Weekend Reading for Financial Planners (May 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.

Weekend reading for May 7th/8th:

Women, Millennial Advisors More Likely To Change Firms (Christopher Robbins, Financial Advisor) - A recent Fidelity study look at nearly 34,000 advisors who changed firms in 2014, and found that there were significantly more females than in the past (14% in 2014 vs 8% in 2013), and more Millennials (22% in 2014 vs 14% in 2013). Notably, though, it's not because the advisors are struggling; to the contrary, the Millennials in particular had significantly higher average asset levels, and overall 43% of total advisors with >$250M of AUM who changed firms in 2014 were Millennials (up from just 14% in 2013). In other words, the more successful the Millennial advisor, the more likely they are to make a change if they're not happy with their current firm. The majority of those making a move are switching from captive firms (e.g., wirehouses and insurance companies) to independent channels like RIAs and independent broker-dealers, and notably the changes are being driven not by financial motivations but a desire for more control of operations, the ability to focus on clients, and more independent in crafting and executing strategies for clients. What this implies is that if advisory firms want to keep successful Millennial advisors, giving them flexibility to exercise their entrepreneurial inclinations is crucial, particularly as they approach the 3-5 year mark with the firm, when the odds of leaving start to increase.

T. Rowe Price Accused Of Charging Excessive Mutual Fund Fees (Tim McLaughlin & Ross Kerber, Reuters) - A group of investors have filed a civil lawsuit against T. Rowe Price regarding a wide range of their most popular funds, alleging that the fees it charges on its retail investor funds are "excessive". Notably, T. Rowe Price actually has a reputation for being quite reasonably priced in its expense ratios, with its $31B Blue Chip Growth Fund charging only 0.57%. However, the lawsuit notes that T. Rowe Price is still charging significantly more than what it charges as a subadviser on similar funds for other asset managers, implying that T. Rowe Price is overcharging in its retail mutual funds compared to the fees it agrees to in an arms' length negotiation with other institutions for otherwise similar-sized assets. T. Rowe Price has indicated that it will aggressively defend itself against the litigation, and that the lawsuit is without merit. And to be fair, it's worth recognizing that institutional investors have long been able to negotiate lower prices than retail investors, and that T. Rowe Price's pricing is not unusual in this regard (and again, is actually lower than many competitors). Still, the lawsuit raises interesting questions about what a mutual fund's expected obligations are to their mutual fund investors when assets under management experiences significant growth, as the lawsuit notes that in the past 6 years the Blue Chip Growth Fund has surged from $12B to $30B in AUM, producing an extra $81M of management fees, even as its expense ratio dropped by only 1 basis point (from 0.58% to 0.57%), which means T. Rowe Price only shared $2.3M of its newfound $81M management fees back to its mutual fund investors.

What Type Of Inflation Protection Are LTCI Policyholders Buying Today (Tom Riekse, LTCI Partners) - Because long-term care insurance (LTCI) is typically bought when someone is "young" (e.g., in their 50s or early 60s) and not used until much later (in their 70s, 80s, or even 90s), adding an inflation rider to benefits is crucial to ensure that they keep pace with rising costs from the date of purchase until the date of claim. However, as LTC insurance costs have risen, including the cost of inflation protection, companies have been innovating with their inflation guarantees, and consumer behaviors have shifted. An analysis of over 25,000 LTC insurance policies that Riekse's firm has placed since 2011 reveals that significant shifts in consumer buying behavior have been underway; since 2011, the the number of policies with 5% compounding inflation has plummeted from 52% in 2011 to just 3% today. This shift is leading consumers to buy a wide range of alternative inflation options. For a while, companies were experimenting with a wide range of inflation choices (1%, 2%, or 4% inflation, simple inflation vs compound inflation, or CPI-adjusting inflation), but those options have fallen by the wayside. Instead, the leading inflation-adjustment features used in LTCI now are: no inflation protection or "just" a guaranteed future purchase option (the ability to buy more coverage at attained age every 3 years), which has exploded from 2% to 29% of policies; increasing premium products that start out lower and step higher over time (or at least might go higher over time, such as Hancock's new Performance LTC product), which are now 15% of all policies sold (and didn't even exist 5 years ago); and 3% compound inflation, which has risen in popularity from 25% to 45% of all policies and is now the most popular type of inflation rider (which is more affordable than 5% compound inflation, though notably many worry this will still lag medical expense inflation in the long run, even as some parts of custodial care inflation have been more modest in recent years!).

