Weekend Reading for Financial Planners (May 6-7)

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 6th/7th:

TrumpCare: A CFP-M.D. On What Advisers Need To Know (Carolyn McClanahan, Financial Planning) - With the news this week that an amended version of the American Health Care Act (AHCA) has passed in the House of Representatives, substantial changes to the existing framework of the Affordable Care Act could impact advisors and their clients in the coming year, and while it remains uncertain whether the current version of AHCA will become law (it is still has to pass a deeply divided Senate), McClanahan notes that now is the time to start planning for contingencies. Key issues to be aware of include: 1) AHCA would eliminate the current list of "Essential Health Benefits" under the ACA, giving states (and the insurers in those states) the option of enacting a shorter list of required essential benefits, which means it's possible that coverage for everything from pregnancy and contraception, to mental health and preventative medicine, might no longer be required in health insurance policies in at least some states (and the new rules would apply for both individual policies purchased from insurance exchanges, and for employer health care coverage, which means advisors must be especially vigilant in reviewing clients' employer health care coverage in the coming years); 2) AHCA would eliminate the prior ACA requirement that coverage be priced based on a "community rating" (cost of care in a particular area of coverage), and instead will revert back to personal underwriting for individuals and experience ratings for large groups, which means unhealthy individuals may see a substantial increase in premiums, and while pre-existing conditions will be covered, clients will still have to pay more (with one estimate that a 40-year-old with diabetes would increase premiums from $4,020/year to $9,620/year, and someone with metastatic cancer would face premiums of $146,650/year)... which means, at the least, that proactively helping clients navigate health insurance decisions will become more crucial than ever; 3) premiums for older individuals will be permitted to go as high as 5 times the amount for younger individuals (while the ACA limited the cost difference to "just" 3X the premiums), which means costs may get a little cheaper for young people, but could become prohibitively expensive for those looking to retire early (before age 65 when Medicare kicks in), or even those in their 50s and early 60s who are still working but want to become consultants or start a small business (as individuals and small business plans will have less leverage to negotiate pricing compared to large employers). On the flip side, the AHCA would result in tax relief for the clients of many advisors, as the 3.8% surcharge on net investment income (above $200,000 for individuals and $250,000 for couples) would vanish, as would the 0.9% Medicare surcharge on earned income (on the same earned income thresholds).

Orion Advisor Tries To Eclipse The Competition With New Portfolio Rebalancer (Craig Iskowitz, Wealth Management Today) - In the early days of computer software, tools were sold separately... until Microsoft came along, and bundled its full suite of Office applications together. Now, Iskowitz notes that the same type of bundling is coming to wealth management software, particularly when it comes to the wide range of advisor rebalancing software, with more and more companies either acquiring solutions (from Morningstar buying tRx to Oranj buying TradeWarrior), or building them. The latest in the "build" category is portfolio accounting and reporting software Orion Advisor Services, which has announced "Eclipse", its new rebalancing software that will be available in the fall, bundled directly to Orion's core platform. The software uses a modern tile-style interface to navigate key areas (Portfolios, Accounts, Trades, Models, etc.), and to track key information (portfolios Out Of Tolerance, or with a Cash Need, or with a Tax Loss Harvesting opportunity). Notably, the software doesn't do rebalancing across a household, but it can rebalancing multiple accounts to a single portfolio, and aggregate a portfolio-of-portfolios that roughly approximates the equivalent of a household. Constructing models themselves in the software is especially user-friendly, with a drag-and-drop tool to create and edit models, with tiers of asset classes and underlying investments (or models and sub-models). And not only does the software include tax loss harvesting capabilities, but handy supporting automation workflows, such as buying a substitute security for 30 days (to avoid the wash sale rule) and then queueing up a reminder to trade back to the original investment. Other features include: a robust Query tool, allowing for searches of the entire database - e.g., for all IRA accounts at TD Ameritrade with cash greater than $500 - to use the software as a targeted opportunistic trading tool, in addition to "just" a pure rebalancer; the ability to pull in data from held-away accounts via ByAllAccounts or Quovo; and User-level permissioning that allows a home office or operations team to have different (e.g., more in-depth) controls than advisors in the field (who may be more limited). Trades that are queued from the software can be reviewed in an Order Management System before being sent out, and thanks to an integration via FIX, most trades can be implemented with Straight Through Processing (for equities, ETFs, and mutual funds) to various custodians. Pricing for Eclipse will be tied directly to the underlying Orion pricing, at a cost of an extra 15% on top of the existing Orion per-account fee (which effectively comes out to about $6 to $10 per account per year for rebalancing capabilities, depending on the firm's account volume breakpoints).

