Executive Summary
Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with a "surprising" Field Assistance Bulletin issued last week by the Department of Labor on its looming fiduciary rule, noting that there's a real possibility that the rule will not be delayed by the April 10th applicability date, but then stating that if the delay (or even a non-delay outcome) comes shortly thereafter, the DoL won't enforce the fiduciary rule during the gap period (though notably, any damaged clients in the gap period could conceivably just sue directly).
Also in the news this week was the announcement trhat Schwab has officially pivoted away from its robo-advisor to a new hybrid offering dubbed Schwab Intelligent Advisory, which will provide advice directly from CFP professionals (in addition to automated portfolios); at the same time, T. Rowe Price announced the launch of its own pure robo solution, ActivePlus Portfolios, though the offering will be limited to providing an asset allocation of T. Rowe Price's own mutual funds (at no additional cost, beyond the mutual fund expense ratios themselves). Also in the news this week was the revelation that Morningstar is actually preparing to launch its own mutual funds for its Morningstar Managed Portfolios advisor platform, which they suggests will reduce costs on the platform by as much as 20%, but in the process, puts the firm in the conflicted position of being both a rater of mutual funds and a manager of some.
From there, we have a number of technical articles, including: the news that the Tax Data Retrieval Tool from the IRS that is used to facilitate income verification for the FAFSA (and income-based repayment plans for student loans) has been taken offline for several weeks due to potential criminal activity (identity thieves trying to steal taxpayer information); an analysis from Ed Slott of the prohibited transaction rules for IRAs that can potentially disqualify the entire account if non-traditional assets are not handled properly; and new research that suggests a slightly different approach to retirement income planning, where consumers don't simply diversify their portfolio assets, but instead try to diversify amongst the available "Retirement Income Generators" (RIGs) - which might include systematic portfolio withdrawals as one component - to effectively "pensionize" retirement.
We also have several practice management articles this week, from the challenge of figuring out the "right" valuation of your advisory firm (recognizing that outsider buyers often offer higher valuations than internal succession plans, but if key employees leave the outside deal could end out paying less in the long run after all), to the question of whether advisory firms should offer more flextime to employees (and how to structure it), and a look at the rise of Interactive Brokers as a new low-cost niche custodian for independent RIAs (especially those who trade actively and globally).
We wrap up with three interesting articles on the dynamics of managing advisory firms: the first reviews a major new research study of the industry, finding that there appears to be a substantial gender bias in advisory firms when it comes disciplining misconduct, with male advisors being 3x more likely to commit serious misconduct, with a 20% larger average damages settlement for consumers, yet it's female advisors with misconduct who end up being 20% more likely to get fired and 30% less likely to find another advisory job (though notably, the difference largely vanishes once there are females amongst the ownership or executive suite!); the second is a look at an advisor who decided to establish her RIA as a B Corporation, a new voluntary certification that businesses can obtain to affirm that they will operate not just to maximize profits, but the interests of all stakeholders (which aligns especially well to independent RIAs that serve as fiduciaries to clients in the first place!); and the last is a look at how businesses need to be cautious not just to espouse certain "noble values" that all employees aspire to, but actually include those values in their interview/hiring process, firing employees who fail to live up to them, and promoting those who espouse them best in practice – because otherwise, it doesn't matter what the firm says, if what it rewards is different, eventually all employees will migrate their behaviors to fit the values that are being rewarded, not the ones written in a corporate Core Values statement.
Enjoy the "light" reading!
