Weekend Reading for Financial Planners (Mar 7-8)

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.

CFP Board Removes Compensation Descriptions From Consumer Website (Mark Schoeff Jr., Investment News) – This week, the CFP Board announced that it was removing all references to how CFP professionals are paid on its Let’s Make A Plan consumer website for finding an advisor. Previously, the site allowed advisors to note whether they were Fee-Only, Commission-Only, or Commission and Fee, but in the change the CFP Board suggested that, going forward, it believes consumers should be expected to have a conversation with their advisor to determine how they are compensated (and/or to read the advisor’s applicable disclosures). The change comes just a few months ahead of the June 30^th enforcement date for the CFP Board’s new Standards of Conduct, which notably includes new definitions of what constitutes “sales-related compensation” for advisors to hold out as Fee-Only in the first place. In practice, the CFP Board may simply be wary about having compensation explanations on its own website as the new definitions take effect, having had trouble back in 2013 when the CFP Board unwittingly changed its compensation disclosure definitions via enforcement of the Alan Goldfarb case, which in turn resulted in the Wall Street Journal pointing out that the CFP Board’s own website wasn’t consistent with those new definitions (as it was permitting CFP professionals at broker-dealers to list themselves as “Fee-Only” despite their relationship to a commission-based brokerage firm). However, rather than communicate that the CFP Board was concerned about potential enforcement challenges, it instead explained the change to remove advisor compensation information by claiming such details are “not… helpful to consumers”… setting off a firestorm of criticism from the RIA community, drawing further criticism from consumer advocates who point out that the entire origin of the Investment Advisers Act was to separate advisors from salespeople based in part on how they’re compensated (and that, therefore, advisor compensation is a central issue for consumers), and even hitting mainstream consumer sites like CNBC. The CFP Board defended itself by suggesting that it’s more important to focus solely on Fiduciary responsibility and not necessarily compensation, that only about 6% of the 500,000 searches on its site were for fee-only, and that NAPFA and the FPA already knew the change was coming (albeit with some debate about whether NAPFA or the FPA were really in a position to stop the change in the first place). On the other hand, the growing debate about the proper definition of fee-only itself, and who can appropriately use the term, highlights the growing consumer interest in understanding how advisors are compensated, with NAPFA itself noting that in 2019 alone there were more than 2.6 million visits to its fee-only Find An Advisor site (more than 5X the searches on CFP Board’s no-compensation-disclosure website despite a nearly-$12M-per-year public awareness campaign to support its compensation-neutral approach). Nonetheless, the CFP Board is thus far standing by its insistence that such compensation information is “not helpful to consumers” in a world where advisor compensation is increasingly complex and diverse beyond the three specified categories (albeit not a new challenge, and one the CFP Board has declined to address for years already), and that it has no intention of reinstating compensation transparency on its consumer website.

Pershing Rolls Out Subscription Fee Or Proprietary Cash Pricing Options For RIAs (Janet Levaux, ThinkAdvisor) - When Charles Schwab announced the shift to zero-commission trading last fall, nearly every other RIA custodian followed suit within hours or days... except Pershing Advisor Solutions, that kept its 'traditional' pricing on stock, bond, and ETF trades in place (or assessing a basis-point wrap fee for custody services). Now, however, Pershing has announced a series of new pricing options, including a similar-to-Schwab approach of zero-commission trades (for stocks, bonds, and ETFs, but not mutual funds) tied to the advisor agreeing to use Pershing's low-yield cash sweep program... or a monthly-subscription-fee model that would start at $25/month for each client to access zero-trading commissions (which would include mutual fund trades as well, along with an alternative, higher-yielding cash option for clients who may be holding more substantial cash positions and/or using cash as an investment vehicle). Notably, coinciding with the new pricing change is the announcement that industry legend Mark Tibergien will be retiring as head of Pershing Advisor Solutions, and transitioning the leadership reins to next-generation executive Ben Harrison, who in turn has stated that Pershing is aiming to leverage its new pricing model to expand its reach and addressable market to a broader range of "emerging firms" (which, notably, doesn't simply mean 'smaller' firms, but firms that are extremely growth-oriented and want to expand from a practice or business into an enterprise), who increasingly are demanding less opaque and more transparent pricing for RIA custody services to make effective business decisions.