First Look: RobustWealth (Joel Bruckenstein, Financial Advisor) - Notwithstanding the proliferation of digital wealth management platforms for advisors in recent years, Bruckenstein suggests that newcomer RobustWealth has a strong potential to compete. Its founder, Michael Kerins, is a CFA and CRM who previously managed a $40B investment team at Franklin Templeton, and headed their asset class research, though Bruckenstein suggests that RobustWealth's potential is its technology as much as its investment chops. The platform is designed to construct and manage (model) portfolios, providing tools to construct models, automate trading and rebalancing, facilitate client billing, along with offering a (private white-labeled) client portal. In essence, the platform operates as a form of "robo-advisor-for-advisors" tool, but focused primarily on model construction and management, plus digital onboarding, without including the full portfolio accounting and reporting capabilities of other (often more expensive) platforms. Currently, RobustWealth is fully integrated with TD Ameritrade, but intends to be multi-custodial, and is currently in testing phase with Fidelity, and "close to reaching an agreement with at least one other custodian". The software is designed to be "goals-based", in that portfolios can be tied to various goals for reporting purposes, allowing clients to track their progress towards their goal (e.g., retirement), and also includes a basic Wealth Projection capability to show how client goals project given current assets. Assigning goals also makes it possible to give clients goal-timeline-specific glidepath funds - for instance, if the client will retire in 2037, you can create a glidepath allocation specifically tying to the 2037 retirement year - in addition to simply creating and assigning your own (static) model portfolios. The software provides the typical suite of rebalancing and tax loss harvesting capabilities, including tracking for portfolio drift to rebalance, holding off the rebalancing trades if the costs (e.g., trading costs, exit penalties) exceed the benefits or if there are substantial tax implications, and tagging certain assets as "hold" or "ignore" to not rebalancing around or tax loss harvest them at all (which is helpful is a security is being held as a proxy for another allocation, such as keeping the client's legacy GE stock in lieu of a large cap growth fund). Notably, for advisors who want the full automated trading capabilities, they can choose to go "robo on" or off for various accounts, and RobustWealth only charges for the "robo on" accounts, at a fee of 20bps (which also includes access to third-party models, a la "model marketplace" choices). The biggest caveat so far is that RobustWealth does not include performance reporting capabilities, though the company claims it is under construction with a planned launch within three months. Further details on the RobustWealth website here.

