused on their own tasks and not yours; yet in the advisory firm context, Herbers points out that this approach is often difficult because employees don't necessarily know what their "lane" should be, if roles and not clearly defined in the first place. Instead, the end result is that when employees stay in their own lanes, key tasks can fall between the lanes/cracks and not get done at all. Yet from the broader perspective, Herbers suggests it's hard to get employees properly aligned in the first place, if the firm owner doesn't know where he/she is trying to go with the advisory business and his/her own role as its founder. So the starting point is to set some vision of what the firm is supposed to accomplish in the first place; if employees don't know why they're there, it's difficult to get them properly focused. Similarly, have you conveyed the business purpose to the point that employees can articulate it and buy in (otherwise, you'll basically just be managing staff like a bunch of unmotivated drones, who may or may not stay on task effectively!). Once there's clarity about the goal, it becomes more feasible to ensure that employees are doing what they should be doing, what best fits their strengths (it's easier to stay in your lane when you are doing what you do best!), and employees who "buy into the dream" may be far more willing to make their own sacrifices to ensure it happens.

Sales In An Anti-Selling Culture (Philip Palaveev, Financial Advisor) - The word "sales" is still a bad world in many independent advisory firms, yet Palaveev notes that in the end all advisory firms require sales efforts to grow, and that the stigma around sales activity may become increasingly problematic in the coming years. The issue is especially severe for established firms whose founders are retiring, forcing the firm to shift its business development activity to a second generation of advisors who have never been trained to do it and/or avoid "sales" altogether. And for many firms, business development isn't even part of the culture and reward system; in many firms, becoming a partner has been completely separated from demonstrated success in marketing and sales and business development, and while many different types of people can bring (partner) value to the firm, the absence of a culture that rewards for business development virtually ensures the next generation of advisors won't step up to learn it. And even for firms with business development expectations, they are often relatively "low" - the median business development expected from a partner is $10M in new assets from new assets, which isn't enough to grow and sustain a bllion-dollar-AUM firm. And even for firms who do focus on business development, there is debate about "who" should be responsible; is business development the responsibility of a particular person, or should it be part of the culture that everyone is responsible for (Palaveev suggests the latter should be the goal, with all lead advisors contributing).  Notably, Palaveev does make a distinction here between "sales" and prospecting (lead generation); sales isn't about finding potential clients, which may increasingly become a marketing-driven process, but about convincing a prospective client to become an actual client who completes paperwork to come on board with the firm. Ultimately, though, Palaveev notes that most firms struggle with both; lead generation is arguably the hardest activity, though even firms that are successful in that regard may still struggle to actually "sell" and "close" those clients with existing advisor staff, especially if there's no formal sales process (and tracking) in place and the advisors have never practiced overcoming typical prospective client objections.

Getting Fired By Clients Isn’t Always Bad (Deena Katz, Financial Advisor) - Getting fired by a client is a challenging and depressing experience for any advisor, second only perhaps to finding out a client is firing you because the accounts have been transferred when you didn't even have the opportunity to talk to the client and try to convince them to stay first. Research suggests that clients most commonly fire their advisors due to poor communication (where "poor" might be as little as not returning phone calls the same day or slow email responses!), followed next by poor investment results. Yet Katz suggests at an even more basic level, the decision of a client to fire the advisor is about a lack of trust and unfulfilled expectations; after all, "poor" investment results are still poor relative to some expectation, and the same is true of being fired for "poor" communication that was poor because it too didn't meet client expectations. And unfulfilled expectations lead the client to no longer be credible to the advisor, which undermines whatever trust there might have been. On the other hand, in some situations the issue is that the client's needs have changed, and the advisor no longer meets expectations simply because the client no longer has the same needs anymore. Which means in the end, if you're going to manage client expectations and set expectations you can realistically achieve, it's only fair to recognize that sometimes it may actually be better for the client to "fire you" and move on anyway.