The Risks Of De-Risking (Jerry Miccolis & Gladys Chow, Journal of Financial Planning) - In the past 2 years, the S&P 500 has gone through four corrections (a decline of -10% or worse from a recent peak), though thankfully none have gone so far as to reach "bear market" territory (a drawdown of -20% or worse). This rising level of volatility and more frequent drawdowns may have clients (and even some advisors) wanting to "de-risk" their portfolios, reducing volatility exposure to minimize the potential drawdown that may come next time (especially important if the next drawdown is "the big one"). However, for those who want to de-risk, the question still arises of how to do so. The most common approach is simply reducing the client's allocation to equities, and shifting the funds to another asset class like cash, fixed income or (liquid) alternatives. However, these "de-risking" solutions introduce their own risks and problems:  the return on cash historically has lagged inflation (which means volatility risk is eliminated by purchasing power risk is a near certainty!); fixed income investments don't look much better with the potential for rising rates going forward (as the favorable stints of fixed income outperformance in the past several decades, driven by a secular decline in interest rates, aren't likely to repeat, and stretching for year with longer duration or higher credit risk just amplifies the volatility again); and liquid alternatives are theoretically an appealing diversifier but in practice have still been exhibiting an extremely high positive correlation to other risk-based assets (e.g., equities). Given these dynamics, Miccolis and Chow suggest that the future of de-risking may be less about selling equities to buy other lower-risk asset classes, and instead about simply shifting risk exposure within equities, such as deliberately buying "low-vol" or "min-vol" index funds, engaging in tactical sector rotation strategies, or using put option overlays to manage tail risk exposure. In fact, some investors are finding that risk-managed equity strategies are such an effective way to manage the volatility that they're actually increasing equity allocations (albeit filled with those lower-volatility equity strategies).

Index Investing Makes Markets and Economies More Efficient (Jesse Livermore, Philosophical Economics) - U.S. equity index funds have exploded in popularity over the past several decades, from a mere $0.5B in the early 1980s to a whopping $4 trillion today. Yet as indexing has become more popular, many have begun to express concern as to whether so many investors just buying the index, and not doing the fundamental work of studying securities and making company-specific buy/sell decisions, could actually cause securities to become mispriced and give active managers more opportunity to outperform (at the expense of those very index funds). Yet Livermore suggests that in the aggregate, these fears may be incorrect, at least for the foreseeable future. For instance, those who adopt index investing strategies are most likely to be the lower-skilled investors, who capitulate to indexing after failing to succeed in their own investment efforts; yet that means those who adopt indexing were the ones least likely to do anything good for market efficiency anyway, while the highly-skilled investors who are the most effective at driving security prices towards their intrinsic will continue to fulfill that function. And because all indexers hold the same investments (because the index is the index), the highly-skilled investors will only trade with each other, which can even accelerate the process of markets finding their most efficient prices (because there are fewer low-skill investors to cause them to deviate). In other words, the small subset of highly-skilled investors will still set the prices, which determines the (cap-weighted) allocations in the index, and the index investors will still simply buy at whatever prices the skilled investors efficiently priced into the market (because in the aggregate, the average performance of active investors must equal the average performance of passive investors, before accounting for fees, since they all own the same market in the aggregate). In addition, Livermore notes that if lower-skilled investors spend less time trying to (badly) manage their portfolios, and more time in other productive endeavors, the rise of passive investing can literally make the entire economy at least a little more efficient, because it reduces the amount of labor and capital used for price discovery in markets, allowing that labor and capital to be shifted into positive-sum economic activities instead (things that grow productivity and the economy in the aggregate!).

Mark Tibergien Reveals Big Pershing Robo Future And Follows TD Ameritrade's Open API Lead (Brooke Southall, RIABiz) - This week Pershing Advisor Solutions announced that it is adding SigFig, Vanare, and Jemstep to its list of RIA "robo" choices integrated to its custodial platform, as part of a strategic decision to offer its advisors an ever-wider choice of potential solutions, rather than forcing them into a single proprietary experience. And to further facilitate this growth, Pershing also announced that it is opening its API to software makers to make it easier to engineer connections. In turn, this suggests that Pershing may not only add more "robo" tools in the coming years, but an entire "API [app] store" of choices, following the lead of TD Ameritrade, which has built their Veo API platform in recent years and now boasts 105 software integration partners. Commentators note that Pershing's launch will help them to play "catch-up" on robo capabilities, as its announced robo partnership last year with Marstone still hasn't rolled out, and the open API should allow Pershing to upgrade many of its 250+ current integrations as well.

