Weekend Reading for Financial Planners (May 9-10)

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 9th/10th:

Envestnet Acquires FinanceLogix As The Integrated Financial Planning And PFM Buying Frenzy Continues (Michael Kitces, Nerd's Eye View) - As the annual Envestnet Advisor Summit got underway this week, the big opening announcement was that Envestnet has acquired financial planning software maker FinanceLogix for $24M cash plus over $6M in Envestnet stock (and some additional long-term options). The deal marks the third financial planning software acquisition in just the past 3 months, after eMoneyAdvisor was purchased by Fidelity, and LearnVest was bought by Northwestern Mutual. While the FinanceLogix deal was smaller - the other two acquisitions were for $250M+ - the recent Financial Planning magazine Tech Survey shows that FinanceLogix had about 1/5th the user base as eMoney, which implies that perhaps the FinanceLogix valuation was similarly valued. From Envestnet's perspective, the acquisition suggests that the company may be trying to build a "Holy Grail" technology platform for advisors, as given Envestnet's other acquisitions in recent years - including Tamarac rebalancing software and the Upside Advisor "robo-advisor-for-advisors" platform - it has now assembled what is virtually the entire unified technology stack for advisors. Though it remains to be seen whether Envestnet can successfully integrate all these platforms and keep them cutting edge, given that other companies who have tried to build Holy Grail solutions have struggled to keep up with the pace of technology in the long run. In the meantime, from the perspective of financial planning software itself, FinanceLogix will remain open to existing and new advisors, but the acquisition itself means the available pool of financial planning and personal financial management (PFM) solutions for potential acqsuition continues to shrink, in what was already a relatively sparse landscape of competitors, which means the next acquisition by a large financial services firm could even spark a bidding war for the remaining players.

Will Vanguard’s New Hybrid Platform Crush Robos? (Janet Levaux, ThinkAdvisor) - This week, Vanguard announced that it is expanding its Vanguard Personal Advisor Services offering, dropping its asset minimum to as little as $50,000 (from a prior minimum of $100,000) while keeping its 0.3%-of-AUM price point. In a related article, it was also revealed that Vanguard's "robo" unit is now up to a whopping $17B of AUM, including $7B of new assets, and $10B transferred from its existing Vanguard Asset Management Services. Notably, though, despite its common characterization as a "robo-advisor", the Vanguard solution actually provides access to human advisors, who are simply engaged virtually/online with Vanguard's clients; those with more than $500,000 in assets will have a dedicated advisor, while those below the threshold will be assigned to a team of advisors to create the client's financial plan, as well as provide monitoring and rebalancing services. Portfolios are generally implemented with Vanguard mutual funds (though existing non-Vanguard holdings can be incorporated as well). As the serve grows, some have raised questions of whether the Vanguard solution will squash the existing robo-advisor platforms with its human-hybrid solution, although others - including yours truly as quoted in the article - have raised the question of whether Vanguard is going to raise the minimum bar for the quality of financial planning advice from existing human advisors as well.

Incorporating The ABLE Act Into Special Needs Planning (John Nadworny, Journal of Financial Planning) - After nearly a decade of legislative efforts and lobbying, last December President Obama signed into law the ABLE Act, which will create a new form of Section 529 "ABLE Account" that can grow tax-deferred and ultimately be spent tax free for qualified expenses (including housing, health, transportation, and more) of a disabled beneficiary. Only one ABLE account can be set up for a disabled beneficiary (who must have become disabled before age 26 to be eligible), which will be administered by the state (where each state will likely run its own plan) and the maximum annual contribution (from anyone/everyone) is the annual gift exclusion amount, currently $14,000/year. The benefit of 529 ABLE accounts is that up to $100,000 of assets can be accumulated without impacting eligibility for state and Federal aid (though expenditures for housing may impact SSI eligibility). The drawback is that 529 ABLE accounts will have a "Medicaid payback" provision that requires Medicaid to be paid back for any amounts expended on behalf of a beneficiary if an account balance remains at death. Some potential planning situations for 529 ABLE accounts include: individuals with disabilities who generate some income of their own can save it in an ABLE account without disqualifying themselves from SSI; a minor who is a special needs child can use an ABLE account to shelter existing assets he/she has when turning 18 to avoid being disqualified from aid (but without being forced into a spend-down or to create a Medicaid payback trust that may not be economical to have drafted); and grandparents can fund an ABLE account for a disabled grandchild. Given the 529 ABLE account limitations, they may not necessarily be a "cornerstone" of a family's special needs planning strategy, and especially not for very high-net-worth families that may still wish to use a special needs trust for estate planning purposes; nonetheless, expect to see growing interest in using 529 ABLE accounts and their tax benefits as a part of the special needs plan.

