Weekend Reading For Financial Planners (May 4-5)

IBD Channel Faces Exodus To RIAs As Autonomy Becomes The New Independence

(Michael Fischer | ThinkAdvisor)

Historically, broker-dealers, and large wirehouses in particular, have led the way in terms of advisor headcount and Assets Under Management (AUM). Nevertheless, recent years have seen a shift toward the RIA model, both among advisors (as brokers break away to start their own independent firms and aspiring advisors seek positions that don't rely on an 'eat what you kill' approach) and consumers (who might be attracted to the differentiated service proposition they can experience working with an RIA that isn't manufacturing its own financial services products for sale). 

According to a report by research and consulting firm Cerulli Associates, the movement of advisors to RIAs over the past decade has largely come at the expense of wirehouses, but Cerulli now finds that the Independent Broker-Dealer (IBD) channel could soon be seeing an exodus as well. In fact, their latest research shows that a whopping 32% of IBD brokers have considered opening an RIA in the past year. This interest is being fueled by a desire for higher payouts, the ability to create enterprise value in an independent business, a desire to create a more personable culture, and a pursuit of not just independence but having greater autonomy over how their businesses are run and their clients are served (one of the key differentiators between thriving and struggling advisors, according to Kitces Research on Advisor Wellbeing).   

That being said, concerns about the operational requirements of transitioning to an RIA appear to be weighing heavily on brokers' decision making, with 46% viewing the greater operational responsibilities (e.g., staffing, technology, and compliance) as a major concern… which bodes well for platforms and service providers that can fill in these gaps on an outsourced basis. Further, while a number of brokers in the IBD channel are considering transitioning to an RIA, they might not break ties with their broker-dealer completely, as 36% of those who have considered a move indicated that they may retain affiliation with their current broker-dealer's RIA platform (with only 13% responding that they would unquestionably prefer to move to an RIA custodian). 

Ultimately, the key point is that while the RIA model can be attractive to many of those currently working in the IBD and wirehouse channels, such a transition can require significant preparation, from running the numbers on whether a move will be profitable to potentially needing to navigate the broker protocol (which is the essential roadmap for how a broker can leave their current broker-dealer in the cleanest and most efficient manner possible). Nonetheless, those who do decide to go independent do not necessarily have to 'go it alone', as they could leverage advisor platforms that provide a range of tech tools and services in one bundle or create their own  'stack' of tech and compliance tools (or join an existing RIA to take advantage of its established infrastructure!). 

Vanguard, Schwab, Fidelity Human Advice Services Cutting Into RIA Market Share

(Lisa Shidler | RIABiz)

When robo-advisors first came onto the scene more than a decade ago, some industry observers thought this innovation could threaten the business of financial advice, as these tools could offer a variety of services (e.g., asset allocation, automated tax-loss harvesting) at a lower price point than most human advisors. However, this turned out not to be the case for advisors offering comprehensive planning services, as research has shown that clients prefer a human advisor to a digital tool for many parts of the planning process (e.g., understanding a client's goals and motivations, supporting them through market volatility). 

Nevertheless, a new threat to independent advisors emerged a few years later as several of the large asset managers (e.g., Vanguard, Schwab, and Fidelity) debuted services that combined 'robo' asset allocation tools with on-demand financial advice provided by humans at a price point below that of most RIAs. And according to a study from Cerulli Associates, these "direct" firms have increased their share of the wealth management market increase to 26.4% as of 2022, up from 22.5% in 2017 (while human advisors, including RIAs, have seen a decline in their market share to 61.7% from 64.8%). Further, during this 5-year period, direct retail programs saw assets increase by 10.7%, compared to 6.2% for other advisors. 

These large asset managers appear to be taking advantage of their hefty marketing budgets and national brands (with Cerulli data indicating that 39% of affluent investors currently working with an advisor and 32% of those who are unadvised prefer working with a large, national organization, compared to about the 18% of these groups who would prefer to work with an independent, local practice), as well as the ability to cross-sell (and upsell) retail clients with accounts on the platform as well as those with retirement plan assets with these custodians. Further, by employing CFP professionals and offering a range of advice services, they could cut into some of the marketing messages RIAs might have used.