Betterment's New Per-Advisor Fee For RIA Custody Underlines Industry Shift (Jessica Mathews, Financial Planning) - As the RIA custody model continues to shift, Betterment For Advisors announced that it, too, is adopting a monthly service fee approach going forward (rather than its historical 0.25% platform fee), at a base cost of $150/month for each advisor, plus a tiered basis point fee that will vary from 0.12% to 0.20% (depending on the firm's aggregate assets)... a blended approach that is in contrast to the 'traditional' model of charging a single basis point wrap fee, or a solely monthly fee (e.g., Pershing's recent monthly-subscription-pricing structure, which will be more all-in without a separate basis point charge but priced per client instead of Betterment's per advisor approach), while also ensuring that clients stay 100% invested (i.e., Betterment makes no revenue from cash sweeps, and in fact tries not to keep any client dollars in cash in the first place). The shift appears to be intended as a way to have more generous AUM fee breakpoints for larger advisory firms - where Betterment's prior 0.25% fee on a $100M+ AUM advisor induced some "sticker shock" - while ensuring a sufficient minimum revenue per advisor for smaller firms (provided to Betterment via its new monthly base fee). More generally, Betterment's shift is part of a larger trend of RIA custodians trying to restructure and/or reprice their services, from Pershing to Betterment For Advisors and recent startups like Altruist, as Schwab reportedly generates an average of 15 basis points of revenue per client (on a cost of about 9 bps, given Schwab's size and scale), and other platforms are finding it increasingly difficult to compete with Schwab head-to-head on a similar pricing structure.

They Did It: The First Emergency Interest Rate Cut Since 2008 (Josh Brown, The Reformed Broker) - This week, the Federal Reserve enacted its first 'emergency' cut in the Federal Funds rate, trimming by 0.50% from 1.75% down to 1.25%, in response to the growing risks the coronavirus presents to the broader economy. The initial reaction from stocks was a big positive swing (from nearly 700 points in the red back to the positive), though stocks have continued to gyrate positively and negatively in the hours and days since. From the broader economic perspective, Fed Funds rate cuts that reduce business' cost of capital are stimulative, support liquidity, and can help reassure the business community. Still, though, as Brown notes, "not one Fortune 500 company is reinstating employee and executive travel because of an interest rate cut. Not one vacationer is booking a new, unplanned trip because of this. Not one additional meal will be eaten in a restaurant. Not one school or office building that would otherwise be shuttered as a precaution is going to be held open. A change to the Fed Funds overnight lending rate can’t affect epidemiology or biology." And some economists have suggested that in the end, fiscal stimulus from Congress - for instance, expanding small business loans to help companies weather the storm - is likely to provide more support for the real economy (especially small businesses) than the Fed's monetary policy tools. Still, though, in the short-to-intermediate term, markets are more likely to react to the ongoing news of the coronavirus itself, as markets try to determine the extent of the spread of the virus, and whether or to what extent it will have an actual impact on the real economy if/when/as business activity slows if more and more workers are compelled to stay home (whether due to sickness, or broad-based quarantines to reduce exposure and the risk of having the virus spread in the first place).

Is It Time To Refinance Your Mortgage? (Julia Carpenter, The Wall Street Journal) - The bad news of the coronavirus - beyond the emerging health risks themselves - is the potential economic slowdown it may portend if businesses and consumers stop traveling (or in the extreme, stop going out to work or shop altogether)... which has led to a substantial market decline that erased almost 4 months of gains in a matter of weeks, and led to an emergency rate cut from the Federal Reserve. The 'good' news, however, is that the concomitant flight to safety by investors is driving up bond prices, and driving down their yields... to the point that the 10-year Treasury dropped for the first time ever below 1%, and pulling 30-year mortgage rates down to 3.25% and potentially heading towards 3% (with 15-year mortgages now averaging just 2.79%, and ARM rates even lower!). Which may now set off a massive refinancing binge for homeowners (with mortgage rates dipping even lower than the rate troughs in 2016 and 2013)- and an opportunity and talking point for financial advisors to review mortgage rates and refinancing opportunities with their clients, both as a means to add value in a difficult time, and perhaps even helping to partially ameliorate client concerns by showing them a path to being able to save more (after the savings on their mortgage interest rate) to help make up for recent market losses. Of course, it's important to bear in mind that there are still some costs to a mortgage refinance as well, which means it may still only be worthwhile for those who have several years remaining before an anticipated move. On the other hand, for those who previously used adjustable-rate mortgages in the past, and haven't actually moved, the drop in mortgage rates may make it especially appealing to refinance and lock in record-low mortgage rates for a long time to come.

