Weekend Reading for Financial Planners (Nov 17-18)

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.

Commonwealth Financial Network Launches [Standalone] RIA Unit (Tobias Salinger, Financial Planning) - The hybrid broker-dealer movement, where B/Ds add a corporate RIA that their advisors can dual-register themselves with, has been underway for the better part of 10 years now, and the majority of registered representatives at the industry's largest broker-dealers are now dual-registered. However, #4 independent broker-dealer Commonwealth Financial has announced that earlier this year, they launched an entirely standalone "RIA Services" division, now staffed with 22 employees, who are providing support for 75 advisors that have completely abandoned their Series 7 licenses and gone "full" RIA (either under Commonwealth's corporate RIA or as their own independent RIA) while otherwise remaining with the Commonwealth platform. The move is significant, as it signals a coming reinvention of broker-dealer platforms themselves to be less focused on product distribution (and the associated FINRA licenses), and instead becoming outright competitors in the world of RIA support and infrastructure services, alongside what are still very small (by advisor headcount comparison) competitors like Dynasty Financial and HighTower, who also provide multi-custodial RIA infrastructure and support. In fact, Commonwealth specifically noted that its new RIA division is intended to compete for attention with standalone "fee-only" RIAs, and to capture (or at least retain) the growing trend of advisors who are dropping their FINRA licenses altogether as they fully transition their firms fee-based (only to discover that many still want the support of what broker-dealer platforms provided, albeit outside of the product distribution and product compliance oversight functions). If the trend continues... perhaps in 10 years, broker-dealers like Commonwealth will have completely reinvented themselves as RIA support platforms and "spin-off" their no-longer-relevant legacy broker-dealers?

Interactive Brokers Eyes RIA Accounts As It Rolls Out Platform (Dan Jamieson, Financial Advisor) - Historically known as an online discount brokerage firm catering to active traders and small hedge funds, Interactive Brokers announced this month a series of platform enhancements intended to compete for advisors' business in the RIA channel. In point of fact, the company already serves a reported 4,289 RIAs, but most are believed to be amongst their small hedge fund and proprietary trading firms on the platform, not more "traditional" wealth management RIAs. But Interactive Brokers is now adding new capabilities to its native CRM interface, along with opening up its account aggregation and portfolio analysis tool aptly called PortfolioAnalyst (akin to Morningstar's Portfolio X-Ray feature), and bolstering its banking and cash management services (now permitting a bill-pay capability with a debit card directly against the firm's investment accounts). Though for some advisory firms, the appeal is simply Interactive Broker's ultra-low trading costs of $1 or less per trade (along with global markets and currency trading). Which means Interactive Brokers may still cater more to the active-management-oriented advisor than the fully holistic-wealth-management-oriented RIA, but opens up another competitive option for advisory firms looking for a low-cost platform to actively trade client portfolios.

TCA By E-Trade Lures Edelman Financial Engines With Promise Of Client Referrals (Jeff Benjamin, Investment News) - Earlier this year, niche RIA custodian Trust Company of America (TCA) was acquired by and merged into E-Trade, in what was widely viewed as a strategic step for E-Trade to move deeper into the RIA channel and away from being "just" a pure retail discount brokerage firm. And now, TCA by E-Trade has announced a major deal where Edelman Financial Engines will begin to use the TCA by E-Trade platform (for an undisclosed amount of assets moving to E-Trade, or what may just be new assets that Edelman's firm adds to TCA going forward), in exchange for being able to participate in the pending launch of E-Trade's new Advisor Network program (ostensibly intended to mimic similar offerings at Schwab, Fidelity, and TD Ameritrade, that turn "less profitable" or higher-demand retail investors into advisory clients for related RIAs that may ultimately make the clients more profitable for the brokerage platform as well). Given how lucrative the advisor network programs have been for many independent RIAs, it's not entirely surprising that Edelman's firm would be lured by the opportunity of a fresh Advisor Network platform to prospect on, and in practice it's become not-uncommon for RIA custodians to use their advisor network platforms as a carrot to dangle to attract assets from large RIAs. In addition, E-Trade also has a corporate services division with assets of Fortune 500 executives that may also be a cross-referral opportunity for firms like Edelman's. Though, at the same time, the success of advisor network programs, in an age of rising competition amongst RIAs, is turning the ability to qualify for and participate in such programs controversial unto itself, as TCA notes that while Edelman's firm will participate, not all of its own legacy advisors will qualify.

