Weekend Reading for Financial Planners (May 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 May 14th/15th:

Cerulli Finds That Financial Advisers Do better When Sticking With In-House Products (Jeff Benjamin, Investment News) - In an analysis of trailing 5-year returns of client portfolios at broker-dealers through the end of 2014, Cerulli found that advisors who constructed their own portfolios underperformed the in-house model portfolios packaged by their brokerage firms. While portfolios constructed by the "home office" tended to put a stronger emphasis on fundamentals like risk-adjusted returns, consistency of investing style, and the tenure of portfolio managers, advisors who constructed their own portfolios were more likely to rely on the fund's reputation among colleagues, brand recognition among clients, and the influence of wholesalers. In addition, the Cerulli research noted that while home-office portfolios tend to stay fully invested throughout the market cycle, advisor-directed portfolios were more likely to go to cash during market downturns (perhaps acquiescing to face-to-face client demands). Overall, the study found that advisor-customized portfolios lagged their home-office-packaged portfolios by over 300 basis points, cumulatively, across the 5-year time horizon. And notably, while the study was specific to broker-dealer representatives, it also has significant implications for independent RIAs that face a similar decision of whether to centralize the investment management process or allow each of their advisors to create and actively manage their own client allocations.

Three Nontraditional Ways To Boost Your Top-Line Revenues (Bob Veres, Advisor Perspectives) - A growing number of advisory firms are complaining that their growth rates have stalled, a combination of stagnant market appreciation over the past year, and the challenge of bringing in ever more new client revenue to maintain the growth rate on a larger asset denominator. The first strategy is to ramp up surveying your clients, not only to better understand what they want and need, but also because the process itself can better engage your clients, which is crucial as a growing base of research reveals that it is engaged clients (not merely "happy" clients) that drive virtually all client referrals. The second reason to more proactively survey is that it can help you to uncover additional needs of your clients, which in turn can become new services that you offer (for which you can potentially generate separate/additional revenue), and also provides yet another opportunity to engage them further. Notably, though, engaging clients and generating more referrals still doesn't necessarily help, if the reality is that the person who is referred to the firm doesn't actually do anything; in fact, one study finds that only 1 out of every 10-20 referrals actually turns into a prospect meeting, and the rest take one look at the advisor's website and just move on, suggesting that the primary challenge for many advisors may not be getting referrals but engaging referrals to follow through. In fact, this need is now leading to a growing number of "pre-engagement engagement" tools on advisor websites, specifically designed to help turn strangers into bona fide (and engaged) prospects, like MyMoneyGuide, Adivzr Express, Investcloud, Riskalyze, and Veres' own Financial Identities. Of course, the added benefit of such technology tools is that they can also make the new client onboarding process easier and more efficient as well (a plus for both the client and the firm), and may make the firm more attractive to next generation advisor talent as well.

Client Appreciation 2.0: How It Has Changed And Why You Should Care (Julie Littlechild, Absolute Engagement) - Client appreciation events are a long-standing staple of the advisory business, viewed as both a chance to show your outright appreciation to clients, and perhaps even strengthen the relationship and generate a referral or two. However, Littlechild makes a distinction between "passive" client appreciation (which is simply about acknowledging the client and showing gratitude) versus "active" client appreciation that truly tries to engage the client by providing (free) additional value in a manner that also shows appreciation. For instance, a passive client appreciation might simply be a social event, while an active client appreciation might be offering a workshop event that helps clients learn how to protect their data online (an important value-add in its own right). The upside of active appreciation event strategies is that not only do they have more potential to increase client engagement, but it's also less likely to create the awkwardness that can occur when some clients don't want to spend their social time with the advisor (but would spend time on something that's actually relevant and meaningful to them). Unfortunately, though, the challenge is then figuring out what to offer, where just asking 100 clients for suggestions could result in 100 miscellaneous choices. Littlechild suggests a starting point is to focus in a particular area, such as a workshop on something specific (e.g., their children, or a particular common concern of the clients). This also makes it easier to narrow the scope of the event, to target your top clients (or those most likely to be engaged). And if the event goes well, you can always add in more active client appreciation events in the future, that better engage even more clients. But at a minimum, recognize that just doing broad-based social events to "appreciate" clients may not really be doing much to bind them closer to you in today's increasingly competitive environment.