Weekend reading for March 18th/19th:
The Takeaway From Friday's DoL Rule Guidance Is 'Significant' (Brooke Southall, RIABiz) - Last Friday, the Department of Labor issued Field Assistance Bulletin No. 2017-01, which declared a "temporary enforcement policy" that would apply if a gap period emerged between the April 10th applicability date of the DoL fiduciary rule, and the proposed 60-day delay that might not actually be finalized until after April 10th. In a relief to many in the industry, the DoL's conclusion to "temporary" enforcement was to declare that it will not enforce the rule during the gap period, nor will it enforce the will if it turns out the delay does not actually occur after all and the outcome isn't finalized until after April 10th (as long as firms come into compliance within a "reasonable period" after the publication of a decision not to delay). The guidance was important for financial institutions in particular that were struggling with the fact that they need to provide new disclosures if/when the transition occurs, but weren't certain what the timing of the disclosures should be given the potential for a delay that could land just after the applicability date itself. Notably, though, DoL fiduciary expert Fred Reish points out that just because the Department of Labor itself won't enforce during the gap period, firms cannot presume they're "safe" by waiting on compliance, as it's still possible that private litigation (i.e., a private lawsuit directly from investors) could be levied against the firm for failing to comply with some aspect of the rule, particularly with respect to IRAs (where the DoL never had enforcement jurisdiction to waive or delay in the first place). It remains to be seen whether the DoL will follow with even-more-substantive guidance to provide an additional exemption from potential DoL fiduciary prohibited transaction consequences during the potential gap period that may occur.
Charles Schwab Launches Hybrid Human-Robo Financial Advice (Anna Irrera, Reuters) as T. Rowe Price Launches Robo Platform With Only Actively Managed Funds (Bernice Napach, ThinkAdvisor) - The double-header "robo" news this week was the announcement that Schwab has officially launched its Schwab Intelligent Advisory solution, while T. Rowe Price launched a new "ActivePlus Portfolios" robo platform. In the case of the T. Rowe Price offering, the solution will be available for a $50,000 minimum and no investment advisory fee, as the discretionary account itself will simply be various allocations amongst 14 of its own T. Rowe Price actively managed mutual funds (with allocations determined based on the client's risk tolerance and time horizon inputs, plus ongoing automated rebalancing) that will have a weighted average cost of 61 to 82 bps. Schwab Intelligent Advisory, on the other hand, will charge a 28bps advisory fee (plus underlying ETF expense ratios) but provide a combination of "robo" tools (i.e., automated portfolio management) and "unlimited" access to CFP professionals to provide ongoing financial planning guidance. In other words, as Schwab itself puts it, "Schwab Intelligent Advisory Makes It Easy For Investors To Have A Customized Plan And Automated Portfolio". As a result, the reality is that while T. Rowe Price's ActivePlus Portfolios is really just another robo offering (being used as a distribution channel for its own proprietary mutual funds), Schwab Intelligent Advisory is actually not a "robo" at all, but instead, is similar to the new Betterment premium offering: a giant Schwab RIA providing a combination of portfolio management (using Schwab's Intelligent Portfolios "robo" tool) and personal financial planning advice as well, not unlike the massive swath of independent RIAs that also use Schwab's Institutional platform (but targeted primarily at the mass affluent, rather than high-net-worth clientele).
Like Everyone Else, Morningstar Expands Its Advisory Business (Greg Bresiger, Financial Advisor) - This month, a new filing with the SEC revealed that Morningstar is planning to launch nine mutual funds for use in the Morningstar Managed Portfolios that it offers specifically to financial advisors. Given that the funds are already intended for use with financial advisors, the new advisory offering isn't another robo-competitor, per se, but instead is intended to compete with (and be a lower cost solution alternative to) the other mutual funds currently being used inside the Morningstar Managed Portfolios offering. In other words, Morningstar is hoping to reduce a layer of external costs by vertically integrating its managed portfolios offering, choosing internal mutual funds that are managed by sub-advisors, rather than its current approach of using external managers who in turn pick third-party funds, with an estimated cost savings of 20% of investor fees. Yet while the goal of reducing its investor costs is admirable – and a favorable positioning with a looming DoL fiduciary rule that will likely drive advisors towards lower cost solutions – the move has raised significant industry controversy, given that Morningstar is also a rater and arbiter of third-party mutual funds, for which its objectivity might be questioned when it is also in the mutual fund business itself. In fact, given these concerns, Morningstar has already noted that it will not be initially assigning its (subjective) forward-looking analysts' ratings, although once the new Morningstar funds have been in place for 3 years, they will become eligible for star ratings like any/all other mutual funds in Morningstar's comprehensive database. On the other hand, it's notable that "independent" research firm competitor Value Line has been running its own mutual funds as well, going all the way back to 1950.
