Weekend Reading for Financial Planners (Nov 20-21)

Authors:

Ben Henry-Moreland

Team Kitces

Ben Henry-Moreland is a Senior Financial Planning Nerd at Kitces.com, where he specializes in writing and speaking on financial planning topics including tax, practice management, and technology. He also co-authors the monthly Kitces #AdvisorTech column. Drawing from his experience as a financial planner and a solo advisory firm owner, Ben is passionate about fulfilling the site’s mission of making financial advicers better and more successful.

Read more of Ben’s articles here.

+ Read More +

Adam Van Deusen, CFP

Team Kitces

Adam is a Financial Planning Nerd at Kitces.com. He previously worked at a financial planning firm in Bethesda, Maryland, and as a journalist covering the banking and insurance industries. Outside of work, he serves as a volunteer financial planner and class instructor for local and national non-profits.

Read more of Adam’s articles here.

+ Read More +

CFP Board Cracks Down On Failure To Report Misconduct (Melanie Waddell, ThinkAdvisor) - In recent years, CFP Board has acted to raise the standards to which CFP certificants are held. For example, the revised Code of Ethics and Standards of Conduct for CFP professionals that took effect in 2019 required (for the first time) that CFP certificants act as fiduciaries at all times. But even as it has raised its professional standards over time, the CFP Board has long struggled to enforce them. For instance, the standards require certificants to report to CFP Board within 30 days any information (such as material public disclosures listed on the FINRA BrokerCheck site) that could reveal potential misconduct or ethical violations by the certificant. However, enforcement of that rule relied largely on self-reporting by certificants themselves, leading to many unreported violations and a 2019 Wall Street Journal story finding that over 10% of certificants listed on CFP’s “Let’s Make A Plan” website had potential unreported disclosures. Furthermore, when certificants were found to have not reported disclosures, CFP Board’s recommended sanction was merely a “private censure”. This meant that if a certificant committed a regulatory violation, then failed to report that violation to CFP Board to avoid having their CFP mark suspended or terminated, there would be no public record of that subsequent reporting violation on the certificant’s public “Find A CFP Professional” profile page or anywhere else. CFP Board took steps to rectify this enforcement gap in July, by proposing to make the censure for failure to report information public instead of private, and, for the first time, proposing to impose a monetary fine in the form of an “administrative fee” for violations of the rule to offset the cost of enforcement. On November 11, CFP Board announced they had adopted the public censure part of the sanction… but notably, the proposed monetary fine was not adopted. Reportedly, CFP Board is “still conducting the evaluation” on whether to impose fines, which is understandable given that its status as a standards-setting nonprofit organization (and not an “official” industry regulator) leaves it with a narrow path to tread between enforcing its own standards and imposing yet another regulatory burden on its members. Not to mention the prospective conflict of interest in fining CFP certificants to generate revenue to expand its own enforcement (which in the long run, can create situations where CFP Board ‘has to’ generate a certain amount of revenue in fines to sustain its enforcement?). In the meantime, however, the CFP Board hopes that the prospect of a public censure will be enough of an incentive for certificants to report their own violations and subject themselves to CFP Board’s (gradually more rigid) discipline.

Bill To End Mandatory Arbitration Faces Steep Climb In Senate (Mark Schoeff, InvestmentNews) - Investment advisory and broker-dealer firms often include arbitration clauses in their client agreements, which stipulate that any dispute between a client and the firm will be heard not in the court system, but through a third-party arbitrator who hears evidence from both sides and issues a (typically binding) ruling. The financial industry generally favors arbitration because it can be faster and less expensive than the court system; also, unlike a lawsuit heard in court, arbitration hearings do not become public record. But clients may not always want to resolve their disputes through arbitration, not least because of the perception (backed by research) that arbitration rulings are biased in favor of the financial industry. However, arbitration clauses are often mandatory, meaning that a client who signs a brokerage or advisory agreement containing the clause loses their right to ever take that firm to court in the event of a dispute. A bill called the Investor Choice Act, approved on Tuesday by the House Financial Services Committee, would end the practice of mandatory arbitration clauses amongst broker-dealers and RIAs, and give investors the right to choose to sue in court rather than go through arbitration if they wish. In other words, the bill would not ban arbitration entirely, but would allow clients the option (i.e., the choice – thus the “Investor Choice” Act) to go through the court system if they felt it was in their best interest. Not surprisingly, however, the bill is stiffly opposed by the financial industry lobby, and has no support from Republicans (who would likely filibuster the bill to block its passage in the Senate). Interestingly, the SEC has had the authority to limit or ban mandatory arbitration since the passage of 2010’s Dodd-Frank Act as well, but also has not done so. Meaning that, if the Investor Choice Act does not pass, Democrats in Congress could still push SEC Chair Gary Gensler – who acknowledged in his confirmation hearing the importance of investors having an avenue to pursue claims in court – to take up the reins to end mandatory arbitration.