5 Data-Driven Startups Nurtured By Envestnet | Yodlee (Craig Iskowitz, Wealth Management Today) - In the hypercompetitive world of startups, especially in FinTech, access to incubators and accelerators (which provide mentors, networking opportunities, technical resources, and funding, in exchange for small equity stakes) can be crucial for survival and success. Envestnet | Yodlee launched its own incubator back in October of 2014, with the goal of supporting startups, and encouraging them to leverage Yodlee's technology and data, and now some of the early incubator firms are debuting their solutions at the recent Envestnet Advisor Summit. Notable solutions include: Draft, which analyzes an advisor's client portfolios and identifies marketing opportunities (by leveraging Yodlee's data on held-away assets) to spot anything from identifying clients whose household assets (including held-away assets) are not invested properly, to outside accounts that have unusually high fees (and low returns), or quickly segmenting clients who have especially large IRA rollover opportunities; Genivity, which offers advisors a series of "gamified" tools that help clients perform health assessments and identify life risks, which can then be used for everything from changing the client's retirement time horizon, to assuming higher or lower healthcare spending in retirement (as appropriate), and also includes tools that encourage other family members to try out the application (which provides marketing/prospecting benefits); InvestReady, which makes it easier for clients to invest in small businesses by using technology to quickly assess whether they're an accredited investor, and then giving them access to private market crowdfunding opportunities (similar to crowdfunding sites like Kickstarter, except thanks to the JOBS Act in 2012, on InvestReady clients can actually invest in companies for equity stakes, rather than "just" donating to them in exchange for the product itself); StreamLoan, which aims to make it easier to apply for a mortgage, cutting down the processing time from 1-2 months down to about 2 weeks, and allowing clients to upload financial data directly via Yodlee to expedite the mortgage underwriting process; and Totum Wealth, a new competitor in the world of risk profiling tools that is aiming to do a better job at quantifying risk capacity of clients, including not just available portfolio assets, but the client's employment status and stability, health, geographic data (to assess real estate risk), and more.

Quick Takes: Truelytics, A Business Intelligence Application For RIAs (Joel Bruckenstein, T3 Tech Hub) - Back in 2014, Gladstone Associates (a consultant that provides advisory firm valuation and succession planning guidance) launched a new business intelligence application at the Orion Fuse Hackathon, and won the best business intelligence award. But in the years that followed, the software disappeared from the landscape; now, however, it's back, having been sold by Gladstone to a third party, and being rebranded and relaunched as Truelytics. While its roots are in calculating the valuation for an advisory firm, Truelytics is aiming to be a full business intelligence platform for advisors, allowing us to enter the details of our advisory firms, and then get insights on an ongoing basis about what can be done to improve the valuation of the firm (as a business management tool). For those roughly 35% of advisors who reportedly will retire in the next ten years, Truelytics may be appealing as a solution to get an approximate business valuation, and then begin making adjustments to increase the value of the business before taking it out to market for a seller. Though even for advisors who aren't looking to sell, arguably there's a lot of value in a platform like Truelytics to help understand the drivers of value creation for the business, as a mechanism to manage an advisory firm in a manner that maximizes shareholder value. For those who are interested, a high-level firm evaluation is free, while the paid service - at $100/month or $1,075/year - offers a more in-depth valuation (using varying industry valuation models), and a scorecard with over 40 advisory firm key performance indicators (KPIs) that can be tracked and benchmarked on an ongoing basis. Further details on the TrueLytics website here.

Everyone Is Merging (Philip Palaveev, Financial Advisor) - While a small subset of big advisory firm acquisitions with high valuations garner all the publicity, Palaveev notes that there are a growing volume of small-to-mid-sized mergers occurring, as larger advisory firms join forces with like-minded smaller firms to create bigger organizations with larger market footprints (and more potential economies of scale). The caveat, however, is that there are still far more large firms interested in bringing a merger in, than small firms that want to be merged; one recent study from Palaveev found 83% of firms had actively sought to buy another firm, but only 19% of firms were looking to sell to an outside buyer (and only 5% of firms with more than $250M of AUM). Notably, though, Palaveev specifically sees growth in mergers, and not just acquisitions; the key distinction is that in mergers, the founders/executives of the smaller firm typically don't retire or exit, and instead become active in the new organization (and in fact, that's often a requirement), and the deals typically don't involve cash (instead, it's a "paper for paper" exchange of shares). The difference between mergers and acquisitions is also notable because of how they tend to come about - because mergers rely heavily on an alignment of like minds amongst the leadership, they are far more likely to come about from a study group relationship, or at a custodian conference, or through volunteering at membership associations, rather than through introductions from investment bankers or cold calls from serial acquirers. In fact, the greatest driver of successful mergers is the ability of the firm owns to create a shared vision of what they're going to pursue together, with goals that are well aligned (and can then be supported by the right deal and business structure). Palaveev notes there are three common types of mergers - a true "merger of equals" where big firms come together (usually to expand their regional or even national footprint), a merger of large-and-small firms (often to bring in a specific capability/expertise, or presence in a particular market), and a "tuck-in" merger of a solo practice (more commonly done simply to accrue size to the larger firm and provide more resources for the solo advisor). Ultimately, Palaveev sees mergers continuing to grow in volume because for many advisors, the reality is that they don't want to exit and leave the business; they simply want to stay competitive, and perhaps have the support of a larger infrastructure so they can focus on what they enjoy doing the most (spending time with clients and/or prospects).