Online Tool To Apply For College Financial Aid Taken Down Due To 'Criminal Activity' (Douglas Belkin & Melissa Korn, Wall Street Journal) - Earlier this month, the world of college financial aid planning was abuzz with the surprise announcement from the Department of Education that the IRS has disabled its Data Retrieval Tool (DRT), used to automatically import tax information into the online FAFSA form. Initially, the reasoning given was "concerns" that information from the tool could be misused by identity thieves, but now the IRS has revealed that there is an active criminal investigation into potentially fraudulent use of the tool – in other words, it appears that criminal activity may have already been happening. Notably, there's no requirement to use the DRT system to obtain tax information for the FAFSA; the paperwork can be completed and submitted by hand, with income verified later. However, a key part of the recent change to use prior-prior-year tax data with the FAFSA was specifically to streamline the process and make it possible to submit tax information upfront (rather than apply and get income verification after the fact), and there are concerns that losing access to the DRT system could create a stumbling block that slows or deters financial aid applications for those who might have otherwise been eligible, or put families in the challenging situation of applying and finding out later (after income verification) that they weren't eligible for as much aid as they might have thought or expected. As a result, lawmakers are putting pressure on the IRS to resolve the security issues, and get the tool back online in the coming weeks, which fortunately would still be well in advance of the late spring due date for the FAFSA process (though some states with earlier deadlines have already been looking to delay them). In the meantime, it remains to be seen how much tax and identity information may or may not have actually been compromised through whatever prior security loophole existed in the DRT system (which, notably, could extend beyond "just" those families currently applying for financial aid). And the lost access to the DRT system is also having over spillover effects, as it was increasingly being used to validate eligibility for various income-based repayment programs for those with existing student loans as well.
Steer Clear Of These Taboo IRA Investments (Ed Slott, Financial Planning) - While it's most common to use an IRA to invest in "traditional" investment vehicles like stocks and bonds, mutual funds and ETFs, bank accounts and CDs, the reality is that IRA investors can actually put their money towards almost anything. But it's only "almost". Because there are still "prohibited transactions" that IRAs cannot engage in. Though notably, part of the confusion is that with "non-traditional" IRA investments, it's not only a matter of certain investments that are outright prohibited – including life insurance and collectibles – but in some cases, what's prohibited is how you use the IRA investment asset. For instance, there's nothing wrong with using an IRA to purchase residential real estate; however, living there, letting relatives live there, or letting business associates use the space in a manner that provides any form of direct or indirect benefit to the IRA owner, is prohibited. Having an IRA-owned business can have similar complications (where, for instance, paying a salary FROM an IRA-owned business to an IRA owner can potentially be a prohibited transaction). In addition, loaning money to/from your IRA is a prohibited (self-dealing) transaction as well (even though you can invest in a bond – which is really just a loan) from any other third-party besides the IRA owner or a related person. And the consequences of running afoul of these rules can be severe – if a prohibited transaction does occur, the entire IRA account will be deemed distributed as of January 1st of that year (which is both taxable, and subject to an early withdrawal penalty if otherwise applicable). In addition, it's also notable that if funds are borrowed to purchase an asset in an IRA (which is permissible, as long as the money isn't borrowed FROM the IRA owner, and/or isn't personally guaranteed by the IRA owner), that asset's income could be subject to the Unrelated Debt-Financial Income Tax (UDFI), a form of Unrelated Business Income Tax (UBIT); as a result, even though an IRA is normally tax-deferred, the IRA (or rather, its custodian) would have to file a Form 990-T tax return, and the IRA would have to actually pay income taxes on that portion of its income.
