Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the big announcement that traditional insurer Northwestern Mutual has bought out "robo-advisor" LearnVest for a sum reported to be more than $250M in cash, though it's not entirely clear whether Northwestern is looking to grow and adapt LearnVest's fee-only financial planning business model, or simply adopt LearnVest's unique technology, including a consumer Personal Financial Management (PFM) app and financial planning software, internally for Northwestern's own agents and brokers. Also in the news this week were new details about Schwab's Institutional Intelligent Portfolios, its "robo-advisor-for-advisors" offering that appears to have more flexibility than the direct-to-consumer solution, but will still entail some indirect and possibly direct costs for advisors and their clients.
From there, we have a number of additional technology-related articles this week, from a discussion of why it's important to "own" and not "lease" your website from a packaged template provider, to a review of the latest "3.0" edition of the FinaMetrica risk tolerance software, to a review of the latest in rebalancing software tools, and also a discussion of some important caveats and exclusions to be aware of when considering cybersecurity insurance for your advisory firm.
We also have several more technical articles this week, including: recent new research into how retirees spend on health care as they age, showing that medical expenses are actually far more stable than most believe (but long-term care remains a big wildcard); a discussion of sequence of return risk and what it really means; and a look at how, even in times of volatility, only a portion of a diversified portfolio is really at risk for retirees, which has implications for both how funds should be invested in retirement, and how to manage that risk with dynamic spending policies.
We wrap up with three interesting articles: the first looks at the rising trend of RIA custodial platforms moving into more and more direct competitor with the independent RIAs they serve (from growing their own wealth management offerings to giving consumers money-back guarantees that independent RIAs can't match); the second is a review of the ways that broker-dealers make money off their own advisors, in both transparent and not-so-transparent ways; and the last is a discussion of how the nature of client review meetings is evolving, as information that once had to be discussed in a meeting can now be easily accessed from a smartphone, raising interesting questions of just how often it's really necessary to meet with clients in person and what role shorter virtual meetings could play in the process.
And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including his own discussion of the new Schwab Institutional Intelligent Portfolios for advisors, and the Northwestern Mutual acquisition of LearnVest.
Enjoy the reading!
Weekend reading for March 28th/29th:
LearnVest Sells (Out?) To Northwestern Mutual – Successful Robo Sale Or Just Another FinTech PFM Software Deal? (Michael Kitces, Nerd's Eye View) - This week, insurance company Northwestern Mutual announced that it was acquiring so-called "robo-advisor" LearnVest, for an undisclosed sum rumored to be more than $250M in cash. In point of fact, though, LearnVest was not actually a robo-advisor, but a human advisor solution that leveraged a Personal Financial Management (PFM) and financial planning software tool the company built itself to serve its clientele. Yet it's not entirely clear to what extent Northwestern was interested in LearnVest's financial planning business itself, versus the opportunity to leverage the LearnVest software for its own sales force of insurance agents and brokers; the press released noted that there were "only" 10,000 premium clients paying for LearnVest's planning services (for less than $2.3M of recurring revenue), and another 25,000 clients enrolled by employers as a part of the LearnVest at Work program, while LearnVest had a whopping 150 employees at an undoubtedly high burn rate. In fact, it may be that LearnVest's greatest asset was the 1.5 million users who had enrolled themselves - and their personal financial data - in the LearnVest software app, who might someday be cross-sold on Northwestern Mutual's financial services. For now, LearnVest will be an independent subsidiary of Northwestern, and insists that it will continue to run independently and retain its focus on its core model; nonetheless, many are raising questions of whether the clash of culture and business models will ultimately be too great between the fee-only no-product LearnVest Planning and the more traditional Northwestern Mutual that is in the business of manufacturing and distributing its own financial services products. Time will tell.