Cost Is King For RIAs Picking ETFs But Performance Still Comes Close Second (Ian Wenik, CityWire) - According to a recent study of advisor investment trends from Schwab, the most important factor when picking index funds and ETFs is cost, which 66% of RIAs rate as extremely important, while the brand name of the provider mattered least (albeit still with 43% of advisors stating brand is "extremely" important and another 47% stating it is at least "somewhat" important). Of course, the challenge is that as ETF costs race closer and closer to zero, at some point it will literally be impossible for advisors to differentiate ETFs on cost alone. To explore this, the Schwab survey also questioned advisors on the factors that would drive selection assuming two funds had the same cost and the same objective... at which point advisors perhaps unsurprisingly concluded that performance history (58%) and track record (49%) were most important, while ancillary services from the asset manager like "portfolio construction education and guidance" for advisors and/or their clients ranked at only 37% and 33%, respectively. Although notably, when asked to rate asset managers themselves (rather than just index funds and ETFs), advisors did not report the availability of low-cost funds as a dominating factor, and instead focused first and foremost on trust (80%) and performance (78%), though once again as with other recent studies Schwab's results showed that the asset manager's practice management advice was rated as far less relevant (only 58% of advisors). In other words, notwithstanding a lot of the non-investment "value-adds" that asset managers are trying to provide in recent years to stay competitive, the advisory industry is increasingly focused on selecting providers based solely on their results... and trust (that those results will be likely to persist in the future).

An Excellent Pure-Play Inflation Hedge (Brian Moriarty, Morningstar) - While still low by historical standards, the Consumer Price Index (CPI) has begun to "firm up" with the ongoing economic recovery, with inflation for 2018 on pace to be the highest in 7 years. Of course, the Fed's actions to increase interest rates and keep the economy from overheating will theoretically prevent inflation from accelerating much faster or further... but nonetheless, the uptick in CPI has begun to raise the discussion with some clients about hedging against inflation. For which Morningstar's latest Fund Analyst Reports suggests that Vanguard's Inflation-Protected Securities (VAIPX) is still one of the most compelling options available. Notably, the Vanguard fund is not a pure index fund like many of Vanguard's others, as while it does track and benchmark to the Bloomberg Barclays U.S. Treasury Inflation Protected Index, the Vanguard team can and does periodically make high-conviction tilts towards or away from the index (though still only with relative bets amongst bonds, as the fund is almost entirely invested into TIPS, and does not add in higher-risk inflation-hedging vehicles like commodities). Notably, with inflation low in recent years, the fund has generated an annualized return of just 1.3% over the past 7 years (albeit still enough to beat 80% of its peers!), but given an expense ratio as low as 0.10% (for the Admiral share class), and strong ratings for Vanguard as a parent company, VAIPX scores an overall "Gold" Analyst Rating from Morningstar for those seeking inflation-hedging protection in the face of a potentially-heating-up economy.

C-Sharing: Declining Revenue (John Anderson, SEI Practically Speaking) - Based on broad industry research, SEI estimates that the average advisor's business is about 2/3rds fee-based and 1/3rd commissions. Of which a material portion of commissions are often old 12b-1 trails from A-share mutual funds, or higher-payout C-share mutual funds back when it was "easier" to get 1% on a C-share than to open up a 1% advisory account. However, not only is there an ongoing trend away from broker-dealer-based C-shares and into advisory accounts, but regulators are increasingly scrutinizing the use of C-shares (especially amongst hybrid advisors who could also simply be charging a 1% advisory fee instead), and to the extent that C-shares were really only intended to be "levelized commissions" (paying out a sizable upfront commission at 1%/year over several years) and not an indefinitely paying 1% trail, a growing number of asset managers (including Blackrock, Franklin Templeton, Fidelity, and Putnam) are now beginning to "automatically" convert C-shares to A-shares after 7-10 years (cutting the 12b-1 fee commission trail from 1% down to just 0.25%!). Accordingly, Anderson suggests that as the end of year approaches, it's a good time to take a fresh look at your current use of C-shares (if you still have any), and reassess whether they still make sense... if only to convert from a C-share 12b-1 trail into an advisory share class and then move the client into an advisory account so the advisor can actually continue to get paid 1%/year for the foreseeable future (assuming, of course, they're still providing ongoing advice to justify the fee!). Alternatively, though, the starting point may be to simply look at your current book of C-share clients, figure out if there are commonalities they share (that the advisor can effectively service), and decide whether it's time to do more to enhance the relationship, or simply transition the clients away because they're no longer a good fit... before the looming automatic conversion from C-shares to A-shares cuts the advisor's revenue anyway.