Fidelity's Big Bet Unveiled (Joel Bruckenstein, Financial Advisor) - Fidelity recently unveiled the vision for its next generation "total advisor" technology platform, dubbed Wealthscape. The new platform will be a combination of its current WealthCentral platform (for independent RIAs), and Streetscape (for broker-dealer representatives and hybrid advisors), though the combination is not just about melding two software platforms into one, but also more easily integrating other third-party solutions, not to mention Fidelity's eMoney Advisor planning software. Rather than focusing solely on the fully open API approach, Fidelity suggests that the overwhelming number of choices can be paralyzing for advisors, and that the new WealthScape platform will make it easier for advisors by removing the guesswork about what may or may not work well together, instead delivering a single tightly integrated unified platform (though Fidelity suggests it will still "remain committed to an open architecture environment" for firms who want it). The core features of the new WealthScape platform will include advanced analytics and business intelligence for the advisory firm, automated work flows and integrated portfolio management solutions (including proposal generation, model building, performance reporting, rebalancing, and fee billing), deep eMoney advisor integrations (e.g., Fidelity communications like trade confirmations delivered directly to the eMoney client vault), and a new-and-improved client portal, all built around a central consolidated data platform (which Fidelity indicates will still support multi-custodial advisor relationships). Ultimately, Bruckenstein suggests that the new platform will be a great fit for many advisors, particularly small-to-mid-sized broker-dealers struggling to keep up on technology, along with some RIAs who like the Fidelity integrated experience, though advisors who prefer best-of-breed open architecture approaches may wait to see just how effectively the new WealthScape platform really works with outside third-party providers. Either way, Fidelity is working on the platform now, and expect more announcements in the coming year as features eventually become available.

Hiring An Intern For Your RIA Practice (Kelli Cruz, Financial Planning) - Using interns has long been a popular strategy in many industries, including financial planning, as a way to leverage inexpensive talent while offering a valuable experience opportunity for a young person. However, as it becomes increasingly difficult to find young financial planning talent for full-time job openings, Cruz suggests that internships should be viewed as a long-term relationship strategy, with the ultimate goal of hiring the intern into a full-time position upon graduation. This both provides a pipeline to future talent to hire, and makes the firm's investment into training the intern more beneficial in the long run, in addition to reducing the risk of a "bad" hire by getting a chance to try the intern out in a working capacity before the moment of providing a full-time job offer. Notably, if firms intend to hire into a permanent job position, it makes sense to find interns that will be qualified to do so, which means seeking out interns at CFP Board registered financial planning programs (as opposed to any random local college student). And because the competition for talent is so active at many schools, firms committed to the process may want to try to establish a relationship with the faculty, attend the school's career fairs, get involved with the student financial planning community, and even become a guest lecturer (to become more known on campus, and get the opportunity to identify the top students in person). Also, remember that even though it's "just" an internship, if you're building towards a potential permanent hire, it's important to thoroughly evaluate and interview the intern, which means reviewing resumes, conducting a phone interview (with questions you prepare in advance), consider using behavioral-based interview questions, and be certain to have a clear job description written so everyone knows what's expected. And don't forget that under the Fair Labor Standards Act, you should be paying your interns (and it's more likely to attract qualified talent anyway); the going rate for undergraduate interns is about $13 to $15 per hour.

The Benefits Of A Virtual Mentor (Bala Iyer & Wendy Murphy, Harvard Business Review) - It's long been recognized that having a mentor can help with professional development and career advancement, but today's digitally connected world has made it possible to have "virtual" mentors in an ever-wider range of domains. And a recent study of over 100,000 employees at HCL Technologies (a leading IT and software-development outsourcing company based in India) found that with a platform to help find and match mentors and mentees based on their experience/expertise/interest, there was a strong interest in virtual mentorship relationships. And as adoption of virtual mentorships grew, employees gained all the benefits attributable to 'traditional' mentorships, including guidance about what skills to work on to advance their careers, and making connections to people and groups who could help them move forward. Mentors also benefitted, as the easier access to mentoring partners helped them better float some of their own ideas and get constructive feedback. And since HCL facilitated the virtual mentoring program internally, the employees felt more loyal to the organization, as well. Of course, for financial advisors, there isn't necessarily a large parent company involved to facilitate mentoring, but the study's authors found that social media tools make it possible for anyone to find and then cultivate virtual mentor relationships, both inside and outside their organizations.

In An Age Of Privilege, Not Everyone Is In The Same Boat (Nelson Schwartz, New York Times) - Norwegian Cruise Lines recently launched a new 4,200 passenger ship, and it includes an area called the "Haven", which provides 275 elite guests a concierge and 24-hour butler service, private pool and sun deck and restaurant, and more. The elite-passenger offering is part of a rising trend of businesses trying to cater to upper income consumers, and while it has always been true that many businesses pursue the affluent (on the Titanic the rich were also separated from the rest of the passengers on the ship, with metal gates!), in today's world companies are getting better than ever at identifying their top customers and knowing which psychological buttons to push. For instance, top travelers on Delta now get ferried between terminals in a Porsche, and Walt Disney World has an "after-hours access" option for elite guests, basically allowing them to get the Magic Kingdom all to themselves. Yet still, the segmentation of "the rich" from everyone else seems to be getting more extreme, if only because big American companies are going further and further than ever before to pamper the biggest spenders. In turn, the trend is raising questions about just how obvious the distinctions should be, or risk creating a form of money-based caste system, especially since companies have found that at least some of the elite passengers often complain if they're not also surrounded by similar peers. Nonetheless, as growth in consumer spending for the top 5% of earners continues to rise faster than everyone else, high-end services for big spenders is a growing business, and doesn't look like to subside anytime soon.