Advisor Firms Are At A Growth Crossroads (Mark Tibergien, Investment Advisor) - Advisory firms, like most small businesses, tend to go through four distinct phases: birth, growth, maturity, and decline (or what Tibergien often calls "Wonder, Blunder, Thunder, and Plunder"). At the end of each stage, the transition to the next requires making substantive changes to the business - in essence, a crossroad is reached, where new actions have to be taken to move forward. And a recent new white paper, aptly entitled "Crossroads", delves into these major transitions, which advisory firm owners face key issues from whether to add a support advisor or a(nother) full-time experienced advisor, when an advisor should become a partner, when it's time to hire a full-time executive, when to invest in building a brand that goes beyond the founder's personal reputation, when to open offices in new locations, etc. In fact, the crossroads study finds that these challenges occur at remarkably consistent points in the growth cycle of an advisory firm, as the business hits certain capacity walls around the role of the founder/advisor in the firm, and must be adapted to continue to grow... with the obvious caveat that if the transition isn't handled correctly, the outcome could be very detrimental to the business instead! Nonetheless, whether it's reaching the point where the advisor has very little time to service clients anymore (and must hire another advisor), or has to hire administrative and management staff (to handle the growing infrastructure), or must take on a new partner (to share the risk but also expand the capabilities), or transition to professional management (when the complexity of the business exceeds the founder's personal capabilities to run it), Tibergien notes that ultimately the biggest blocking point to the growth of a firm is the willingness (or lack thereof) of the founder/advisor to make the transitions when the crossroad is reached. In fact, arguably one of the biggest differences between the subset of emerging firms that are rapidly outgrowing their peers is not simply their growth strategy, per se, but their ability to navigate the most quickly and successfully to the next stage when a crossroad is reached.

Overcome Succession Planning Paralysis (Kelli Cruz, Financial Planning) - The core purpose of succession planning is about securing the continuity of an advisory firm and its future existence... in other words, how the business will continue to grow and create value for clients, as a business, beyond the tenure of the original founder/owner. For those who really want to build a business that lasts, Cruz suggests that there are four core areas to consider: 1) setting strategic vision (what, exactly, do you want the firm to be in the coming years?); 2) cultivating a human capital program (how will you attract, develop, and retain quality talent to sustain the firm's value proposition); 3) operational efficiency (reinvesting to sustain the growth capabilities of the firm); and 4) risk management of the business (reducing reliance on key clients, key employees, or key demographics or geography). Cruz notes that human capital management in particular is crucial for a successful succession plan - the owner can't transition clients to a new advisor, management to new managers, and ownership to new owners, if the next-generation talent isn't there to execute it. Which means it's crucial to consider the average age of employees, the percentage of employees that might retire in the next five years, and the process for identifying upwardly mobile employees who might take on future leadership roles. And because future leadership capabilities in particular are often only developed (and only identifiable) over time, Cruz notes that it's crucial to recognize that future leadership must be developed over time. Of course, ultimately succession planning involves a lot of change, which can feel very disruptive... and not surprisingly, many advisory firm owners would rather not put themselves into such an uncomfortable position. Nonetheless, given the time it takes to execute successfully, waiting will usually just make the pressures of change even worse.