Will Low Returns Wreck Retirement? (Michael Finke, Research Magazine) - Today's low yield bond environment is creating challenges for retirees; given an average TIPS yield of just 50 basis points above inflation, retirees could only use such bonds to safely secure 27 years of cash flows at a 4% initial withdrawal rate, which is problematic as almost half of higher-income couples would be expected to still have at least one spouse alive at that point. Of course, rates have been low at various points in history in the past, but Finke notes that such low real yields have historically been at times like the Great Depression, World Wars I and II, and in the late 1970s - all time periods when investors were scared of stocks (bonds had rallied on the flight to safety), which meant that even as bond yields got low, stocks had gotten very cheap. Yet in today's environment, stocks are "expensive" based on long-term valuation measures like Shiller CAPE, which is typically associated with an equity return about 3 percentage points below the long-term average. Accordingly, even Monte Carlo tools that aim to predict retirement income sustainability based on a range of possible outcomes may be understating the risk of especially low combined stock and bond returns. Notably, this doesn't necessarily mean that equity-centric portfolios will be bad - in fact, with low-yield bonds, they may be more crucial than ever - but Finke notes that overall, the dangers of failure may be higher than is commonly believed, and that this will continue to increase the focus on tools and techniques to manage retirement in the low-return environment.

Deactivating Active Share (Andrea Frazzini & Jacques Friedman & Lukasz Pomorski, AQR) - Active Share is a measurement of the extent to which a given portfolio deviates from its underlying passive benchmark; a totally passive portfolio overlaps completely with its benchmark and has an active share of 0, while a portfolio with no overlap to its benchmark has an active share of 1. The measure has become more popular after a research paper by Cremers and Petajisto - which first proposed the measure - found that managers who deviated more materially from their passive benchmark (i.e., had higher Active Share) were more likely to outperform (and to do so persistently). However, the AQR team suggests that the Cremers and Petajisto result may be spurious - the majority of high Active Share funds are small caps and the majority of low Active Share funds are large caps, and once benchmarks are controlled for, the predictive power of Active Share dissipates. More generally, AQR also makes the case that there is no sound economic theory to substantiate Active Share either - funds with Active Share are more likely to deviate from their benchmark, almost by definition, but doesn't necessarily mean there's a reason to expect that deviation to always be to the upside as outperformance. And in fact, it's not even necessary to have high Active Share to generate material outperformance, as long as the low active share chooses or avoids high-impact outcomes; for instance, a portfolio of 499 stocks that avoids just the one worst stock in the S&P 500 for the past 25 years would beat the S&P 500 benchmark by a whopping 93bps/year (before fees) despite an Active Share of only 0.4%, and dropping just the worst 5 stocks (and owning the other 495) would beat the S&P 500 by 4.51% per year with active share of a mere 2.2%! Notably, AQR certainly does acknowledge that have a low Active Share fund with high expenses is still a concern - fees do matter - but the fundamental point is that the mere fact a fund has high Active Share isn't necessarily predictive that it will outperform, merely that it deviates enough from its benchmark that it could.

The Biggest Problem With Your Advisor Business? You (Angie Herbers, ThinkAdvisor) - In a world where even "large" advisory firms are relatively small businesses, and tend to be fairly simple as businesses - serve your clients, bring on more, and handle the core financial and operational aspects - Herbers makes the case that even troubled advisory firms don't actually have "business problems", they have owner problems. In other words, the problem isn't actually a true problem of "the business", it's a problem of the owner and his/her role in or management of the business. Unfortunately, though, that actually means that most advisory firm problems are very difficult to fix, because owner problems require a lot of challenging and time-consuming personal change. And because advisory firms go through evolutionary stages as they grow, and face a series of 'new' walls that must be broken through (bringing on a first employee, or a first professional employee, or a first partner, or doing a first acquisition, or going through a first merger, etc.), the challenge for advisory firms is that owner-advisors must continually be changing to adapt, which in turn means owners are continuously forced into new situations with which they are unfamiliar. In turn, this continual progression into unfamiliar territory can shake our confidence, which only compounds indecisiveness or risks triggering bad decisions. Accordingly, Herbers suggests that the solution is that first we have to get confident in ourselves - whatever stage we're in - building on small successes, and use that to remotivate ourselves to build forward again. From there, we can figure out how to be effective leaders to move the firm forward, set goals, and create the relationships necessary to build. But the key point lies in just recognizing that as an owner, if there are 'problems' in the firm, it may require first "fixing" ourselves - or at least, recognizing the role that we play - in order to solve the problem and move forward.