Should An RIA Firm Utilize A Password Manager Tool (RIA In A Box) - As advisors increasingly move to cloud-based technology platforms, remembering an ever-growing number of passwords can be challenging, even as cybersecurity becomes a hot topic in advisor regulation. Of course, the "easiest" solution is simply to use one password that can be easily remembered, but even if it's a long and "strong" password (10+ characters, containing upper and lower case letters, numbers, and special characters), this approach is dangerous because it means if even just one system is ever compromised, the hacker gains access to all sites (using the same password). And unfortunately, many people end out choosing shorter and easier passwords to remember across multiple platforms, which just further increases the risk of being compromised, as having multiple strong passwords are hard to remember (and writing them down just introduces the new risk that someone will steal the sticky note with your passwords written on it!). So what's the alternative? To use a password management program (e.g., LastPass, 1Password, Dashlane, etc.), which can automatically generate a unique, strong, random password for each software system the advisor uses (who instead just has to remember one very strong password for the single system, rather than lots of strong passwords for multiple platforms). In addition, some password managers can themselves require 2 factor authentication, further supporting the security of the platform, and an audit trail of password manager usage gives the firm an additional level of compliance oversight, as well as an easy way to terminate a staff member's access to the software as soon as they leave the company. Notably, in the end a password manager tool alone is not a substitute for a full cybersecurity policy for an advisory firm, but the authors suggest it's a good start for improving password strength and protections for the cloud-based software that advisors use, and the enterprise features to manage strong passwords across all staff members may be especially appealing for some larger firms as well.

Get The Most Out Of Advisor Conferences (Bob Veres, Financial Planning) - While financial advisors themselves have grown increasingly sophisticated businesses in the past 20 years, Veres laments that conferences for advisors have not kept pace, and still suffer from common challenges, including exhibit halls that advisors just want to avoid, keynote presentations from people who know nothing about financial planning, speakers who give the same canned speeches year after year after year, and more. Fortunately, there are at least a few standout financial advisor conferences every year, from FPA NorCal to AICPA PFP, FPA Retreat and the NAPFA National conferences. And Veres notes that he has tried to tackle many of these issues at his own Insider's Forum conference, from making the exhibit hall invitation-only (to ensure it includes relevant companies, rather than just the ones that pay the most to distribute their products), to more carefully vetting the content lineup of speakers. From the advisor's perspective, Veres suggests that the best approach is to plan out your time in advance, which means reviewing the list of sponsors in the exhibit hall to identify which ones you want to talk to, looking over the agenda and deciding which sessions to attend, and finding opportunities to talk with other attendees (including during presentation time slots that have nothing of interest to you). Veres also suggests that if you have multiple team members in your firm, that you should send everyone to one conference (rather than split them up across several events), as it provides more opportunity to talk through what you see at the event, really digest the opportunities, and implement some of your key takeaways. But perhaps most important is simply to read up on the conferences in advance, and who they really target, so you can be certain to attend an event that's really relevant for you and what your firm needs.

What Advisors Should Look For In Legal Documents (Martin Shenkman, Financial Planning) - While financial planners aren't lawyers, they do often have the opportunity to help review a client's estate planning documents, and spot potential issues that could be subsequently taken to an attorney to fix. For instance, does the client actually have a durable power of attorney, and does it empower the attorney-in-fact enough for the advisor to help implement typical planning tactics that might be done in the event of incapacitation, such as gifting (boilerplate documents often don't give the agent the right to make them), change beneficiary designations, or make investment changes (especially if there are unique investment vehicles involved). Other notable provisions in estate planning documents that advisors should watch out for include: in what state(s) will any trusts be created under the Will (and is it possible to change states to reduce any state tax burdens); is the document flexible enough to fund a bypass trust, or not, as appropriate after the death of the first spouse; are any irrevocable trusts being used for planning grantor trusts (and if not, should they be, and if they need to be, can the document be modified or the trust decanted into a new one that qualifies); are there investment standards regarding how the estate or trust can be invested, and are they actually consistent with the advisor's typical Investment Policy Statement (IPS); and if there's family LLC or limited partnership, does that document permit the advisor to manage the business entity's investment assets, as such provisions are typically not part of the usual boilerplate documents for business entities and often must be specifically added.