Here's An 'Income Menu' That Could Help Retirees Make Their Savings Last (Andrea Coombes, Marketwatch) - The 'traditional' approach to retirement in a defined contribution plan world is to accumulate a retirement portfolio, invest it into a diversified range of assets, and then use it to generate retirement income. However, a new approach being advocated in a joint project collaboration between the Stanford Center on Longevity and the Society of Actuaries, is instead to focus on the different types of "retirement income generators" (or "RIGs" for short), and then aim to diversify amongst the different types of RIGs. Potential options on the RIG menu might include: creating a guaranteed floor that covers essential expenses (e.g., housing, food, and utilities), which might be funded with Social Security benefits (delaying to the maximum extent possible); the next option would be purchasing a guaranteed lifetime annuity income stream, which could be used to supplement the guaranteed income floor to the extent necessary to cover monthly expenses; the third option would then be creating a systematic withdrawal plan from the retirement portfolio, as the third RIG, supplemented as necessary from other assets (e.g., using a reverse mortgage to take housing wealth, or working part-time). Overall, the idea of the strategy is to help retirees think about how to "pensionize" their retirement assets by creating one or several streams of retirement income – but framing the goal in the context of creating those diversified income streams, rather than "just" creating the diversified portfolio and trying to tap it as needed for retirement expenses.
The Valuation Conundrum (Mark Tibergien, Investment Advisor) - As Yogi Berra once famously quipped, "Nobody goes there anymore. It's too crowded." So too does a similar case seem to be emerging in the world of advisory firms, which are now getting so large and becoming so valuable, that nobody can afford them. And as Tibergien notes, the trend of growing advisory firm valuations isn't just a matter of size and growth, but also because advisory firms are getting better at managing client retention, achieving compliance efficiencies, and diversifying their key-person risks, which further enhances valuation multiples. Yet the caveat remains that if no one can afford to buy the firm, it won't be sold at that price, which means the "valuation" isn't real – a dilemma that many owners of growing advisory firms are now facing, as they weigh the options of either internal succession plans or external strategic acquisitions. Especially since, as Tibergien notes, while the financial capabilities of internal successors may be more limited, selling externally and having those key employees walk out the door shortly thereafter could actually result in a lower valuation and fewer dollars to the firm owner anyway. Which means selling to employees internally, even at a "discount", could actually result in a better final valuation, if the key employees are more likely to stay, and retain the clients. Which means, ultimately, the decision of who to sell to requires far more careful consideration than "just" whichever prospective buyer offers the largest initial estimate of valuation.
Should Your Firm Be More Flexible About Flextime? (Kelli Cruz, Financial Planning) - As the fight for a shortage of industry talent gets more severe, firms are increasingly looking at new ways to attract and retain top talent, and "flexibility" is amongst the top perks of interest to young talent today. Unfortunately, the challenge is that traditionally, serving clients has meant being physically at one's desk from 8AM to 5PM, Monday through Friday. Though notably, more flexibility can refer to both varying work hours, and/or just varying work locations; in other words, at least one solution is to allow employees the flexibility to occasionally work from home, but still under the same working hours schedule. Yet just giving flexible work location alone may not be enough, either; with the accessibility of technology tools, the younger generation is also increasingly demanding more flexible work hours, noting that the technology makes it feasible for them to get some work done in "off hours" as well to ensure that job tasks are still done as needed. In fact, some advisory firms are now providing laptops/notebooks to all staff, specifically to facilitate their flexibility and availability, whenever clients might need to reach them for service. More generally, Cruz notes that there are a few more common "flextime" arrangements starting to emerge amongst advisory firms, including: flexible hours (e.g., the option to work from 10AM to 6PM, instead of 8AM to 4PM); compressed workweeks (letting employees work four 10-hour days instead of five 8-hour days to put in a 40-hour workweek); options for part-time work (at reduced salary for reduced hours, but retaining access to other key employee benefits like health insurance); and "job sharing" where a role's full-time work is split 50/50 between two people who do it on a part-time basis each. From the employee's perspective, the appeal of flextime is not just the outcome flexibility itself to better maintain work-life balance, but also the opportunity to avoid rush-hour commutes, schedule work during quiet times to increase more productivity, and a positive feeling of greater control to manage time off to handle the vicissitudes of life (e.g., taking care of sick children or scheduling doctor's appointments).