In the end, competition from large asset managers offering human advice at a lower price point suggests that, for independent RIAs, marketing how they are 'different' could be particularly effective. Which could mean focusing marketing messages on the needs of their ideal client type (in contrast to the marketing of the national firms, which target a broader swath of the population) and highlighting the specific planning expertise that the firm offers (i.e., the ability to 'go deeper' than one of the asset manager's call-center advisors) that is most relevant to these clients. Because not only could these messages attract clients looking for an advisor who specializes in their unique needs, but also those who have been on the asset managers' platforms (perhaps starting when they had relatively few investible assets) but are looking for a deeper, more personal planning relationship as their financial situation gets more complicated over time!

How Tech Is Propelling RIA Growth

(Holly Deaton | RIAIntel)

While the business of financial advice requires a certain amount of face-to-face (or perhaps Zoom window-to-Zoom window) contact with clients, there is no shortage of advisor technology solutions to increase the efficiency of their business and how the advice they provide is prepared and delivered. That said, because building a tech stack requires an outlay of time (to research various solutions) and money (as the costs of software build as the tech stack gets larger), a firm owner might wonder whether having a top-tier tech stack is worth these costs.

According to a recent study from Fidelity, the answer to this question is a resounding yes. The study found that "digitally empowered" firms have a range of defining features, from being 2.5X more likely than other firms to have a process for evaluating technology by strategy or need, twice as likely to use automated workflows to be more productive, twice as likely to provide adequate training on tech tools for firm staff, and 1.6X as likely to have well-integrated tech stacks. In return for these investments, "digitally empowered" firms on average saw both greater client growth rates (20% versus 8% for other firms) and stronger growth in assets under management (22% versus 11%), which could be the result of both greater advisor efficiency (in areas such as client onboarding, trading and rebalancing, and money movement) and client engagement (as these firms were more likely to offer access to digital tools such as client portals). Further, advisors who work at "digitally empowered" firms (notably, only 36% of the advisors surveyed) reported greater career satisfaction (81% to 59%) satisfaction with their firm (64% to 44%) and average compensation ($489,000 to $373,000), suggesting that, at a time of steep competition for talent, being tech-forward can promote advisor retention.

In sum, investments in advisor technology appear to pay off for many firms in the form of increased growth and advisor satisfaction. And given that there are many ways to build a tech stack (from using a platform that combines tools across multiple categories to selecting them on an a la carte basis) and that this software is available at a range of price points (from free tools bundled into custodial platforms to pricier standalone options), firms have the opportunity to a "digitally empowered" environment based on their unique needs (perhaps after first creating a strategy to guide its research?).  

HSAs As 'Medical IRAs': A Great But Neglected Strategy

(Steve Garmhausen | Financial Advisor)

Although numerous tax-advantaged vehicles are available for retirement savings, Health Savings Accounts (HSAs) have particular benefits for individuals saving for retirement. Specifically, HSAs offer a "Triple Tax Benefit" that includes tax-deductible contributions, tax-deferred growth, and tax-free withdrawals for qualified medical expenses (though a few states tax contributions, capital gains, and/or income generated in the accounts). This can allow individuals to save a significant amount that can be withdrawn tax-free for medical expenses later in retirement.

Nonetheless, while individuals are often focused on their workplace retirement plans or IRAs when it comes to funding their retirement, the inevitability of medical expenses in retirement and the unique tax benefits of HSAs suggest that these accounts could be a valuable supplemental retirement vehicle (perhaps alternatively dubbed a "Medical IRA"). To maximize such a strategy, a client might make the maximum allowed contribution each year ($4,150 for individuals and $8,300 for families in 2024), or at least as much as their cash flow allows, invest the funds (as they would do for other retirement accounts), and let the balance compound until funds are needed to cover qualified medical expenses in retirement. 

Despite the advantages, data suggest that relatively few consumers take advantage of this strategy. To start, some are dissuaded by the requirement to be covered by a qualifying High-Deductible Health Plan (HDHP) (and with no other non-HDHP coverage, including Medicare) to contribute to an HSA in a given year, as the might be concerned about the potential outlays needed to cover deductibles that are higher than 'traditional' health insurance plans (though the higher deductibles can sometimes be mitigated by lower premiums and/or employer HSA contributions). Even for those who do have an HSA, the funds are sometimes kept in an interest-earning vehicle (which could provide a lower long-term return than if it were invested) and many account holders use their HSA to cover ongoing medical expenses (which reduces the balance available to benefit from long-term compounding), even though there is no requirement to use contributed funds in a given year.