Technology Details Of Institutional Intelligent Portfolios From Schwab Advisor Services (Bill Winterberg, FPPad) - Also in the news this week was the announcement from Schwab Advisor Services of the details about its new Institutional Intelligent Portfolios, the advisor version of the retail "Schwab Intelligent Portfolios" platform that will become available to advisors sometime in the second quarter of this year. Unlike the consumer version, that uses Schwab's own proprietary models, the Institutional Intelligent Portfolios will allow advisors to create their own custom allocations from a list of over 200 ETFs on the platform, and also provide automated rebalancing and tax-loss-harvesting for investor accounts greater than $50,000 (the tax-loss harvesting feature can be turned off if desired). Advisors will be able to view the Institutional Intelligent Portfolios on Schwab Advisor Center, and data feeds will be available for download into third party portfolio management software solutions, just as with any other advisory accounts held via Schwab. Additional features include the ability to privately brand the Institutional Intelligent Portfolios offering with the advisor's firm name, logo, and contact information, although the enrollment process and client interface will be hosted on a Schwab domain (which means an advisor's website would need to link out to the Schwab platform for clients to go through Schwab's proprietary paperless enrollment process), and clients will still need to go through Schwab's questionnaire about goals and risk tolerance to sign up (apparently even if the advisor has already done his/her own due diligence in this regard). In terms of pricing, the platform will be free for advisors with more than $100M in AUM already with Schwab, and a 10 basis point fee for everyone else; a separate article on the Schwab announcement also notes that Schwab will require all portfolios to maintain at least a 4% cash position, which will be swept to Schwab Bank (where it earns an interest rate spread) and become a secondary revenue source for Schwab (along with revenue-sharing agreements for many/most of the available ETFs on the platform).
Why Lease When You Can Own Your Website? (Christopher Norton, Investment News) - As advisors have slowly but steadily built websites to improve their digital marketing, a number of service providers have popped up to provide solutions, most commonly using template-based designs that then go through varying levels of customization but can be up-and-running quickly. And while there's nothing necessarily wrong with building on a template (at least as a starting point), Norton notes most such solutions have a major drawback: technically, the advisor doesn't actually own their own website, because it's built and housed entirely within the provider's own technology ecosystem, and the advisor is simply paying a (usually monthly) fee to keep it activated. Which means when the advisor leaves, the advisor cannot take the underlying code for the website, nor the template, and in most cases the advisor doesn't even have rights to take their own photos and the words/text of the website; in other words, the advisor doesn't actually own the website, but is simply leasing it. In addition, there is a danger that proprietary ecosystems - especially from smaller providers - may not maintain the same pace of software and security improvements, even when built on top of otherwise-robust platforms like WordPress (this is why many such systems invite you to "get the latest version" of their template every two years - because it's the only way they can manage to upgrade users, albeit on a delayed schedule that can introduce security risks and/or lagging technology). So what's the alternative? Actually buy and own your website and domain, have it hosted yourself, and built on a legitimate open-source platform that allows the website to evolve and be maintained - and be owned by you.
Into The 21st Century, Finally (Joel Bruckenstein, Financial Advisor) - Long before more recent technology 'upstarts' like Riskalyze or Pocket Risk, the most popular comprehensive risk profiling solution was FinaMetrica; originally developed in Australia with assistance from the University of New South Wales' Applied Psychology department, the software debuted in Australia in 1998 and came to the US in 2002 (and is now available in seven different languages around the globe). Recently, FinaMetrica released its new FinaMetrica Plus solution, essentially a "Version 3.0" of its software, which Bruckenstein notes was "long overdue" as the "old" FinaMetrica was showing its age - and as a result, the new offering appears to be (at least technologically speaking) a big step up from the previous. The core of FinaMetrica is still a 25-question comprehensive risk tolerance test, although there is now a shorter 12-question version for those who are doing investment-only work (e.g., simply advising on 401(k) plans). The output provides both a final risk tolerance score, and a "risk group" for comparison (where your answers can be compared to others at similar risk levels to confirm the results or identify potential discrepancies). The software is now also more easily built to test spouses separately, and Bruckenstein notes that the tool's input and use process is more efficient, especially around mapping client risk scores to recommended asset allocations (which previously required manual spreadsheets but now can be done online). So how does FinaMetrica compare to the alternatives, given its update? In terms of its rigor, Bruckenstein notes that the company has a pure focus on high-quality risk assessment, a massive database of more than 770,000 responses and associated demographic data that has allowed it to test and retest its tools, and what is generally a deeper questionnaire process that can also provide more opportunities for engaging clients in discussion. However, the software has trailed technologically until recently (and Bruckestein suggests that competitive threats may have been what spurred FinaMetrica to step up), and it still trails in some regards (for instance, FinaMetrica still has not integrated with leading CRM systems, so results have to be manually keyed into the CRM once clients complete the process); Bruckenstein suggests that ultimately, while the company's core intellectual property around risk assessment is strong, FinaMetrica will need to continue iterating on technological improvements to stay competitive.