Interactive Brokers Quietly Builds Major Custody Biz (Dan Jamieson, Financial Advisor) - Interactive Brokers Group has historically been known as a deep discount brokerage firm catering to active traders, but in the past decade it is has built a custody service that now serves over 3,500 "professional" advisors (which includes both investment advisers and commodity trading advisors) that collectively handle about $14.5B of client assets. In addition, Interactive Brokers is providing clearing services to over 180 broker-dealers, and white-labeled clearing services for another 150+ broker-dealers as well. In total, the various platforms total over $27B in advisor AUM, up 41% year-over-year, with growth amongst both RIAs, and overseas broker-dealers that have limited choices for local clearing firm solutions. In fact, Interactive Brokers' "universal global account", which allows advisors to trade multiple vehicles in multiple currencies from a single account, has become especially popular for those engaging in global trading activity, along with its low costs (with the average cost per trade a mere $2.36) and favorable order-routing capabilities for best execution. The firm is also trying to appeal more to buy-and-hold investors, providing a "stock-yield enhancement program" that allows clients to share in rebates of stock-lending fees. Notably, though, Interactive Brokers does not have banking capabilities, so it's not feasible to offer clients check-writing capabilities from their accounts, though obviously many advisors simply have their clients hold their checking and savings accounts at local or national banks, anyway.
Proof Wall Street Is Still A Boys' Club (Ben Steverman, Bloomberg) - Despite ongoing efforts to improve the gender imbalance amongst the financial advisory community, a recent study has found that there remains not only a substantial imbalance in the total number of men compared to women in the industry, but that the imbalance exists despite the fact that male financial advisors are three times more likely to have a record of engaging in serious misconduct than women advisors (at 9% versus 3%, respectively). Even worse, after misconduct is discovered, female advisors are 20% more likely to lose their jobs, and 30% less likely to find new advisory jobs, compared to male advisors. And the difference isn't because female advisors are engaging in more severe misconduct (which might explain the higher firing and lower rehiring rate); in reality, misconduct allegations against men also cost firms an average of 20% more to settle, and males are twice as likely to be repeat offenders. And it's not even a matter of success in the business; even after controlling for production levels, the researchers found that women are still punished more severely for misconduct. And ironically, despite these statistics, the data also shows that firms are also more likely to scrutinize their female employees for misconduct in the first place (despite their lower actual misconduct rate), as women are more likely to be accused of misconduct by their own firms, while men are more likely to be accused by customers directly. Notably, though, the study did find that having females in the executive suite has a substantial impact; at firms with no female owners or executives, women were 42% more likely to be fired for misconduct, but when there was at least one female representative amongst firm owners or executives, the firing rates between the genders were equal.
Why I Built A B-Corp Fiduciary Wealth Management Firm (Georgia Lee Hussey, LinkedIn) - The financial services industry has a bad reputation for ethical business practices, which some suggest have only been exacerbated further by the immense pressures of Wall Street to meet quarterly performance numbers (which potentially leads to ethical compromises) as a publicly traded stock, where leadership is 'compelled' to maximize shareholder value. Hussey, however, decided to establish her advisory firm as a Certified B Corporation instead; for those who are unfamiliar, a B corporation structure is legally required to consider the impact of its work on all stakeholders, including employees, suppliers, clients, community, and planet. As of now, there are 56 B Corp Investment Advisers overall, a miniscule 0.001% of the 32,000+ RIA firms currently in existence. In addition, as an independent RIA, Hussey's firm Modernist Financial also operates as a fiduciary to clients. But ultimately, she suggests that the ramifications of running a B Corp go beyond "just" being a fiduciary – though notably, operating as a fiduciary advisor means most RIAs are already relatively well aligned to the B Corp principles, making it easier to obtain B Corp Certification.