Altogether, financial advisors can add significant value for their clients when it comes to the use of HSAs, whether in terms of how they are framed (as a "Medical IRA" instead of a tax-advantaged account for ongoing medical expenses), evaluating the cost-benefit tradeoffs involved in having an HSA-eligible HDHP versus a traditional medical plan for a client's individual situation, by creating an appropriate asset allocation for the funds in the account, and by creating a drawdown plan (given that HSAs receive comparatively poor tax treatment to other retirement accounts when left to beneficiaries other than a spouse). Which could ultimately provide clients with a sizable medical 'nest egg' in retirement, allowing them to use funds in their other retirement accounts for other spending goals (that are likely to be more enjoyable than medical bills!).

Assessing Health Insurance Options For Early Retirees

(Gail MarksJarvis | The Wall Street Journal)

Many financial planning clients will end up retiring at age 65 or later, at which point they will be eligible for health insurance coverage under Medicare, which tends to be quite affordable given premium sharing with the Federal government (funded via the Medicare taxes deducted from workers' wages and/or self-employment income). However, those who decide to retire earlier (which means they will not be eligible for Medicare, unless they are disabled or have permanent kidney failure) typically have to seek out an alternative source of insurance once they are no longer eligible for coverage from their employer, which can be significantly more expensive than the (often heavily employer-subsidized coverage) they received during their working years. 

Nevertheless, early retirees have a variety of options to choose from for their health insurance needs until they achieve Medicare eligibility. For those clients who have a relatively short gap between their retirement date and Medicare eligibility (e.g., if they retire at age 64), liked their insurance coverage from their previous employer (and/or would like to ensure they can continue to see the same doctors), and worked at a company required to offer it (typically those with more than 20 employees), continuing coverage under "COBRA" could make sense. Under COBRA, former employees (and eligible spouses and dependent children) typically can continue their coverage for up to 18 months. However, the employee will have to pay the full cost of the policy (i.e., without employer subsidies), which could be significantly higher than the premiums they are used to paying (employers can also charge an additional 2% administration fee). Given the time limits and cost of COBRA coverage, it often makes the most sense for early retirees who will become eligible for Medicare during the COBRA-eligible period.

For those retiring well before they reach age 65, finding health insurance coverage on a state health insurance exchange could make sense. To start, early retirees (who no longer have wage income) might find that they are eligible for income-based subsidized coverage with premium assistance tax credits. In addition, these policies will not disallow coverage based on pre-existing conditions and cannot deny coverage if an insured becomes sick after buying the insurance. With these plans coming in a range of coverage tiers (that vary in terms of premiums, deductibles, and other factors), early retirees (and their financial advisors) can compare available options to determine the best option for their needs.

While many early retirees will choose coverage either COBRA or their state insurance exchange, retirees in certain situations could choose from a variety of other options, including joining a still-working spouse's employer-subsidized health insurance plan (which might be 'Plan A' for those in this situation), getting a part-time job that offers health insurance coverage, converting their employer-based group insurance plan to an individual plan (notably, this is only offered by some employers and the terms of these policies can differ from the employee's previous policy), pursuing private insurance coverage off of the insurance exchanges (which can offer lower premiums than exchange policies, though early retirees could be denied for pre-existing conditions and/or be subject to maximum coverage amounts), or joining a healthcare sharing program (though pre-existing conditions can lead to coverage limits).

In sum, while health insurance coverage is often one of the larger line items on an early retiree's budget, they have several options to choose from to meet their unique needs. Which means that financial advisors can add significant value to their clients by comparing the various options and helping them select the one that meets their medical needs and fits within their budget (and, for those on state exchange plans, perhaps creating an income strategy during this period that will help them maximize the subsidies available to them!). 