What’s New in Portfolio Rebalancing Tools? (Craig Iskowitz, Wealth Management Today) - This article covers the highlights from the Portfolio Rebalancing Software panel at the recent T3 Advisor Technology conference, which featured panelists from iRebal, Tamarac, Total Rebalance Expert (TRX), and TradeWarrior. At a high level, the key value proposition of rebalancing software is its operational efficiency - it can take 15-20 minutes to manually rebalance a single household, which quickly adds up across a large firm, but automated software can do all of a firm's accounts within a single trading day, while also better handling rebalancing across the entire household (rather than just account-by-account), and doing so with greater accuracy and fewer errors. Being able to rebalance more quickly also makes it easier to execute good decisions about when to rebalance, because software allows it to be done rapidly once decided, although most rebalancers can actually automate this part of the process as well by setting target thresholds for how far the portfolio can drift before it is automatically rebalanced (usually paired with a minimum trade size to avoid a high volume of small trades). And most rebalancing software now has cash monitoring features as well, to check for the daily arrival of cash (for anything from deposits and account transfers to bonds that maturity and dividend/interest payments and fund distributions), and then put it to work immediately (though most advisors keep at least 1%-2% cash aside just for fees and occasional distributions, but some use the software to target "all-in" 0% cash allocations, particularly when using mutual funds). Other trends in rebalancing software going forward include: rebalancing software continues to be more tightly integrated into other software and custodian systems; software integrations are getting better as all the rebalancing tools become cloud-based (allowing better integrations through available APIs); and rebalancing software is becoming key for advisors to bring themselves up to speed with the "robo-advisors" (who also used technology to automate their rebalancing process around their own TAMP-like models).
Thinking About Cyber Insurance? Watch Out For These 5 Exclusions (Sid Yenamandra, LinkedIn) - With increasing focus on cybersecurity, and concerns that some advisory firms may not be up to snuff, many advisors are now seeking out Cybersecurity Insurance policies that can help to mitigate losses from a cyber incident, as Errors & Omissions (E&O) coverage alone generally does not provide protection for advisors. However, there is a lot of confusion about what cybersecurity policies really do and do not cover, and Yenamandra highlights 5 key exclusions advisors should be especially aware of: 1) cybersecurity policies only cover CYBER breaches, not breaches of private client data that was still on paper, so recognize that if client physical files are stolen to gain access to private data (whether by an external thief or a disgruntled employee), the cyber policy will not pay; 2) no coverage is provided for claims brought by the government or regulators, so a cybersecurity policy won't protect you from a regulator's fine or punishment for poor cybersecurity practices; 3) vicarious liability from the data breach of a third-party vendor may not be covered if it's the vendor's system that was penetrated, even though the advisor may remain liable for having chosen to use that vendor; 4) if the data breach was accessing unencrypted data in the first place, the policy won't cover it, so make sure all client data is being encrypted (including on your own hard drive, which could still be physically stolen); and 5) cyber policies will not cover "negligent" computer security - which itself could be a tough issue to debate, but suffice it to say that failing to stay up-to-date on software releases and security patches could definitely put you at risk.
How We Spend Our Health Care Dollars As We Age (Howard Gleckman) - The prevailing wisdom about spending on health care in retirement is that health care expenses rise as we age. However, recent research suggests that in reality, health care costs are actually relatively modest and steady as we grow older. A new study from the Employee Benefit Research Institute finds that out-of-pocket spending for "routine" care changes very little after age 65, and even beyond age 85. Notably, this doesn't necessarily mean that seniors don't need more care as they get older, but simply that because Medicare pays such a big chunk of the costs of these services, and the consumer's share of expenses are just for relatively stable co-pays and limited deductibles, the out-of-pocket spending doesn't actually rise much. In fact, while there are a subset of people who are less healthy and/or tend to use medical services more - for instance, the average senior spender pays $1,900 of medications over a 2-year period, but the top 10% spend $4,800 over the same time frame - the costs still tend to remain stable, as the high-spenders at age 85 were usually high-spenders at 65, too. However, the results are quite different when it comes to long-term care needs, where we definitely are more likely to use these costly services as we age, and because the coverage of Medicare is limited (and relatively few people have long-term care insurance), the out-of-pocket costs can be significant, with the average two-year cost for people spending any time in a nursing facility at $24,00 (and for the 10% of spenders, nearly $67,000). The bottom line, though, is that as advisors we may need to make a clearer distinction between "rising health care costs" in retirement between what actually appear to be rather stable medical expenses in retirement, and a much larger (and more uncertain) potential long-term care expense.