Questions Every Advisor Needs To Discuss With Clients Right Now (Ben Carlson, A Wealth Of Common Sense) - One of the interesting phenomena that quickly becomes evident in a casino is that gamblers often believe they have a level of 'control' over outcomes (e.g., the famous "blow on the dice before rolling" strategy!); of course, the reality is that random events are still random and gamblers can't change the likely outcome by throwing dice harder or software or blowing on them... but the strength of the tendency to try to do so anyway highlights the extent to which we want to find any way to feel more in control (even if it's just an illusion of control). Which is significant not only in the realm of gambling, but also when it comes to investing... especially during turbulent markets. Thus why investors often seek out some level of predictability and control when the market gets volatile... even if it manifests as taking otherwise-ill-advised actions in their portfolio (e.g., selling stocks or getting more conservative after the market has already declined). Accordingly, Carlson suggests that a key talking point for advisors working with clients is to talk through whether or how those potentially-impulsive client actions will really give them a more controlled outcome, with questions including: if you sell stocks now, what is the plan for getting back in?; has your time horizon, risk profile, or circumstances meaningfully changed enough to warrant the change?; will your actual lifestyle be impacted in a meaningful way if stocks do continue to fall?; have you overestimated your appetite for risky assets?; do you fully understand the potential range of outcomes when investing in stocks?; what are your core investment beliefs?; and do you understand what you actually own... and why? Notably, there are not necessarily any "right" or "wrong" answers to the questions; the point instead is simply to help clients (or investors more generally) to reflect on how they're invested, the risks they're taking, and where/how they fit into the bigger picture?

I Own My Own Firm... What's The Best Way To Actually Pay Myself? (Jason Brown, XY Planning Network) - For most advisory firms, the advisory 'business' is simply an extension of the individual advisor themselves, and getting 'paid' from the business simply means taking dollars out of the business account. Yet in practice, the exact way that such distributions are characterized depends on what type of business entity the advisor has in place for the firm, and the depth to which the business maintains its books (and wants to explicitly track the owner's payments as an 'expense' of the business). Broadly speaking, advisory firms will end up being either a sole proprietorship "Schedule C" business (if you simply 'hung your shingle' and started earning income and doing business without creating any entity at all), a partnership, a corporation, or an LLC. Although notably, C corporations and S corporations have different tax treatments (as they pertain to the owner's salary and other distributions), and an LLC is not actually a type of tax entity; instead, an LLC decides whether to be taxed as a partnership entity or a corporation by filing a Form 8832 Entity Classification Election to "check the box" on which entity tax treatment is preferred (and if no form was filed, it is generally treated as a Schedule C disregarded entity for a solo advisor, or a partnership with more than one owner). Accordingly, then, the path to getting paid out of the business as the advisor-owner will be: for a Schedule C entity (either a sole proprietor, or a solo-owned LLC), everything is simply a distribution (or "draw") from the advisor's accounts, as there's technically no distinction between business and 'personal' accounts anyway (which means no way to put yourself on payroll as a W-2 employee, even if other employees of the business are); for a Partnership (either as a partnership entity, or an LLC taxed as such), income of the business passes through to the partners anyway, which means they can't be a W-2 employee on payroll and instead simply take outright distributions from the business account to a personal account, though there is an option to shift relative allocations of income by making "guaranteed payments" for services the partners render to the partnership; for an S corporation, it is permissible for the owner to be on the payroll as a W-2 employee for a taxable salary (for whatever salary is agreed upon with the business) that is deductible to the business, or to take a distribution as an owner  that is not deductible to the business and not taxable to the owner (albeit because the S corporation income already passes through to the owner, and consequently distributions must be pro-rata to all S corporation owners based on their relative ownership); or as a C corporation, where salary is W-2 wages and distributions are a (taxable) dividend, but owners are only taxed when income is received as wages or dividends (though income held in the C corporation is taxed at corporate rates instead).