Helping Clients Plan For (Unknown) Retirement Healthcare Expenses

(John Manganaro | ThinkAdvisor)

While many individuals recognize that healthcare expenses will be one of the larger items on their budget in retirement, the actual expenses they will face are unknown, making cost estimates a challenge. Nonetheless, by looking at spending patterns across a large population of retirees and then tailoring these figures for a client's personal medical situation, a financial advisor could create a ballpark estimate of these expenses to use when crafting a financial plan for the client.

According to a study from healthcare data and software company HealthView Services that analyzed data from 530 million healthcare claims, the average couple can expect annual healthcare expenses of about $14,700 in their first year of retirement, increasing to $54,500 in the final year (based on expected longevity). Notably, these findings reflect a similar pattern to the "spending smile" identified by retirement researcher David Blanchett, which showed that, after declining in inflation-adjusted terms earlier in retirement, retiree spending rises towards the end of life, driven in part by these increasing healthcare costs. In addition, the research found that healthcare costs had been increasing faster than the broader inflation rate, further stretching retirees' budgets.

The study suggests that an individual using a fixed-withdrawal-rate approach from their portfolio (e.g., the "4% rule") might find that they have insufficient assets to cover larger late-in-life medical bills. With this in mind, advisors could add value for clients by planning for increased healthcare costs over time (both due to inflation and the likelihood of needing additional services), adjusting average costs based on a client's needs (e.g., if they already have a chronic condition that will require regular care), and planning out cash flow needs, an appropriate asset allocation to meet them, and, perhaps, a flexible withdrawal strategy. Though notably, while total healthcare costs in retirement can appear worrisome at first glance (e.g., Fidelity estimated in 2023 that an individual will spend $157,500 in healthcare expenses over the course of retirement), these costs tend to be spread across many years (and could be planned for accordingly), even if they do end up increasing near the end of the client's life! 

The Trends Driving 2024 RIA Dealmaking In 5 Charts

(Michael Fischer | ThinkAdvisor)

While RIA Mergers and Acquisitions (M&A) activity had been brisk for many years, with heightened demand from acquirers (often larger firms, sometimes infused with Private Equity [PE] capital) driving up valuations, the pace of deals started to slow in late 2022 as rising interest rates and other factors served as headwinds to continued deal flow. This slowdown continued into 2023, with the number of RIA M&A deals declining to 321 announced transactions from 340 in 2022 (the first year-over-year decline in more than a decade), according to data from investment bank Echelon Partners (though the average assets per transaction actually increased by 3.9%, boosted by several large deals).

Nonetheless, data from M&A consulting firm DeVoe & Company suggest that RIA M&A could resume its upward trajectory in 2024 and beyond. To start, deal flow was up 20% during the first 2 months of the year compared to the prior-year period. But beyond transaction data, several underlying trends suggest both buyers and sellers could be hungry for deals. Overall, in 2023 65% of firms surveyed indicated that they expect to acquire another firm in the next 2 years, up from 54% the previous year (notably, this number increased to 70% for firms with at least $1B in assets under management). 

For firms looking to buy, acquiring talent was most frequently cited as a main driver for dealmaking (76% of respondents), followed by growing clients and assets (74%) and expanding into new markets or geographies (57%). Perhaps relatedly, 55% of those surveyed indicated that the firm's ability to meet its staffing needs keeps them up at night (compared to 34% who said their company's business results does so). Among sellers, decreasing confidence that next-gen advisors will be able to buy out the firm appears to be a major driver of a willingness to sell (with only 16% of firm leaders indicating that they are confident that next-gen advisors can afford to buy out the founders, down from 39% in 2020). This could be due in part to rising firm valuations, which could make a sale more lucrative (and harder for younger advisors to afford, particularly as higher interest rates make financing a deal more expensive). 

In sum, despite last year's anomalous slowdown, it appears that there is interest among buyers and sellers for RIA dealmaking in the months and years ahead. Which could provide a source of liquidity for firms without a viable internal succession plan, but also lead to increasing consolidation in the industry as larger players buy up small firms (though the continued entry of new firms into the marketplace could mitigate this to some extent?). 