Advisor Retreat? Make Sure It Pays Off (Dave Grant, Financial Planning) - Grant recently created a "mastermind" (study) group of fellow advisors, who have been meeting with weekly video calls, but decided to come together for a 3-day retreat. To prepare, the group created an agenda in advance, covering key issues for all those involved, which in this case included everything from some technical planning topics to a discussion of investment philosophy and ideas to grow the practice (with time limits set for each area, and leadership of each topic rotating around the group based on their expertise). The group deliberately did not host at anyone's house/office, and instead went to a 'neutral' location so everyone could focus, ultimately opting to take on a spacious short-term rental house that - split across the group - was both cheaper than a hotel, and a more flexible accommodation that allowed everyone time to bond as well; in fact, built-in downtime to the agenda was included specifically to allow for time to make deeper connections. Ultimately, the gathering was so rewarding for all involved that the group plans to make it a regular occurrence.

What No One Tells New Advisors (Owen Caterer, LinkedIn) - There isn't much 'unvarnished' advice out there for advisors who are just joining the industry, so Caterer offers up some tips from his own perspective. The key points are: recognize the industry is in change, as the world moves towards getting paid for advice and away from products with upfront commissions (which have been banned to various degrees now in the UK, Australia, Hong Kong, Singapore, and more) which is good for consumers but a challenge for new advisors who can't get that infusion of income that comes with signing a few big deals on commission; this is a helping profession, so you should join because you like helping other people, not (just) yourself - and if you don't like people, this is not the industry for you; you will ultimately probably have to find clients, so be ready to tackle the challenge; pick your mentors carefully, and be certain to get one that is doing business the way it will be done in the future, not as it's been in the past; recognize that you need to put in the hours before you can hit the golf course (yes, financial advising can be a 'dream job' in the long run, but it takes years to get there, with few shortcuts); and if you want to really become a trusted advisor, be ready to become a true expert, not just a great salesperson.

Do You Suffer From Kevin Costner Syndrome (Ric Edelman, Financial Advisor) - Most of us are familiar with the famous Kevin Costner movie "Field Of Dreams", where Costner played a farmer who built a baseball field in the middle of his crops in response to a mysterious voice that suggested "If you build it, he will come." Edelman suggests that in today's environment, too many advisors are also pursuing an "if you build it they will come" approach, failing to recognize that just being a talented and skilled advisor isn't enough, if no one knows in the first place. In other words, it doesn't matter how good of an advisor you are, if you can't figure out how to market yourself and your services. So how do you market effectively as an advisor. The first key step is recognizing that you must find/identify your target audience - what kind of person do you really want to reach, demographically and even "psychographically" - because if you don't know who you're trying to reach, it's impossible to target a message to reach them. Next, you have to decide how you're going to reach those potential clients - will you have a message that tries to "sell" yourself and convince them to buy, or one that educates and lets them come to you (either is an option, though Edelman opted for the latter, as evidenced by his radio and television shows, books, seminars, etc.). After that, you have to decide what platform you'll use to reach your target clientele - will you advertise online, or on the radio, or via some other medium to reach that audience of potential clients? Of course, once all of that is done, you have decide on the actual message you'll pursue - and Edelman cautions that it needs to be a simple, direct, single message. Yes, you may have a lot of knowledge and stuff to communicate, but communicating everything ultimately communicates nothing as people get confused and lose interest. And while all of this may sound time consuming and challenging, the bottom line point is that advisors don't really have a choice; this isn't an "if you build it they will come" world, so be ready to make the commitment, or join a firm that will help to do it for you.