The Hidden Peril in Sequence of Returns Risk (Wade Pfau, Advisor Perspectives) - Retirees who want to handle sequence of return risk can choose to either place their faith in the long-term ability of stocks to outperformance bonds over reasonable holding periods, or instead can shift the risk to insurance companies and count on the insurer to meet its contractual guarantees. While in theory, either the risk retention or the risk transfer approach to managing sequence-of-return-risk still has some risk - after all, a truly massive systemic economic "catastrophe" can threaten both markets and insurers - Pfau makes the case that there are still plenty of scenarios that can be problematic for portfolios without really being threatening to insurance companies. After all, the whole point of sequence of return risk is that markets can even average out to a good and healthy long-term return, but still have such low returns for an (early) period of time, that the overall retirement sustainability is threatened. For instance, rolling 30-year real returns on a 50/50 portfolio have varied from 3.4% to 5.7%, which would imply sustainable withdrawal rates ranging from about 5% to 6.5%, yet in practice the safe withdrawal rate has been as low as about 4% (thus, the "4% rule" of safe withdrawal rates) - the gap between the two (implied safe withdrawal rates versus actual) is the embodiment of sequence of return risk. (Michael's Note: On the other hand, an initial withdrawal rate of 4% adjusted for inflation for 30 years is still roughly comparable to the payout rate for a lifetime inflation-adjusted annuity, so Pfau's analysis still doesn't make it clear why a portfolio-based solution is necessarily worse for managing sequence of return risk.)
Is ALL of your portfolio at risk of loss? (Larry Frank, Better Financial Education) - Nervous investors often worry that they might 'lose everything' in a volatile market, yet while it's certainly true that an individual stock or bond can have a catastrophic loss in a recession, Frank notes that this is not the same thing as having a diversified portfolio experience such a loss, which would essentially require not just a stock or bond to go to zero but all stocks and bonds to go to zero! The distinction matters, for everything from keeping clients invested during volatile times, to what kind of asset allocation "glidepath" might be appropriate in navigating through retirement. Frank makes the point by using ocean waves as an analogy - while investors might see a lot of turbulence as waves ebb and flow, the overwhelming majority of a body of water lies beneath the waves and remains quite stable while only the top moves, which means looking at just the surface volatility could lead someone to grossly misjudge how volatile the whole body of water really is. Accordingly, investors can build appropriate portfolios for retirement by first recognizing how much of the portfolio will be unaffected by the market "wave" action - in essence, the role that bonds play, as well as a portion of equities (as they only fall "so far" in the aggregate, and the portion below the "water line" effectively remain "safe"). Alternatively, since ultimately not all of one's portfolio is really affected by volatility, Frank makes the case that more dynamic spending strategies can be an effective means to manage the situation, as if only a portion of the portfolio (the waves at the top) are impacted by volatility, adjustments to only a portion of spending should be sufficient to manage the waves.
Crowded Out (Diana Britton, Wealth Management) - Some level of competition between independent RIAs and their custodian have existed for years, especially given that three of the four largest have direct-to-consumer businesses as a part of their model (Schwab, Fidelity, and TD Ameritrade). However, Britton makes the case that recent growth efforts of the custodial platforms are increasingly putting them in more and more direct competition with the RIAs they service, and some advisors even report of situations where retail branch advisors solicit clients (perhaps unknowingly but still problematically) away from an RIA already on their platform. Awareness of the conflicts have heightened as Schwab and Fidelity in particular continue to beef up their own internal wealth management offerings, targeting higher and higher net worth clientele 'traditionally' going to independent RIAs, from Schwab's Private Client Group and ETF strategist Windhaven, to Fidelity's private client group, and even TD Ameritrade has its managed-account platform Amerivest. In turn, these issues raise even more concerns about what could come next; for instance, with Fidelity's recent acquisition of eMoney Advisor, the company appears to be making a significant push into beefing up its wealth management offering, as the eMoney platform may not "just" be available for its independent RIAs but also internally, which means wealth managers can't use solutions like eMoney as a differentiator for their services over Fidelity retail branches. Similarly, the launch of internal online and 'robo' services, from Schwab Intelligent Portfolios to the Vanguard Personal Advisor Services program, raises even more questions of competition between advisors and their custodian and asset management partners. And some advisors are still bristling about Schwab's "Accountability Guarantee" program launched in late 2013 that offers customers their last quarter's worth of fees back on certain fee-based accounts if they're not happy with their service, especially after TD Ameritrade decided to also follow suit by offering fee rebates to Amerivest managed-account clients who experience two consecutive quarters of negative performance, given that most compliance experts suggest an independent RIA couldn't even offer such a fee rebate without violating SEC rules.