In Defense Of Wall Street (Barry Ritholtz, Bloomberg) - In his recent 2010 book, "Enough: True Measures of Money, Business, and Life," Vanguard founder Jack Bogle stated that the "financial system subtracts value," but Ritholtz suggests that - notwithstanding his own frequent criticisms of many Wall Street practices - there is still a fundamentally positive value to the functions that Wall Street fulfills. First and foremost is the ability of Wall Street to steer capital towards new ideas and new inventions, from the light bulb to the iPhone, where eventually it was Wall Street capital that helped to scale the reach of those innovative breakthroughs. Of course, the fact that investors have the potential to participate in the next Apple can also lead them to a number of bad investments and busts, but the fact that many Wall Street investments end out losing value isn't a sign of the failure of Wall Street, but simply the fundamental nature of risk-taking investments of capital. Similarly, Wall Street not only fulfills the need of businesses to access equity capital, but also credit, along with helping to distribute the risk-taking of credit lending by securitizing loans (which can ultimately bring down the cost of borrowing by making it easier for lenders to diversify their risks). And of course, it's the capitalistic innovation of Wall Street itself that's allowing the financial services industry to reinvent itself, from low-cost index funds and ETFs cannibalizing higher-cost legacy players, to simply making it easier for the average household to participate in the compounding wealth investment opportunities of the system. Which means that while there are some problems and excesses on Wall Street, which are often very high profile when they blow up or fail, the point remains that one of the "good" things about Wall Street is that eventually, it even drives reinvention of itself too. (Even if not as quickly as some might hope.)

What To Do When Couples Have Differing Risk Tolerances (Dan Moisand, Financial Advisor) - While financial planning projections show the ability of a couple to achieve their financial planning goals, the reality is that couples don't always have the same goals, nor the same risk-tolerance about the best pathway to achieve those goals. In the case of goal disparities themselves, a good financial planning process can often help clients to reconcile their differences and come to shared goals, particularly if the advisor (and software tools) help to more effectively frame the trade-off decisions for them (e.g., "If you want to pay cash so Junior can come out of college with no debt from an Ivy League school, you can be confident your retirement income will be at least $X/month. If he goes to an in-state public school, $Y/month is more likely."). However, reconciling differences in risk tolerance to pursue those now-agreed-upon goals is much more difficult. In part, that's simply because the process of measuring risk tolerance itself is still a challenge, and many of today's risk tolerance tools aren't actually up to the task, although a good starting point is to at least give couples their risk tolerance questionnaires separately and then collectively discuss the results (and any disparities). If the couple's results are materially different, and can't otherwise be reconciled, Moisand suggests a few potential paths, including negotiating a common portfolio that is a compromise between the two (but be prepared for extra hand-holding for the less-risk-tolerant spouse whose lower tolerance isn't being fully accommodated), creating two (or more) portfolios for each spouse separately and letting each be anchored to their respective portfolio's risk (while affirming that the combined allocation in the aggregate still has a reasonable chance to achieve their combined goals), or simply taking a more authoritative approach as the advisor of determining the "right" portfolio based on the couple's shared goals and then focusing the advisor's time on coaching both clients to stick with the plan and ensure that their risk perceptions don't deviate from reality.

Why Webinars Are Effective In Volatile Markets (Bob Hanson, Advisor Perspectives) - When market volatility spikes, clients often start calling... and even if they don't, advisors often want to proactively reach out to clients with phone calls or in-person meetings just to ensure clients' nerves aren't fraying. Except the challenge is that most advisors have too many clients to efficiently meet with all (or even most) of them in quick succession on volatile market days or weeks. The alternative? Reach clients in a one-to-many format with a webinar. The appeal of the webinar format is that it's feasible for the advisor to reach and "be seen" by lots of clients at once. And because the webinar is done once (centrally) and can be repeated many times, a webinar for clients once recorded can be broadcast live, repeated as a subsequent "virtual-live" event, and then sent directly to any clients who didn't attend and might want to watch the recording. Alternatively, the advisor can also use a webinar format to showcase outside expertise to further reinforce the advisor's value proposition, such as pulling in an economics expert or an investment thought leader (e.g., from the firm's home office, or by engaging an outside expert). And in turn, that webinar content can then be further repurposed, such as writing up the webinar into a white paper or turning it into a blog article for the advisory firm's website. Not to mention being shared out to Centers Of Influence (COIs), who might then share it with their friends and colleagues, further amplifying the advisor's potential for referrals. But for many advisors, the most appealing part of the webinar format is simply the chance to deliver a key message in one hour to dozens of clients, rather than spending dozens of hours seeing each client one at a time. (Of course, there's still room to follow up individually with the known-to-be-most-nervous clients who might need a little additional hand-holding!)