Net Asset Values Can Fool You (Dave Nadig, ETF.com) - While the Net Asset Value (NAV) of a mutual fund or ETF is commonly viewed as the definitive indicator of what an investment is worth, Nadig points out that there are actually some significant caveats to how an NAV is actually calculated. The first is that the NAV is not actually just the portfolio's holdings divided by the number of shares of the fund. The reason is that the NAV is calculated based on when a securities trade settles, not merely when the trade is executed; thus, for instance, if a fund started the day 100% in Apple, but sold at the opening bell to buy Microsoft instead, at the end of the day the NAV would still be calculated based on the price of Apple and not Microsoft, because the trade won't actually settle until tomorrow (even though once it does, pricing based on Apple the prior day will have been 'wrong'). Fortunately, most funds don't have such extreme investment changes that this creates a material disparity; but nonetheless, technically today's NAV is yesterday's closing portfolio marked to today's closing prices, and is not necessarily based on what's actually been bought and sold in the portfolio that day. Second, the reality is that the NAV can't always reflect the exact closing price of all investments in the portfolio, because not all investments are traded through the close of the market, whether because a stock got halted, or because it's traded on an international exchange that closed hours ago. In such scenarios, the fund's Board of Directors either sets the price manually based on their judgment, or at least establishes a policy for the fund to do such human-judgment-based valuations in a standardized way. Of course, the caveat is that these prices may or may not truly reflect "fair value", since they're still based on a particular fund company's subjective call. And of course, when it comes to ETFs, it's important to remember that the ETF will not necessarily trade at the fund's NAV price in the first place; instead, it's up to arbitrageurs to ensure that the trading price is consistent with the intrinsic NAV, which usually happens, but isn't guaranteed, and can again be especially challenging to do when the ETF includes underlying securities that aren't being traded when the ETF is (e.g., in the case of emerging markets funds that trade on markets with different market hours than the U.S. stock exchanges).

The IRS Attack On Illiquid IRAs (Donald Jay Korn, Financial Planning) - With the growing use of alternative investments by investors, the IRS is increasingly starting to scrutinize their use, particularly within IRAs. The primary concern is whether hard-to-value alternative assets are being undervalued in a manner that inappropriately minimizes requirement minimum distributions, which the IRS can now spot thanks to an updated requirement of Form 5498 (which reports IRA balances to the IRS for RMD calculations) that must note whether the account includes any hard-to-value assets. Notably, the point here is not specifically to reduce the use of alternatives in IRAs, but simply to ensure that they are being used for bona fide investment purposes, and not simply to obfuscate the value of the account to minimize RMDs (or the value for Roth conversion purposes), although it's possible that some IRA custodians will eschew holding alternative assets to avoid any risk that they "mis-report" the valuation (particularly as IRA custodians are now expected to help calculate the RMD amount). And even IRA custodians who will hold hard-to-value assets are now starting to require that the IRA owner get a third-party unbiased valuation estimate, to ensure that the value is properly recorded and the RMD is determined accurately. With the new Form 5498 reporting requirements, expect this issue to hit the radar screen more often going forward in 2016 and beyond.

Longevity Lens: Predicting Client Life Expectancy (Carolyn McClanahan, Financial Planning) - Although financial advisors often joke about the fact that we can't predict the future (of market returns), we are often still called upon to make key predictions that have a significant impact on a client's financial plan, such as an estimate of how long they will likely live and a 'reasonable' life expectancy assumption. Yet advisors have remarkably little training in how to properly determine what life expectancy assumptions should be; McClanahan finds anecdotally that most advisors either arbitrarily assume a 'conservative' age 100, or simply use standard life expectancy tables. While it may be appealing to assume 'arbitrarily' conservative time horizons, though, McClanahan notes (as a former doctor-turned-CFP) that a client's current health issues should still be considered as well, and that assuming age 100 life expectancy for a 45-year-old 300-pound diabetic smoker simply isn't realistic (even with medical advances). In practice, McClanahan suggests that a starting point is to understand the client's health situation, and ask them "what do you do to take care of your health", which can provide a further indicator about their relative likelihood to make it to or past normal life expectancy. In turn, McClanahan then breaks clients into three groups: those who are healthy and proactive about taking care of their health, where life expectancy is assumed to be 100; those who are healthy but aren't proactive in maintaining their health, where life expectancy is assumed to be average; and those who have significant health issues, where below-average life expectancy may be used (for instance, by getting a customized life expectancy estimate through LivingTo100.com). The ultimately benefit of the more customized approach - a way to ensure that clients with good health don't overspend based on an unreasonably short assumption of life expectancy, but also a way to help clients with poor life expectancy recognize that it's "ok" to spend a little more, if the reality is that living to 100 isn't realistic at all.