Adding Life To Years (Mitch Anthony, Financial Advisor) - The famous quote often attributed to John F. Kennedy on aging is "It is not enough for a great nation merely to have added new years to life - our objective must also be to add new life to those years." Yet in the nearly 50 years since the first White House Conference on Aging, retirees now expect to live a whopping 11 years longer, which means there are a lot more years to add life to! At the same time, corporations are facing a crisis of their own, as the workforce ages and companies that can't figure out how to productively utilize those workers face significant risks as well. Anthony suggests that there is ultimately potential to kill two birds with one stone - that as companies figure out how to better employ older workers with new career paths and employment structures, those employees will have the opportunity to remain more meaningfully engaged in their work and add life to their years. In fact, some research suggests boomers are already beginning a sort of "two-step retirement" process, where they retire from an original job/career and begin a new more "aspirational" one, and only retire from that second career much later (though only if companies are ready and willing to adapt to those work goals and desires). In the end, Anthony suggests that with meaningful work transitions, most may ultimately go through three major work phases - a foundational stage, a mid-career stage, and a final "legacy" stage focused around intellectual capital, with retirement not beginning until age 75 or beyond.

Nick Murray's Hard Truths For Advisors (Jane Rusoff, Research Magazine) - Nick Murray was a financial advisor for nearly 30 years, before launching a second career as an "advisor for advisors" imparting practice management and career advice through his monthly newsletter and keynote speaking engagements. In this interview, Murray shares his wisdom with his usual "no pulled punches" style, including: advisors who talk about markets and current events are "lost souls" who think their job is investment selection and timing when it should be planning; an advisor who positions himself as providing alpha in return for his fee is setting up a guaranteed negative value proposition; the only three values crucial to success as an advisor are integrity, passion, and empathy, and connecting with clients emotionally is critical to success (and is also why Murray believes robo-advisors are no threat, as they can't relate on a human level); figuring out a life-sustaining three-decade retirement income is the central financial planning problem of our time; doing a financial plan is the only way to engage the client and "everything else is sand"; advisors should give more seminars to obtain clients (and despite criticism they aren't effective anymore, Murray says "seminars work if you work them"); from the outset, clients need to be "instructed in the ordinariness of market declines", as trying to coach clients through a market decline in real time is already too late ("you don't start lifeboat drills after the ship hits an iceberg; they have to be done in port"); it's critically important for advisors to set a [written] agenda for every client meeting, or clients will set the agenda unconsciously and often in the wrong terms (e.g., focusing too much on investment performance); financial planning issues should be the exclusive items on a client meeting agenda, as the portfolio is merely the funding medium for the plan; and be cautious not to meet with clients too often, as if the meetings outpace the frequency of planning issues to cover, they will inevitably devolve into "counterproductive performance reviews."

Broken Values & Bottom Lines (Adam Nash, Medium) - As a Silicon Valley native, Wealthfront CEO grew up admiring Charles Schwab as a disruptive company to aspire to, founded with 'anti-Wall-Street' values including no conflicts of interest, no sales, no advice, and always placing customers first. By contrast, though, Nash notes that Schwab's launch this week of their Schwab Intelligent Portfolios "robo-advisor" solution for consumers (the advisor version is coming in Q2), appears to have strayed far from those values. In particular, Nash highlights the decision of Schwab to allocate from 6% to 30% of a client's account value to cash, which in turn will be swept into Schwab Bank where Schwab earns a significant interest rate spread; in fact, Schwab's interest rate paid on deposits is dramatically lower than other online bank competitors, which allows Schwab to generate over $1.7B/year in net interest revenue, almost 3x what it makes on trading commissions. From the consumer perspective, even "just" having 6% out of the market for a multi-decade accumulation time horizon can have a dramatic effect, with a 25-year-old making $65,000/year and saving 10% annually ending out with $138,000 less at retirement due to the drag of low cash returns. Similarly, Nash also criticizes Schwab's decision to use "smart beta" ETFs, which are not just higher expense than other index funds in general, but are all selected from either proprietary Schwab ETFs or from issues that pay Schwab to be on their platform. The end result - Nash suggests that while Schwab's roots were to disrupt Wall Street and be different than firms like Merrill Lynch, its conflict-of-interest-ridden proprietary solution means it has now "become Merrill Lynch" instead. Notably, the Nash article generated an immediate and strongly worded response from Schwab on its own site, defending its cash allocations as being prudent and consistent with the cash allocations that typical independent RIAs hold on the Schwab Institutional platform anyway, and noting the research supporting fundamentally-weighted "smart beta" indexing.

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!

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!