Three Hidden Broker-Dealer Profit Centers Exposed (Jon Henschen, ThinkAdvisor) - While there's nothing wrong with the fact that broker-dealers are in the business of being profitable and making money, Henschen makes the case that both clients and advisors themselves deserve to know and understand all the revenue sources of broker-dealers so they can effectively evaluate costs and benefits. The revenue area that advisors at broker-dealers are most aware of is the spreads that broker-dealers earn from payout grids - the fact that the broker receives something less than the full gross dealer concession paid on a product. Beyond the percentage of GDC a broker-dealer keeps based on its grid, though, Henschen notes several other key profit centers for broker-dealers. For instance, most broker-dealers participate in revenue-sharing from vendors (e.g., of mutual funds or variable annuities), which pay the broker-dealer basis points on all assets that their registered representatives sell, in addition to the broker-dealer's share of GDC when any upfront commissions are paid; these payouts can be anywhere from 1 to 10bps on either assets or sales of products for 'traditional' products (generally higher payouts for larger broker-dealers with more negotiating leverage), and in the case of REITs and alternatives a broker-dealer might also earn a "marketing reallowance" of another 1% to 1.5% in extra upfront commissions as well. Another profit center is the markup on clearing firm costs; for instance, it might actually cost the clearing firm $9 for a trade, but the broker-dealer charges $19, or a clearing firm might charge $1 for postage and handling fees but the broker-dealer charges $4-$7. Yet even beyond these revenue areas, Henschen points out three other lesser-known profit centers: third-party money manager markups (what registered reps and their clients pay for third-party managers is often 10-15bps higher than what the outside manager actually charges (and sometimes as high as 25bps for advisors with less in assets); on Variable Universal Life (VUL) policies (for those still selling them), broker-dealers often negotiate backdoor allowances with product vendors to pay out commissions above the target premium but only pay the target premium commissions to the advisor and pocket the difference; and with Fixed Indexed (also known as Equity-Indexed) Annuities, broker-dealers often send advisors out to a third-party Insurance Marketing Organization (IMO) to do the business, but the broker-dealer negotiates a preferred vendor arrangement where the IMO pays 25-50bps on business that goes through it back to the broker-dealer, and in addition broker-dealers will sometimes negotiate for products to pay out "national level" commissions but only pass through the "street level" commission to the client (and keep the difference) which means getting a "100% payout" (but of the street level commission) could actually be less than just getting paid on the grid for national level commissions. Ultimately, the point here isn't that broker-dealers shouldn't get paid, but that advisors may not have a good understanding and perspective on how to even negotiate on behalf of themselves and their clients when they don't know how the broker-dealer is really getting paid in the first place.
The Evolution Of The Client Meeting (Steve Wershing, The Client Driven Practice) - Decades ago, regular meetings as a financial advisor with your clients were crucial; account statements were just a pile of numbers (no pretty charts and graphs), often coming from multiple places, and a financial plan (admittedly also just a pile of words and numbers then) were crucial just to weave everything together into one coherent picture. The planning process brought order to everything, and regular meetings and plan updates communicated that information. Now, however, clients can get a consolidated view of their portfolio, with everything from performance statistics to pie charts and line graphs... on demand, on their smart phone, and without the need or involvement of a financial advisor. Which means the function of a client meeting is no longer just about reviewing financial statements and an economic review - all of which can be gathered online - but instead of about highlighting truly key issues, to discuss, and to make decisions. Thus, for instance, a client meeting shouldn't just review a performance statement; the statement should be sent in advance for review, and the meeting should highlight just the most important issues to discuss and address. And if there's nothing to address in the portfolio - and hopefully, there usually won't be! - then the meeting is now an opportunity to talk more than ever about financial planning issues, not portfolios at all. And of course, since there isn't necessarily a lot that happens in our financial planning lives - events are big when they happen, but not necessarily frequent - it raises the question of how often clients even really need to meet; in Wershing's experience with client advisory boards he's involved with, the increasingly common response from clients themselves is that "high-touch" quarterly meetings are just wasteful, and that 1-2 meetings per year is sufficient. Additional interaction can be supplemented if necessary by meeting virtually, with shorter more efficient client interactions. Which means ultimately, client meetings may actually be a better way to provide "high-touch" interaction and communication with clients... even if it involves actually physically meeting with them less often.
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!
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