How AI And Crowdsourcing Are Remaking The Legal Profession (Sean Captain, Fast Company) - The world of tech startups in the legal world is booming, with nearly 500 companies now offering technologies to the legal industry and a recent doubling in the number of listings on startup directory AngelList. The trend appears to be driven in part by the growing number of Gen X and Millennial lawyers becoming partner, who 'grew up' with technology, and are more open to implementing it professionally, such as by using natural language processing tools to analyze court documents (e.g., to figure out how a particular judge tends to rule on particular types of cases, or scan through patents and trademarks in intellectual property lawsuits against patent trolls). And notably, the challenges are not only these types of 'robo-lawyer' solutions, but also portals like Casetext that provide access to reams of case law data and information, which previously were only available through expensive services from a few large providers. As all of this information comes online into centralized databases, this also creates the potential for "big data" analytics projects, which make it easier to connect key court cases and find legal precedents. Notably, though, this explosion of legal tech still isn't expected to actually replace lawyers with robo-lawyers; instead, the purpose of the technology is to make it easier for lawyers to apply their professional intuition and judgment more effectively, by putting more relevant data than ever at their fingertips.

This Is The Business Model Needed To Master The Fourth Industrial Revolution (Knowledge@Wharton) - With the nascent rise of platforms from Uber to Airbnb to Kickstarter and Spotify, the founder and executive chairman of the World Economic Forum recently suggested that we are now witnessing the fourth industrial revolution. The key distinction is that they are all built around digital networks, which tie together the physical, digital, and biological realms in ways that were never before possible. And notably, the idea that this is the onset of the fourth industrial revolution means that the rise of networks and platforms is not unique to a few early adopters, and instead may become the way more and more business is done in the future. Accordingly, firms in a wide range of industries may soon face "The Network Imperative", as all business models have the opportunity to evolve from being asset builders to service providers to technology creators, and finally to becoming "network orchestrators" that create a platform that participants can use to interact and transact. And the opportunity isn't merely one of evolution and competition; as the researchers show, companies that are network orchestrators tend to have higher growth, better margins, and stronger returns on assets, which ultimately lead to better valuation multipliers as they are literally "more valuable" on a dollar-for-dollar basis. The challenge for existing businesses, though, is figuring out how to adopt a network mentality when they didn't start that way in the first place (as companies like Airbnb, Uber, and Facebook did). Still, a growing number of companies are figuring out how to adapt and build a network layer, suggesting that the age of the platform may still just be in its early stages.

Why Financial Planning Is The Most Important Profession Of The Century (Dave Yeske & Dick Wagner, Journal of Financial Planning) - Dick Wagner has long been recognized as a thought leader and futurist on financial planning, and is now working on a new book, "Financial Planning 3.0: Evolving Our Relationships With Money". As Wagner views it, financial planning is on the rise as the most important profession of the 21st century, driven by the fact that abstract money is perhaps the most powerful and pervasive secular force on the planet to impact people (playing a role in everything from social justice to scientific advances), yet most people need help to improve their relationship with money (which he views as the fundamental role and purpose of a financial planner). In turn, though, this suggests that the attributes of a quality personal financial advisor need to be improves as well, though Wagner points out that qualifying as a professional should perhaps exist in gradations, as opposed to a single central qualifying requirement (such as the CFP exam). In addition, the "garden" of financial planning knowledge also needs to be expanded and adapted, under a framework that Wagner calls "finology" (the study of money and value exchange). This might encompass not only technical knowledge about finances, but also the study of the connection between humans and money, which covers not only topics like behavioral finance but also the connections between money and happiness, recognizing that the "soft" side of money issues can actually be the hardest to learn and implement. And ultimately, it's the combination of all of these that Wagner sees as the emerging "Financial Planning 3.0" paradigm of the coming years, where 1.0 was the academic knowledge alone, 2.0 was the 'interior' life planning movement, and 3.0 is about bringing it all together as a bona fide profession.

I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!