Finding The Ideal Buyer For Your Practice (Emily Chiang, Journal of Financial Planning) - As someone who had a successful 25-year career as a financial advisor, Chiang shares her own experience and insights as someone who began the process of selling her solo firm in 2010. Ultimately, the process took 2.5 years, during which time she interviewed 10 advisory firms as potential acquirers, until she found one that she was comfortable with. Often, the first key is simply recognizing if/whether you're really ready to retire; in Chiang's case, the moment came when she realized that she was getting bored, and just didn't have the same interest in hearing and dealing with client stories that she once did, though other advisors may decide they're just exhausted from running the business, no longer feel on top of their team, or because the business just isn't growing and enjoyable anymore. Once you make the decision to sell, especially to an outside firm, you'll then have to build your support team to facilitate the transaction, including someone to value the practice, an attorney who can help draft the agreement, and a tax advisor who can consult on the terms and structure of the deal (which can have significant tax ramifications). Finding a buyer can also be challenging; Chiang deliberately sought out firms in her area that had more than 10 years of experience, and had similar fee structures and a common custodian (to reduce transition risk and make it easier for clients), and asked lots of questions about their practices, investment philosophy, and client service model, and even asked for samples of the buyer's financial plans and recommendations to existing clients to ensure a good fit.In fact, because there are likely to be a lot of interested buyers, Chiang suggests forming a standard list of questions that you can use to screen down the list of prospective buyers to ones that are at least a close enough fit to merit going deeper and spending more time (and even then, it may feel like you're working two jobs while going through the selling process, which is why some advisors engage outside consultants and business brokers to help). Notably, for advisors who have spent a career advising clients, it's important to recognize that the transition itself can be very challenging and bittersweet; Chiang notes that she felt "rudderless and disengaged" during the 1-year transition period, as she effectively lost a part of her own identity with the sale... which, ironically, culminated in her writing a book about her succession planning experience (aptly entitled "Selling Your Financial Advisory Practice: A Step-By-Step Workbook"), and becoming a consultant who works with advisors looking to sell!

People Trying To Save Prefer Accounts That Are Hard To Tap (Shlomo Benartzi & John Beshears, Wall Street Journal) - The classic view of money is that we prefer as much freedom and flexibility as possible; given $5,000 and a choice of where to save it for a future goal, we "should" prefer a flexible account with no restrictions, to one that has a penalty if you withdraw in the first year, or one that doesn't allow any withdrawals at all for a year. Yet a recent study by John Beshears and colleagues finds that the majority people actually prefer putting some of their money into more restricted accounts. In a similar follow-up study where consumers could choose between an unrestricted account and a single restricted account, they allocated nearly half of their money to the restricted account, and the amount they allocated increased with the level of restrictiveness... even if it offered a lower interest rate! In other words, restrictive accounts don't just limit future choices; we actually find them appealing as a means to save, effectively knowing that the limitations may help to save us from ourselves. In fact, one prior study in Filipino households found that those who chose to use a restricted account to save increased their savings by 337% compared to a control group - through a combination of both an increased desire to save, and simply because the restrictions were actually successful in limiting people from subsequent failures of self-control. In essence, the decision to choose a restricted account is a form of "commitment device" - a means of making a deliberate decision upfront to commit to a future act. Which ironically means that, despite the popularity of flexibility amongst economists (and financial planners), it's possible that increasing the penalties associated with retirement accounts (e.g., the 10% early withdrawal penalty from IRAs) could actually improve savings behavior, both by limiting our ability to make subsequent bad decisions, and because many consumers actually find it appealing to seek out accounts that will "help them" by imposing such restrictions in the first place!