Retirement Planning Needs A Better UX (Shlomo Benartzi, Harvard Business Review) - As the debate about the Department of Labor's fiduciary proposals rage on, Benartzi makes the case that our need to update the fiduciary framework extends beyond just issues like fee transparency and disclosing conflicts of interest, but that we need to update our fiduciary standard for the digital age when increasingly major financial decisions are made using computer screens and smartphones. Specifically, Benartzi points out that plan fiduciaries could 'unwittingly' have a significant impact on the behaviors of their plan participants - in support of or violation of their fiduciary duties - with issues as simple as how choices are presented. For instance, in a recent test study, two groups of investors were presented with a decision to allocate retirement assets across up to 8 different investment funds; the first group had up to four blank lines to fill in when selecting funds, while the second group had up to eight blank lines to fill in. As the results showed, this relatively simple difference had a big impact; when presented with four lines to fill in funds, only 10% of people diversified across four funds, but when eight lines were presented, 40% selected at least four funds to diversify! Similarly, badly designed websites - such as ones with onerous username and password requirements - can significantly decrease participation rates; in other words, poor digital design can adversely impact participation in 401(k) plans! Conversely, improved design comes with improved results; in one test case, the U.S. government partnered with H&R block to pre-fill up to 2/3rds of student loan applications based on available family tax returns, and the end result was that students were 40% more likely to submit a loan, 33% more likely to receive a needs-based scholarship, and 25% more likely to attend college! The bottom line - a good execution of retirement plans in the best interests of consumers is about more than just better transparency and disclosures of financial costs and conflicts... simple user design recognizing how consumers interface with their finances and the world of retirement can have a very material impact, too!

Here's What Top Firms Are Doing Right (Bob Veres, Financial Planning) - The standard practice management techniques, like using technology efficiently, systematizing your processes and procedures, and compensating staff for what you want to accomplish, are quickly becoming mere table stakes for the top firms. Instead, Veres notes that the real breakthrough focus of top firms - based on a recent visit to the Ensemble Practice coaching program - is in the top firms' approach to talent, and the recognition that developing staff into future leaders and partners may have a better ROI for a firm that virtually anything else. In turn, this means that good advisory firms must always be ready to hire quickly and opportunistically when a good candidate appears, as only a small number of people have the qualifications and motivation to be a leader so they should be pursued actively when they come along. And once those people are in the firm, they should be supported with more attention from upper management, more recognition and opportunity, and a visibly accelerated career path, as long as they continue to perform well. In fact, arguably the CEO's most important job is to spend quality time with the best people at the firm, especially the early adopters and the talented and motivated staffers. Putting people onto a leadership track also identifies those people who can be tapped with the opportunity to step up as leaders and change agents when new projects are initiated. Similarly, recognize that created a management structure that is too flat and a culture that is 'too' democratic is also problematic, as it can discourage the top performers who want to feel recognized and rewarded for their successes. The bottom line: for advisory firms to succeed in the long run, it's all about the ability to develop the future leaders that will take the firm there, and advisory firm owners who want to succeed may need to spend less time doing, and more time focused on helping to mentor the doings of future leaders instead.

The Day Wall Street Changed (Jason Zweig, Wall Street Journal) - Last week marked the 40th anniversary of what Zweig suggests was "the most momentum day on Wall Street since the predecessor of the New York Stock Exchange was formed in 1792." The significant event was "May Day" of 1975, when fixed-rate commissions on stock transactions were abolished by regulators. Up until that point, it had for the preceding 183 years(!) cost the same amount per share to trade 100 shares or 1,000 or 100,000 (and brokers regularly shaved 2% or more for themselves as well); in other words, there was no volume discount for institutional buyers, and overall transaction costs between a minimum trading commission to the stockbroker and wide bid-ask spreads averaged a whopping 2.5%. The deregulation of those fixed trading costs, driven in part by a "trustbusters" effort from the Justice Department under Nixon, was forecasted by the brokerage industry to be destructive and that it would "bring about the downfall of our free enterprise system", and the NYSE even threatened to sue the U.S. government to block the effort. Yet as Zweig notes, for all the forecasts of doom, it turned out that getting rid of the monopolistic restrictions led to a massive boom for the industry, its most explosive profitability ever, costs for trading fell over 80% (from 2.5% down below 0.4% today), and it turns out that when brokerage firms treat customers more fairly, both the customers and the industry prosper. Which Zweig suggests is a telling tale for today's environment, when once again regulators are pressuring the brokerage industry to treat its customers more fairly by applying a fiduciary duty, the brokerage industry is insisting that it will lead to a disaster for consumers, yet history suggests that when Wall Street is eventually forced to do the right thing, consumers simply benefit with more access to services and lower costs after all?

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! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!

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!