An Intro To The Profit-First System [For Solopreneurs] (More With Money) - The traditional approach to business is that we earn income, pay expenses, and take whatever is left over as profit... with the caveat that if we generate too much in expenses, and/or not enough in income to support those expenses, there may not be any profit left at the end. The alternative, popularized as the "Profit First" approach (by the book of the same name) from Mike Michalowicz, is to start with a profit goal, subtract that from income, and then spend the rest as expenses (i.e., instead of [Income - Expenses = Profits], it's [Income - Profit = Expenses]). The appeal of the Profits First approach is that it effectively puts the business on a budget - not one constrained by how much revenue the business generates, but by how much the business is willing and aiming to spend after allocating a targeted profit to the business owner. Or stated more simply, the Profits-First approach ensures that all the income isn't spent by effectively "paying the owner first" (not unlike the traditional investor approach of "pay yourself first" to save money directly from income and then spend what's left over after savings as the household budget). In fact, to reduce the temptation to spend all the income for the business or growth, Michaelowicz suggests literally creating separate bank accounts (similar to the Envelopes system for household budgeting), including an Income account (where all income is deposited), a Profit account (which automatically receives an allocated percentage of the Income, to be used for ongoing distributions and/or a cushion/rainy-day fund), an Owner's Compensation account (to get into the habit of paying yourself a salary for your work in the business), a Tax account (so you don't accidentally come up short on April 15th), and finally an Operating Expense account (where all the business expenses flow from). Of course, in theory the owner can treat the funds this way (regardless of the separate accounts), but in practice actually having separate accounts (even at separate banks) helps to put the available cash out-of-sight-and-out-of-mind to eliminate the temptation to dip into those accounts. In fact, that's actually the real point - by literally seeing certain accounts fall to zero, it helps to introduce business discipline, and keep the owner focused on growing income and revenue to be able to afford to do more in the business (after ensuring they're paying themselves first, so they invest into the business at the cost of their own livelihood!).

The Compensation Conundrum (Carolyn Armitage, Investment News) - For advisory firms in the early stages, how the firm owner pays themselves is primarily about simply ensuring that they get the money out of the business that they need to be able to pay their household bills (and ideally, have some dollars to reinvest for growth). As advisory firms grow, though, how an advisor pays themselves from the business can actually impact the entire valuation of the business as well. The reason is that, despite the popularity of talking about the valuation of advisory firms as a multiple of revenue, in practice, acquirers of advisory firms generally pay a multiple of profits or free cash flow after all business expenses... which typically will include the cost to replace the advisor/owner/founder themselves. Which means if the advisory firm founder simply pays themselves by taking out the profits of the business after all expenses themselves, the firm owner will consequently understate payroll expenses and therefore effectively overstate the actual profits of the business (by not paying themselves a 'salary' commensurate with the replacement cost for the work they do in the business). Accordingly, Armitage suggests that even if the payments aren't literally a salary for tax purposes (e.g., because the business is taxed as a partnership), it's still crucial to carry an expense on the business' profit-and-loss statement for the fair-market-value salary for the owner/founder. On the other hand, it's also notable that some advisory firms do the opposite - paying their owners an outsized 'salary', by again not making a distinction between the job done in the business and the rewards for ownership of the business - which ironically may mean the business is more valuable than realized. Either way, though, the key point is simply that understanding the value of the business is based primarily on a multiple of the business' profits, not just revenue... which means it's crucial to properly reflect all expenses of the business, including the work that the founder/owner themselves does in the business!