Show Clients Their Spending Habits (Mitch Anthony, Financial Advisor) - For many clients who have problematic spending patterns, the fact that they know they have a problem makes it especially hard to actually deal with the issue, without making it confrontational in a manner that makes clients defensive (or worse, just want to avoid advisor meetings altogether). Anthony suggests a "non-confrontational" way to talk about client spending, by simply segmenting spending into four categories: Owe (payments for taxes and debt), Grow (money for savings and investing), Live (lifestyle spending), and Give (charitable donations). The significance of these categories is that most of them can be pulled directly from a tax return (where charitable giving and most taxes/debts are reported, savings [to retirement accounts] can be identified, and gross income minus the other categories produces the "Live" lifestyle spending). Once the four categories are quantified, it's possible to graph them in a pie chart - where, inevitably, the "Live" section of the pie dominates the rest, and can spur further conversations with clients - "Is there anything about this pie chart you'd like to change?" and "What steps will we need to take to get you there?" The upshot of this approach is that not only is it an easy way to talk about lifestyle spending without doing the painfully detailed work of trying to budget and track lifestyle expenses (instead, it's determined by taking gross income and subtracting the rest), but by segmenting between Owe, Grow, Give, and Live, clients can focus more on how to shift money in the aggregate from lifestyle to the Grow or Give categories, without feeling judged about the particular line items of their spending (as now it's up to the client to decide how to shift the slices of the pie). And the segmentation also supports other powerful client conversations, as anthony notes that the relationship between owing and growing is about our freedom, the balance between owing and living is about our comfort, the connection between living and giving is our sense of purpose, and the balance of growing vs giving is about our sense of abundance. In other words, the Owe-Gros-Live-Give framework provides a means for constructive conversations about fundamental financial planning trade-offs of freedom, comfort, purpose, and abundance.

The Science Of Helping Clients Change (Kol Birke, Journal of Financial Planning) - For many advisors, the greatest challenge is that, despite advising clients on the steps to take to improve their financial situation, or stop their harmful behaviors, they don't actually make the necessary changes. Birke suggests that advisors can improve their outcomes by actually focusing on the research around behavior change. For instance, psychologist Roy Baumeister has found that willpower itself (and the ability to self-regulate ourselves) is like a muscle: if you practice and use it, it gets stronger, but in the short run, it can also get tired. Which means if someone has to make a big decision, it's important to actually replenish their energy - literally, offer them snacks that will give them energy before the end of a review meeting when it will be time to make a decision. Or for decisions that have a longer timeline, encourage clients to engage in activities that reinvigorate them, from physical activity to creative pursuits or rest. And because willpower is limited, creating good financial habits - that don't require focus and willpower in the first place - can go a long way to improving outcomes. Similarly, it's important to remember that some clients may struggle with self-confidence, or "self-efficacy" to achieve particular (financial) tasks; as a result, it's a good idea to help clients start with simple and easy goals first, and then work up to the harder ones (this is also why video games start easy, and get harder over time). In fact, even showing clients examples of others who have succeeded in similar situations (i.e., success stories) can help improve their own self-efficacy by giving them more confidence they can succeed, too. Other behavior change tips include: encourage "good" behaviors by making them easier (e.g., automate IRA contributions); ask clients to clarify what, exactly, their goals are, as it can help them both affirm whether they really want to pursue it, and better motivate them to achieve it (e.g., don't let them just say they want to retire in a house on a lake, but ask how big the lake is, how deep it is, whether the client will go swimming or boat, what kind of boat it will be, whether they'll buy or rent the boat, who else is there with them, etc.); and help clients understand that if they've failed in the past, it may have been because of external factors, and not their personal capabilities... which is important to give them the confidence to try again and succeed in the future! And perhaps most important, bear in mind that change isn't natural, and rarely succeeds in full the first time; in other words, "relapse" is common and normal, but it's important to remind clients of this in advance, so an initial failure doesn't unduly discourage them from trying again.

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, you might want to check out this recent new commercial from Schwab for its Intelligent Advisory solution, as the firm ramps up its efforts to compete against broker-dealers with the looming DoL fiduciary rule under the tagline "Intelligent Tech, Personal Advice"... and in the process, may be increasingly putting itself in a position to compete with the RIAs on its Institutional platform as well!

Twins are a great example of unanticipated joys. How you can create a $ plan to get you through the unexpected. pic.twitter.com/AFQuZjLHMN

— Charles Schwab Corp (@CharlesSchwab) April 10, 2017