Why Mergers May Be The Next Big Thing In RIA Dealmaking

(Steven Levitt and John Eubanks | Citywire RIA)

When it comes to RIA M&A activity, outright acquisitions (where a larger firm purchases a smaller firm using cash, equity, or a combination of the two) are the most common deal type, offering the buyer a way to gain talent and client assets, and the seller (frequently a founder looking to retire), liquidity for their investment in their business as well as a succession plan so that their clients will continue to be served after their retirement. Nonetheless, firm owners who want to get the benefits of scale quickly while maintaining a significant amount of control over their firm could look to a merger of equals (i.e., where 2 similar-sized firms combine into a single entity) to satisfy their needs.

In fact, a merger of equals, if executed well, can provide a significant boost to profitability, as it will maintain similar revenue but be able to cut out some redundant expenses that each firm previously paid for separately (e.g., technology, compliance, and marketing costs). Further, given that larger firms currently are fetching higher valuation multiples than smaller firms, the combined firm could achieve a stronger valuation for a future sale than the 2 smaller firms would have separately. However, successfully executing a merger of equals can be tricky, from the need to agree on valuation (i.e., the stake in the combined entity the owners of the separate firms will receive) to ensuring a good cultural fit between the 2 firms (so that both advisors and clients will have a relatively seamless transition to the combined firm). 

Ultimately, the key point is that a merger of equals could be a viable solution for firms looking to gain the benefits of scale without having to grow organically or engage in an outright sale. Though the trickiest part might be finding a partner that not only is a similar size, but also shares similar values when it comes to business operations and client service standards to ensure the combined entity truly is greater than the sum of its parts!

How RIAs Can Get The Best Price For Their Advisory Firms

(Richard Chen | Advisor Perspectives)

Given that one of the main reasons firm owners sell their firms is to obtain liquidity from their business (in which they've invested time and money over the course of many years), the valuation they receive is frequently a major consideration when choosing a buyer (in addition to whether the acquiring firm would be a good fit for the selling firm's clients, among other factors). With this in mind, focusing on maximizing a few common metrics used to value firms can help a firm owner obtain the highest possible offer. 

One commonly cited metric for valuing firms is gross revenue, typically stated as a multiple over a certain period of time (e.g., a buyer might pay 2X the selling firm's gross revenue over the past 12 months). While this figure can demonstrate the selling firm's ability to attract and retain clients, as well as its growth potential and market positioning, it doesn't take into account the firm's expenses and, therefore, its overall profitability. With this in mind, Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) can be used to value a firm based on its profitability (though selling firms could be tempted to manipulate the exclusions in this profitability figure to look more profitable than it really is). Another profitability-based metric is Earnings Before Owner's Compensation (EBOC), which can be a useful way to evaluate the 'core' financial health of a business by separating the business' earnings from the owner's personal income (though an owner's compensation could vary from year to year).

In addition to positioning the firm to show strong revenue and profitability, the terms of a deal can affect the purchase price paid by the buyer. For instance, deal terms might dictate a price adjustment based on client retention after the deal is consummated (which protects the buyer), an 'earn-out' provision providing additional compensation to the seller based on business metrics after the deal is closed (which could be attractive when the buyer and seller have differing expectations regarding the firm's future performance), or deferred payments (where the seller receives a larger payment, but agrees to defer some of it to a later time).

In sum, there is no single metric that is used to value RIAs in a sale or standard set of terms that describe how the sale price will be paid out. That said, selling firms that are able to track and demonstrate strong revenue, profitability, client retention, and (more qualitatively) bring a strong roster of advisor talent to the table (given that many buyers are looking to acquire not only clients, but also successful advisors as well!) will likely be able to command a premium valuation in a deal!

Clients Ranting About Politics? Here's How Financial Advisors Change The Subject

(Steve Garmhausen | Barron’s)

As financial advisors find themselves in the midst of another presidential campaign year, they might find that some of their clients come to their next meeting ready to talk politics, whether in terms of how the election might impact their portfolio or just to get their political opinions off of their chest (and perhaps look to the advisor to agree with them). Given that many of these clients will have strong political feelings and the potential for an extended conversation on political topics to derail a meeting, handling these situations tactfully is key to maintaining the relationship while addressing the full meeting agenda.