The Rise Of American Authoritarianism (Amanda Taub, Vox) - The American media, along with the Republican political establishment, has struggled mightily over the past year trying to understand the ascent of Donald Trump, and why his sometimes extreme statements have not caused him to flame out but instead led him to clinching the GOP presidential nomination. A recent line of research in political science appears to have the answer: that over the past several decades, there has been a growing but largely unnoticed group of the electorate: authoritarians, a group that is characterized by a strong desire for order and a fear of outsiders, who look for strong leaders that promise to take whatever action is necessary to protect them when they feel threatened. In fact, a very recent study found that whether a voter's views align with authoritarianism predicts support for Trump more reliably than virtually any other indicator. And the authoritarian rift is coming from within the Republican party, because the GOP's positioning since the 1960s as the party of traditional values and law and order has unknowningly attracted the group, whose desire for an authoritarian leader has been stoked by the growing economic stresses of the past decade (from the financial crisis to stagnant real wages to demographic and immigration shifts that have further emphasized the role of 'outsiders' impacting these trends). In addition, the authoritarian research finds that the more people live in fear of the world around them, the more authoritarian tendencies are activated, which ironically means that as the Republicans tried to challenge Trump by creating fear about the future, those rising fears were more likely to just accelerate Trump's support even further. Notably, in this context the point is not to use the "authoritarian" as a judgmental term (in fact, the researchers have been trying to come up with an alternative label), but simply as a way to describe a certain voter profile (based on Karen Stenner's "The Authoritarian Dynamic"). Still, the rise of the authoritarians is significant, because it suggests a movement that actually exists independently of Trump, which means whether Trump ultimately wins the presidency or not, authoritarians as a voting block will be here long beyond 2016. The dynamic may be especially challenging for Republicans, as authoritarians have overlapped Republicans in many areas, but are fundamentally different on many key issues, which indirectly explains why establishment Republican candidates failed; for instance, authoritarian fear of outsiders caused them to reject the Republican establishment's conciliatory tones on immigration after the 2014 mid-term elections, while the authoritarians don't particularly care one way or another about a number of classic Republican issues (such as opposing affirmative action or lowering taxes). Going forward, this suggests that the American political system could operate with a de-facto three-party configuration for the forseeable future: the Democrats, the GOP authoritarians, and the GOP establishment, leaving neither side of the GOP with enough votes to control the legislative process, and at best forcing the GOP to dramatically reconfigure many of its policy views to have any chance of uniting the two segments of the party against the Democrats in coming elections.

Wonderful Worlds [That Never Existed] (Morgan Housel, The Motley Fool) - As Housel notes, the easiest way to rationalize today's problems is to recall a time when they didn't exist, which makes today's frustrations seem temporary and fixable, but the truth is that often our nostalgia for the times that were actually "remembers" a world that never actually existed. For instance, there is widespread concern that the median retirement account balance for workers age 55-64 is only $76,381, barely 1/3rd of what a typical couple will need for medical expenses alone in retirement, which is often contrasted with the times-of-old when "everyone had a pension" and they were "universally accepted and expected" decades ago. Except that's not actually true. When pension coverage peaked in 1979, there were still only 38% of private workers in a defined benefit plan, compared to approximately 64% of workers who participate in a 401(k) plan today; while there was a time when pensions were standard at large, deep-pocketed companies, there was never a time when those companies employed most Americans, as the majority of workers are at smaller businesses that don't offer a pension and never did. Similarly, we often lament government deficit spending and wish for the days when the U.S. government ran a balanced budget... except it almost never has. The government has run a deficit for 84 of the past 115 years (73% of the time), and most surplus years were during the 1920s and 1990s, time periods that we now recognize were actually bubbles; the only other time the government ran a multi-year surplus was immediately after World War II, as military spending fell but war-time taxes remained. And complaints about today's market volatility are the same as well; while it's often said that "managing risk and building the 'right' portfolio is harder than ever in today's volatile market environment", the reality is that the markets aren't any more volatile now than they ever were. In fact, based on the standard deviation of weekly market returns, the current decade (2010-2015) is actually less volatile than any decade since the 1960s, and based on monthly or annual volatility the current decade's market volatility has been the least volatile in the past 100 years! The bottom line: the problems of today really aren't any different than the problems of the past. And if we got through the past ok, that should actually be encouraging about the outlook for the future, too!

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!