Your Company's Culture Is Who You Hire, Fire, & Promote (Cameron Sepah, World Positive) - It's a common business practice to espouse various "noble values", often prominently displayed on the walls of the organization; but Sepah notes that the real measure of a company is how it behaves, and whether its hiring, firing, and promotion practices really embody the values it espouses. Otherwise, the business may follow the path of Enron, which included "integrity" amongst its aspirational values... yet clearly didn't represent its practiced values, as expressed by those who were ultimately promoted to the top. In fact, the whole point is that for a firm to really live its stated values, it's necessary to execute it from the top; otherwise, those stated values just become an effort to preach "Do As I Say, Not As I Do", which rarely works in the long run. Furthermore, if people who really do live up to the company's stated values aren't actually rewarded, eventually the organization will behaviorally discourage those behaviors (by failing to reinforce them) and potentially encourage other less-desirable behaviors (by reinforcing those with hiring and promotions instead). And the larger the company becomes, the more these dynamics matter, as it's not possible for leadership at the top to oversee everyone, which means the values that are rewarded in hiring, firing, and promotions in the company become the primary way that rank-and-file employees see the values that are rewarded, and become "trained" to act accordingly. In fact, Sepah suggests that firms espousing certain traits and values should be actively interviewing for them from the start, and even consider engaging new hires for a "trial week" before hiring them full-time (as if there are any values-mismatch red flags, they might be hidden in an interview, but it's hard to hide them for a full week of on-site engagement). The bottom line, though, is just to recognize that if the firm really wants to be successful and fulfill the values it proclaims are important, it's necessary to reward not just positive performance behavior, but specifically to hire, fire, and promote based on the way the employee's behavior is congruent with the company's values.
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.
Always great matrerial Michael. The modernist financial thing is intersting but am I reading the adv correctly that they charge about 2.5% on the first 500k?I’m all for a fiduciary standerd and have no issue with vendors , the community and our planet. But at 2.5% per year – putting the law aside – Can the case be made that clients interests are not coming first here ?
Regarding your review of the “income stream” article, thanks again for thought-provoking material. My reaction is that annuitizing/pensionizing has two aspects; first, a form of “buying insurance” against living too long, but it comes at a high cost (literal commissions, also complexity, payor reliability, etc); and second, once you know about behavioral economics and mental accounting, perhaps you are wise enough to avoid encumbering yourself and your own resources just to “feel good” about having what I call “perennial income streams”. I understand the perceived security of bucketizing of matching income and outgo streams, but I consider it somewhat delusional.
Alan,
I’ve long lamented the issue of ‘comforting’ ourselves with buckets in ways that unwittingly distort asset allocation in problematic ways. See https://www.kitces.com/blog/should-financial-planners-invest-using-bucket-strategies-or-just-report-that-way/
That being said, it’s worth recognizing that lifetime annuitization streams really DO have the capability to pay more than comparable fixed income portfolios alone, thanks to the role of mortality credits. So this isn’t JUST a matter of ‘encumbering yourself to feel good’. It’s a legitimate economic tradeoff to consider. See https://www.kitces.com/blog/understanding-the-role-of-mortality-credits-why-immediate-annuities-beat-bond-ladders-for-retirement-income/
– Michael
Thanks again, I’ll go reread your two older blog posts also.
I think Kelli Cruz hit the nail on the head regarding flextime. I think a lot of it has to do with a generation gap within companies. The managers at the company I work at believe letting you leave at come in 9 or leave at 4 for a doctor’s appointment is being flexible, whereas to me that’s just life, not flexibility. As a back-office employee who never sees clients, what’s the problem with a 4, 10-hour day workweek? Or working from home one day a week? If it’s trust, eventually the performance or results of an employee will come through if they are not being productive and that can be resolved appropriately. I’ve also seen in a team setting where the manager believes since the administrative staff need to be near the phones at all times (8am – 5pm), that means as a team the planners need to be in the office at all times (or else it isn’t fair?!). Shouldn’t be the case, different roles. What are your thoughts on flextime, Michael?
I can certainly understand why an RIA committed to ESG investment practices would elect to organize as a B-Corp. In serving clients who do not want to invest according to ESG principles, however, I think a B-Corp RIA might encounter ethical or philosophical (if not legal) conflicts between fiduciary duty and the directors’ obligations under B-Corp election. Also, if I were a prospective client of Ms. Hussey’s firm, I can’t see why i would care very much about its B-Corp status if I didn’t also care about ESG investing, since B election doesn’t provide me any benefits beyond those already required by a fiduciary duty. I guess I don’t quite understand the value proposition of organizing as a B-Corp investment advisory firm, if you aren’t also advocating for an investment process that creates general public benefits.