You're Not Just Binge Watching Netflix... You're Having An Experience! (Nat Ives, The Wall Street Journal) - While "the client experience" has become a growing focus amongst financial advisors, the reality is that businesses across the landscape are increasingly recognizing that even 'traditional' products and services are now really in the "experience" business, leading to a recent explosion in "Chief Experience Officers" in various businesses. Driving the change is technology - not because the technology is the experience necessarily, but because technology is making it possible to collect more and more data about how consumers engage with products and services, along with a means to engage them more directly. Recent 'innovations' to support customer experiences range from Netflix making it easier to skip the opening credits (for those who are binging the same show and don't need to see the opening over and over again), to Domino's Pizza providing customers with update alerts as their pizza is being prepared, and Harry's razors introducing an audible 'click' when changing razor blades. The fact that experiences can be shared in real time on social media is also attenuating the business focus on the experience, as good experiences can go viral (for a significant positive PR boost), and bad experiences can similarly go viral and damage a brand's credibility if not spotted and addressed nearly instantaneously. On the other hand, new experiences can also create problems; for instance, Mastercard is looking to make it even easier to engage in cashierless grocery checkouts... with the caveat that if no one ever pulls out their credit cards anymore, will they forget that it's a Mastercard solution they're using in the first place?

Grocers Wrest Control Of Shelf Space From Struggling Food Giants (Annie Gasparro & Jaewon Kang, The Wall Street Journal) - In the past, product manufacturers would pay grocery stores to have their goods made available on convenient eye-level shelves rather than being at the very hard-to-reach top or bottom shelves (the literal origins of "paying for shelf space"), which was both important to the product companies (as shelf space placement can and does impact sales), and as a revenue opportunity to the stores for 'selling' that valuable real estate. Now, however, the growing capabilities of data and analytics are leading supermarkets to make their own decisions about where to place items, based on what creates the best engagement of consumers in the store (ensuring they have a positive experience and decide to continue frequenting the store)... and disrupting the historical "shelf space" approach. In other words, supermarkets are realizing that cultivating customer loyalty to ensure the ongoing strength of their brand matters more than the last few dollars of shelf space revenue. Furthermore, the data that stores can collect on consumer behavior is also leading them to spot their own opportunities to challenge a category of product - creating the supermarket's own store-branded (and less expensive) alternatives in categories they can see consumers are most willing to purchase a less expensive option (which in turn further accelerates as the store itself becomes a trusted brand alternative to the traditional premium brand in the product category). Which raises the question of whether financial services firms - and in particular, brokerage platform that historically have relied heavily on their own version of "shelf space" agreements - may soon engage in a similar shift from trying to maximize shelf space revenue from product companies, to maximizing their own brand engagement and loyalty by focusing more on the end client (and the advisor serving them) instead?

What The E*Trade Deal Tells You About The New Investing Game (Jason Zweig, The Wall Street Journal) - Since the 1980s (and especially the 1990s and the rise of the internet), big banks and brokerage firms have been shifting towards the "financial supermarket" model, where consumers could open any and every type of account, all at one institution, to buy any and every type of product available... from insurance companies like Prudential launching subsidiary broker-dealers, to American Express (now Ameriprise) offering credit cards alongside brokerage accounts, Citigroup offering brokerage accounts in its bank branches, discount brokers like Schwab expanding into 'everything', and even Sears once selling securities in its department stores (the so-called "Socks 'n' Stocks" era). Yet in practice, the promise of the supermarket didn't pan out, with many of the early players ultimately selling off their brokerage or investment divisions, and some outright getting into regulatory trouble for cross-selling too aggressively. Accordingly, the game today is increasingly shifting away from the open-platform supermarket approach, to instead a drive of major platforms to get investor dollars into as much of their own in-house products and solutions as possible. The shift is only accelerating in a zero-commission world - where brokerage firms literally can't make money off the transactions anymore - leading to the rise of proprietary cash sweep accounts in particular (now amounting to a whopping 61% of Schwab's entire net revenues in 2019!), a push for more complex proprietary products (e.g., structured notes), and a growing number of internal proprietary mutual fund and ETF offerings (leading the majority of Northern-Trust-owned FlexShares ETFs to be owned by Northern Trust clients, and Vanguard to launch a Personal Advisor Services platform that only recommends Vanguard funds)... with the caveat that while sometimes in-house funds may actually be better or cheaper, it clearly won't always be the case. Which is further exemplified by the recent news that Morgan Stanley is looking to acquire E*Trade, as a means to shift E*Trade customers into Morgan Stanley's own internal advice and product solutions. Ultimately raising the question of whether or how investors will be able to vet a new generation of potentially conflicted models for the distribution of insurance and investment products, and whether it may eventually become necessary to 'diversify' financial advice to mitigate the potential conflicts of such product-plus-advice models?

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.