FINRA Makes Big Adjustments To CE Rules (Melanie Waddell, ThinkAdvisor) - All individuals who are registered with FINRA are required to complete a Continuing Education (CE) program on an ongoing basis to maintain their registered status. On Wednesday, FINRA introduced an overhaul of this system, making several key changes to its CE requirements. One is that the Regulatory Element – a program focused on compliance, regulatory, ethical, and sales practice standards that registrants previously were required to complete every three years – is now an annual requirement, greatly increasing the frequency with which brokers and other registrants must get up to date on regulation and compliance practices. Additionally, FINRA will now develop specific CE programs for each category of registration, meaning that, for instance, a person registered as a General Securities Representative (Series 7) would complete a specific CE for that category, while a General Securities Principal (Series 24) would complete a different CE program. In addition, FINRA introduced a new Maintaining Qualifications Program (MQP), allowing individuals who terminate their registration to maintain their qualifications for a maximum of five years by completing an annual CE requirement. For example, a broker who stopped working to have children/start a family could use the MQP to re-enter the industry within five years without needing to re-take the Series 7 qualification exam (they would “just” need to get caught up on their annual CE requirements). Which FINRA believes will help the industry improve its diversity and inclusion through greater flexibility for those who may move in and out (and back into) the industry over time, and at the very least may help to stem the ongoing decline in the number of FINRA-registered brokers. The MQP rule becomes effective on March 15, 2022, while the Regulatory Element changes do not take effect until January 1, 2023, meaning registrants will actually have until December 31, 2023, to complete their first annual Regulatory Element.

The Hidden Costs Of ‘Free’ Investment Services (John Rekenthaler, Morningstar) - One of the not-so-hidden secrets of the financial industry is that no product or service is truly free. Even when the person using the product or receiving the service does not have cash withdrawn from their bank account, they often end up paying for it in other, less tangible ways (such as when mutual fund fees are withdrawn directly from shareholders’ assets). And at other times, the users themselves become the product that is sold. For instance, when Robinhood and other brokerage platforms began offering commission-free trades, they didn’t stop making money off of trading; they simply sold their customers’ order flow to market makers who were willing to pay to execute those orders. So, when considering a “free” investment service, it is always useful to consider who is really paying for it, and how. One example of this point comes via Charles Schwab’s Intelligent Portfolio service, a digital advice program offering managed ETF portfolios with a 0% management fee. But according to a lawsuit by three Intelligent Portfolio customers, the program came with a hidden cost in the form of its cash allocation. The suit states that the cash allocation recommended by Intelligent Portfolio was much higher (from 6%-23% of portfolio assets) than similar managed portfolios, including even Schwab’s own target-date mutual funds. The high cash allocation, combined with low yields, has led to Intelligent Portfolio’s subpar performance compared to similar portfolios. Which Schwab had an incentive to do, because it invests clients’ cash into Schwab’s own proprietary cash sweep account – from which it earns income – creating a conflict of interest, where Schwab’s high allocation to cash created higher profits for itself via its cash sweep, while clients suffered from lower yields and underperformance. While it is difficult to prove that Schwab’s cash allocation recommendations are motivated by the profitability of its cash sweep account, the fact remains that offering a “free” service, while earning income on certain aspects of that service that are only disclosed in fine print, when clearly running a for-profit business – Schwab obviously intended to profit ‘somehow’ – raises significant concerns given that it operate as a Registered Investment Adviser (at least for its robo-advisory service) that is supposed to be held to a fiduciary standard. Ironically, though, one analysis suggests that charging a standard basis-point fee may have earned Schwab more income than the cash sweep, while clearly demonstrating the “real” cost of its service, rather than opening the door to the allegations Schwab now faces of covertly profiting at its customers’ expense.

Schwab CEO Defends Payment-For-Order-Flow, Claiming It Nets Investors Better Pricing (Jake Martin, AdvisorHub) - The practice of Payment-For-Order-Flow (PFOF) has received increased attention from regulators in recent years as brokerage firms have increasingly relied on the revenue generated by PFOF after largely eliminating commission fees for stocks and ETFs. Though PFOF is most associated with the online brokerage platform Robinhood (which pioneered the commission-free model that later became standard throughout most of the industry), more traditional firms such as Charles Schwab, TD Ameritrade, and Morgan Stanley (and its subsidiary E*Trade) also practice PFOF, and could be affected by any regulation handed down by the SEC. In light of this scrutiny, Schwab CEO Walt Bettinger defended his company’s use of the practice on the grounds that investors receive better pricing for their trades when executed through PFOF. While this is often true (as market makers that fill PFOF orders generally offer better pricing in order to trade with retail investors), regulators have been more focused on the lack of transparency by firms that use PFOF, and the incentives that brokerages have to encourage frequent trading (or select the highest-paying order flow providers instead of the best for their customers) to increase their revenues from the practice. And even though other firms like Robinhood have received more scrutiny for their ‘gamifying’ features that stimulate retail investors to trade more often, any action by the SEC to curb PFOF would also impact Schwab… which, given that trading revenue (which includes PFOF) made up 21% of Schwab’s revenue as of last quarter (and also a non-trivial segment of the revenue it generates from RIAs using Schwab’s platform as well), gives it a significant financial incentive to lobby for PFOF to remain legal.

How Mutual Funds Mislead Investors (Larry Swedroe, Advisor Perspectives) - A mutual fund’s performance is often judged by its return compared to a broad market index known as a benchmark. However, even under existing SEC regulations, the funds themselves are allowed to choose which benchmark to compare themselves to (and are even allowed to change benchmarks if they wish). This creates the possibility that some actively managed funds (whose advertising often touts how much they have outperformed their benchmarks) will intentionally choose benchmarks that make their relative performance numbers look better. In practice, such ‘shopping’ for benchmarks can happen in several ways. The fund can simply choose a benchmark that is easier to beat on an ongoing basis (such as the Russell 2000, which is prone to lower returns than similar indexes like the S&P SmallCap 600, due to the method by which it is updated, and thus easier to outperform). Alternatively, a fund that has gone through a period of poor performance relative to its existing benchmark can retroactively switch to a different benchmark with lower historical returns, making the fund’s own historical returns look better by comparison—even if the new benchmark does not match the fund’s investment strategy at the time those returns were produced. A research paper published in August found that this ‘backdating’ tactic was predominantly used by underperforming active funds, who changed benchmarks to improve the appearance of their past performance, then advertised the artificially boosted returns to attract new investors. But what is perhaps most surprising is that, despite the potential to mislead investors, choosing the benchmark that makes returns look the best by comparison does not run afoul of any securities regulations—a point underscored by the fact that the practice was detailed in an academic research paper, not as a result of SEC or FINRA examinations.

The Holiday Gifts Financial Advisors Are Giving Clients (Steve Garmhausen, Barron’s) - With the holiday season approaching, financial advisors might consider whether they want to give gifts to their clients to show gratitude for their continued work with their firm. And if they decide to do so, advisors can consider what kind of gift would demonstrate appreciation to their clients… without breaking the budget. One option is to send the same gift to each client, with chocolate from local chocolatiers being a popular option. Advisors who take this route often include a custom note with the gift to give a personal touch to each client. Others choose tailored gifts for each client (e.g., a specific book they might enjoy). Instead of giving a gift to the clients themselves, some advisors opt to make a charitable donation to organizations that are important to their clients (for these advisors, reviewing a client’s charitable giving strategy can also serve as a way to discover their favorite causes!). Another option for advisory firms is to create a custom video featuring the firm’s employees to show their gratitude for clients, and offer them best wishes for the holiday season. And while many advisors do give gifts to clients during the holiday season, some prefer to instead send gifts to commemorate important events in clients’ lives throughout the year whenever those events occur, such as transitioning into retirement or buying a new home. And so while there are a multitude of ways for advisors to show gratitude to clients during the holiday season and beyond, the key point is that recognizing clients is not only a generous practice, but is also one that can promote client loyalty to create lasting value for the firm.

Giving Holiday Gifts That Actually Make Clients Happier (Michael Kitces, Nerd’s Eye View) - Giving gifts to family and friends can be one of the most rewarding parts of the holiday season, and financial advisors can join in by giving small gifts to clients. Of course, the gift-giver has to decide what to give in the first place, which can be a fraught endeavor when they do not know (or at least aren’t certain) what the recipient might want. Some solve this problem by giving gift cards to stores with broad appeal (e.g., Amazon or Starbucks) to allow the recipient to purchase exactly what they want. However, this generic approach does not show much thought for the recipient’s preferences, which is often one of the best rewards for both those giving and receiving a gift. Additionally, research shows that spending money on experiences or spending it on others generates more happiness than buying ‘stuff’. With this in mind, an alternative approach to giving ‘things’ is to gift experiences, or give the recipient an opportunity to spend the gift on others. For example, the platforms Excitations and Xperience Days allow users to gift an experience (e.g., flight lessons, city tours, and massages), sorted by geography and occasion; while the experience itself might only last a few hours, the memories (that the advisor gifted) will live on far longer. Alternatively, allowing the gift recipient to select a charity for a donation can also be rewarding. Accordingly, a gift card for the DonorsChoose platform allows the recipient to select from a range of school classroom projects to support, the process of which can be very rewarding. Similarly, an individual can give a gift card to use on the platform TisBest, which has a curated list of charities for the recipients to choose from for their donation. With a wide range of options of experiences and giving opportunities (and not just gifting ‘stuff’), advisors should be able to find gifts for clients (or family members!) that will give a happiness boost to both the giver and the recipient!

How To Write An Effective Client Holiday Letter (Sara Grillo, Advisor Perspectives) - For many financial advisors, the holiday season is a time of reflection on a (hopefully) productive year, and some advisors might choose to share their thoughts on the year with their clients through a holiday letter. Yet writing such a letter can be challenging when balancing the information the advisor wants to get across, with keeping the client recipients engaged. Grillo, an advisor marketing consultant, suggests a five-paragraph format for the client holiday letter that combines useful information and action items in a pithy, readable format. After an opening paragraph that draws the reader’s attention and introduces the rest of the letter, the advisor can move on to a second paragraph asking clients for feedback on their experience with the firm. This not only creates client engagement with the letter, but allows the firm to get useful feedback through a client survey or other means. The third paragraph can include a short, three-sentence economic summary of the year, which helps the advisor establish credibility, and gives clients an idea of what they might expect in the coming year. In the fourth paragraph, the advisor can give clients a list of potential action items (customized for each client if desired), such as encouraging clients to review their account beneficiaries or providing guidance on end-of-year tax planning. Finally, the fifth paragraph serves to evoke emotion, perhaps through reiterating the firm’s purpose and expressing appreciation for the clients’ continued business with the firm. And so, while creating a client letter might seem daunting at first, it is possible to write an informative and compelling letter that can increase client engagement with the firm in a structured format that makes it a little easier to write in the first place.

Why We Can’t Talk About Money Without Talking About Culture (Rianka Dorsainvil, Forbes) - No two individuals approach their personal finances in the same way, yet sometimes financial advice can take a one-size-fits-all approach, implicitly assuming there is one mathematically “right” and “optimal” strategy for any particular financial situation. Yet in reality, clients with similar incomes and assets could have very different approaches to risk, savings, and spending based on the cultural environments in which they were raised and now live, requiring advisors to consider these differences when constructing a financial plan. For advisors helping clients explore their attitudes toward money (or thinking about their own!), identifying the money scripts (money lessons individuals learn growing up) can be a helpful first step. Money scripts are multi-generational and often unspoken, so helping clients discover their money scripts can take time to unearth. Clients can then consider how their community, including family and peers, handles their money. For example, a client whose friends are chronic overspenders might find it hard to cut back their budget to not appear out of step with their peers. Others might come from a culture that values financially supporting family members, or one that prefers tangible investments (e.g., real estate) as opposed to stocks. Finally, clients can consider the actions they have taken with their money, and how they could be changed to improve their financial situation. The key point for advisors is to not make assumptions about why clients make certain financial decisions, but to help them explore how those decisions have been shaped by their cultures and backgrounds. And while these activities can be emotional and require introspection, the exercise of unearthing the causes of an individual’s attitudes toward money can be empowering and inspire changes in how they approach money!

How Black Investors View Wealth & Advisors (Michael Fischer, ThinkAdvisor) - Disparities in income and wealth between Black Americans and other racial groups have come to the forefront of national attention during the past year, and the financial industry has sought to understand how Americans of different races approach money and the industry itself. With this in mind, U.S. Bank conducted a study of Americans with at least $25,000 in investible assets to gauge their opinions on wealth accumulation, treatment by the financial industry, and goals for their money. In terms of priorities for their money, more than 70% of Black respondents said they felt a sense of responsibility to their community, more than any other group, and Black individuals were significantly more likely to say that financial success means leaving a legacy. Black respondents were also more likely to say they had successfully set aside money to start a business. At the same time, Black individuals were significantly more likely than those in other racial groups to report that they had been treated differently by the financial services industry because of their race. Black respondents, and particularly those in younger generations, were also more likely than others surveyed to want to work with financial advisors who were more like them in terms of race, age, gender, and sexual orientation (an indication that the rest of the ‘traditional’ financial services industry may not adequately understand their background and preferences). For financial advisory firms, the study demonstrates the potential business and societal benefits of increasing the number of Black advisors, which not only requires recruitment initiatives, but also inclusion measures to support their career growth. The survey also shows the importance for advisors of understanding potential cultural differences among their clients, and how that can affect their approaches to money and financial goals. And while the causes of income and wealth disparities go well beyond the financial advice industry, advisory firms can play an important role in not only improving the diversity of those in the industry, but also to make financial planning a more attractive service for underserved consumers!

The Racial Wealth Gap And What Advisors Can Do About It (Brent Kessel, Kamila Elliott, Ako Ndefo-Haven) - According to the 2019 Survey of Consumer Finances, the median Black American family has $24,100 in wealth, compared to $188,200 for the median white family. This sharp disparity in net worth has persisted over time, even given a narrowing income gap between Black and white Americans. And while the gap has many causes, from historical discrimination to disparate returns on investments (from less aggressive asset allocations), the choices the country makes today can influence whether Black Americans can make gains into the future. To explore this, the authors trace the path of two fictional young couples, one Black and one white, and base their financial circumstances on what the typical individual at their age (and racial background) would face. The authors then use financial planning software to both project the sample couples’ wealth into the future, but also measure the impact of potential changes in their financial circumstances on their net worth. Based on this analysis, the largest contributor to the future wealth gap was differences in earning, spending, and housing, followed by participation in employer 401(k) programs, and then their asset allocation. And while financial advisors might not be able to narrow racial income gaps – though it does suggest that giving career advice may be an underappreciated financial planning strategy – advisors can provide guidance to Black clients on home-buying strategies, cash flow management, the importance of early and significant contributions to retirement plans, and an appropriate asset allocation given the client’s goals. Also, because Black Americans with high incomes might have fewer assets than a similar white client, the authors suggest that using retainer or project-based fee models can create opportunities for both the advisor and potential clients. Ultimately, the key point is that while the racial wealth gap has many causes, financial advisors can and do play an important role in improving the financial lives of Black Americans… but only as long as the focus of the advice (and associated fee models) fits the needs of the community they’re serving!

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 Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.