Want To Attract Millennial Investors? Time To Rethink AUM Pricing! (Ryan Neal, Investment News) - As the average age of both financial advisors, and clients themselves, continues to tick higher, more and more financial services firms are trying to figure out how to shift to reach next-generation, Millennial clients. Except under the traditional AUM model, small portfolios just don't generate very much revenue, making it difficult for firms to service Millennials unless they provide a very simple and automated solution (e.g., a robo-advisor). But in a recent research study entitled, "Nothing To Lose: Pricing for the Next Generation of Wealth Management Clients," pricing and business model consultant Matthew Jackson of Simon-Kucher suggests that the industry's problem in trying to reach Millennials is its adherence to the AUM model itself. Instead, the alternative is to adopt a more fee-for-service model that simply charges clients directly for advice services, unhinging the firm from needing to find Millennials with sizable portfolios, and focusing allowing any Millennials who want advice to just pay for it outright. Jackson notes the advisors of XY Planning Network as a case-in-point example, where advisors have a wide range of fees for various services, typically presented transparently on their websites for prospective clients to choose from, and clients can then blend together what they wish to pay for (e.g., a small AUM fee for investment management services if desired, or simply an ongoing monthly fee for ongoing financial planning advice). All of which is being expedited by the rise of payment processing platforms for (recurring) financial planning fees like AdvicePay. In fact, the irony of the industry's woes in serving Millennials is that despite fears that next generation clients won't want to pay for human advisors, it turns out that Millennials are most willing to pay advice fees, while it's Baby Boomers who are actually the least willing to pay for financial planning advice (primarily because they're already accustomed to receiving it for "free," packaged with other insurance and investment products for the past 30 years).

Getting Flat Fees Right (Sara Grillo, Advisor Perspectives) - The ongoing shift in the advisory industry towards flat-fee and retainer models is done in part to open up new segments of clientele who can't be served by the traditional AUM model, but also simply as a way to reduce the advisor-client conflicts of interest that still exist with the traditional AUM model. Yet as Grillo notes, any business relationship where a service-provider wants to get paid (more) by a client who wants to manage their costs (lower), means there is still some fundamental conflict of interest. In the context of flat fees, this arises as the potential disparity where either the client pays the flat fee and then doesn't consume enough services to make it worthwhile, or the advisor receives the flat fee and then ends out needing to deliver more than what was anticipated. And over time, the pendulum may swing from one side to the other as the needs of the client rise and fall... which isn't necessarily problematic, as long as the balance doesn't fall too out of whack. Accordingly, Grillo suggests a number of stabilizers or "equalizing adjustments" that can help to ensure the flat-fee relationship (and value proposition) stays in reasonable alignment for both parties, including: set a time adjustment for especially high usage (e.g., time allocated is anticipated to be 2 to 10 hours per month, but overages above 10 hours will be billed at $250/hour); include an automatic inflation adjustment to account for the rising cost of doing business over time; if fees are still tied to a percentage of assets or net worth, set a minimum threshold trigger where the relationship may convert to an hourly or minimum fee to ensure the client remains reasonably profitable to service.

The Good-Better-Best Approach To Pricing (Raji Mohammed, Harvard Business Review) - The conventional view is that consumers are highly price-sensitive, and when possible will always seek out the least expensive option they can find, especially in relatively commoditized industries like automobile insurance. Until, in 2005, Allstate launched "Your Choice Auto" where drivers could pay a little more for a new feature called "Accident Forgiveness" (where rates won't be increased after their first accident after 5 years), keep a "Value" policy without accident forgiveness, or buy a new Gold plan for an even higher price that offered immediate accident forgiveness (and a Platinum plan that would include multiple forgivenesses). The striking result for Allstate: not only were the choices wildly popular, but now 10 years later, they still are... and 90% of consumers do not choose the lowest-cost value plan. Instead, Allstate illustrated a version of the "Good-Better-Best" (G-B-B) pricing approach, also evident everywhere from gas stations selling regular, plus, and super, to credit cards that are gold, platinum, and black... as companies have found that when people have a choice between the three (and an easy way to contrast them and their differences), they often gravitate to the middle option that has its benefits highlighted (by comparison) rather than just choosing the cheapest. In addition, many will upsell themselves to the "Best" most expensive option, and the "Good" basic option can often be an entryway to new consumers (who might not have bought the middle option in the first place, although they, in turn, may upgrade themselves to it in the future). The consumer psychology research on pricing also reveals that when consumers have a choice, they feel more empowered (and become more likely to choose something compared to a single-option all-or-none ultimatum), and the easier it is for consumers to decide that they'll buy something the more time they spend comparing the options (instead of comparing to the competitors)! Notably, the three-tier structure is not dissimilar to many advisory firms that segment clients into A, B, and C clients... although ultimately, the point of the G-B-B pricing structure is not just to segment services to clients, but to actually offer them more pricing tiers and options in the first place (and perhaps be surprised by how many will "upsell" themselves into higher-tier services once they can!?).

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, 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 as well.

Disclosure: Michael Kitces is a co-founder of XY Planning Network, which was mentioned in this article.