When a client raises a political issue, actively listening to what they are saying can often guide the advisor's next move. For instance, if the client is concerned about how the results of the election will impact their portfolio, the advisor could remind them of how markets have reacted (typically not as negatively as the client might assume) after previous elections, and with long-time clients, advisors could show them how 'staying the course' across different presidential administrations has helped them grow their wealth. On the other hand, if the client appears to be venting about the political situation in general, acknowledging their concerns (without agreeing with them) and gently steering the conversation back to the agenda at hand can allow the client to feel heard without allowing the meeting to get off track. 

Ultimately, the key point is that in a charged political environment, the likelihood that a client will bring political issues to the meeting room will increase. Though given that an advisor might have a good idea which of their clients are more likely to bring political concerns to the table, practicing a variety of tactics (e.g., acknowledging the client and refocusing them on the agenda, or perhaps preparing data to show how previous elections affected markets) beforehand in a 'mock' meeting could increase their confidence in handling a similar situation when it actually occurs!

What To Tell Clients In A Nasty Election Cycle

(Allan Roth | Advisor Perspectives)

With a presidential election approaching, clients with strong political leanings might be tempted to apply them to their portfolios, assuming (perhaps without much evidence) that if their preferred candidate loses, the opposing candidate's victory will lead to a market downturn that will hurt their portfolio. With this in mind, they might approach their advisor looking to make major portfolio changes to prevent this from occurring.

In this situation, an advisor might consider bringing data to the table. For instance, they could show data on how markets reacted after previous presidential elections (perhaps highlighting what happened after the party they dislike entered the White House). Further, an advisor might note that if the election of a certain presidential candidate really would have a negative impact on stocks, this likely would already be reflected in their prices, as the market tends to 'price in' known news.   

Nevertheless, given that politics can be an intensely emotional issue for many people, data alone might not be sufficient to persuade a client. In this case, an advisor might remind a client how they felt during previous tumultuous environments (e.g., the March 2020 market crash or leading up to the 2016 or 2020 presidential elections) and how staying the course with their chosen asset allocation proved to be a wise choice. Similarly, having them consider the challenge of deciding when they would want to get back into the market if they pulled their money out (when a new president from their preferred party is elected?) and how they might want to invest their money in the meantime, topics that they quite possibly have not considered. Further, the advisor could remind the client of the tax impact of selling off investments in taxable accounts, which could create a certain cost (compared to the uncertain impact of the election on their portfolio). 

In the end, while clients might understand conceptually that making drastic, politically motivated changes to their portfolio might not be the wisest course of action, they might need the guidance of their financial advisor to help them consider the full ramifications of such a decision when they are laser focused on the current political moment. Which means that advisors can add value for such clients by lending an empathetic ear, offering perspectives they might not have considered, and reminding them of their financial goals (and how staying the course has proven successful for them during their time with the advisor!).   

Preparing Your Team For A Year Of Intense Political Polarization

(Ron Carucci and Caroline Mehl | Harvard Business Review)

Given the salience of political issues during a presidential election year, political conversations can arise in the workplace (perhaps around the proverbial office water cooler). Nevertheless, given the potential for polite political conversations to creep into more argumentative territory, creating ground rules for these discussions can help ensure that a firm is able to maintain a strong, collaborative culture among its employees.

Each firm has the opportunity to set its own unique ground rules for expression (political or otherwise) based on its own values. Further, creating them collaboratively among employees can lead to greater 'buy-in' than if they are decreed from leadership. Possible ground rules that could lead to healthier conversations among team members include giving others the benefit of the doubt (i.e., listening with curiosity first rather than judgment), showing grace (i.e., understanding that hard conversations can be clumsy), and being respectful (i.e., communicating one's perspective thoughtfully rather than 'trolling' others or arguing in bad faith). In addition, teams can set expectations for how they will respond in case a ground rule is violated. For instance, a group might create a norm that members will speak to each other one-on-one first if they have a concern rather than immediately airing it in a public forum. Finally, firm leaders can play an important role in building this culture not only by abiding by these rules themselves, but also by taking steps to diffuse tension when necessary. 

Altogether, while setting ground rules for conversations related to political issues can be an effective tactic for diffusing tension in an election year, doing so can also promote more effective (non-political) conversations throughout the year, for instance during challenging discussions about employee performance or the firm's strategic direction. Because when leaders and employees can feel confident that they will be heard when they express their thoughts, the firm can benefit from the diverse range of ideas they can bring to the table!

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We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog.