Weekend Reading for Financial Planners (Nov 6-7)

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.

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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.

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The Backdoor Roth Lockdown Plan Is Back. Here's What Advisors Should Do Next (Melanie Waddell, ThinkAdvisor) - On Wednesday, Democrats in the U.S. House of Representatives released another version of the ‘final’ text of the Build Back Better Act that re-introduced provisions that had previously been in the House Ways and Means Committee’s original draft of the legislation but were left out of the most recent version. Of interest to many financial advisors is the (re-)inclusion of a provision that would prohibit the conversion to Roth of after-tax dollars in retirement accounts – effectively banning the ‘Backdoor Roth’ strategy popular with individuals whose income exceeds the limits for making standard Roth IRA contributions. If enacted into law, this provision would take effect in 2022, meaning individuals would have until the end of 2021 to convert any existing pre-tax contributions. The new version would also prohibit converting pre-tax dollars to Roth for single filers earning over $400k and married filers over $450k (effectively re-instituting a version of the total ban on Roth conversions that was repealed back in 2010, albeit with higher income limits than the original $100k threshold), though this new limitation on high-income pre-tax Roth conversions wouldn’t take effect until 2032 (giving high-income earners 10 years to convert, and pay taxes on, as much in pre-tax retirement accounts as they want). Elsewhere, the updated legislation also brings back a provision establishing new RMDs for individuals with retirement balances over $10 million (but with the effective date moved back to 2029, from 2022 in the original version). Notably, the new version of the bill does not bring back all of the original version’s provisions on IRAs; prohibitions on investing IRA assets in entities in which the owner has a substantial interest (the so-called ‘Peter Thiel Rule’) and on holding investments that require a minimum level of assets or education were left out of the updated legislation. Also of note for many advisors is the new legislation’s proposed increase to the State and Local Tax (SALT) deduction limit, raising the cap from $10,000 to $72,500 from 2021 to 2031 (meaning that many people in higher-tax states may have a higher-than-expected deduction for 2021, giving them – and their advisors – tax planning options to discuss before the end of the year… though AMT will remain a concern that still limits SALT deductions for many upper-middle-income households in particular).

PIABA To Push SEC To Revise Form CRS (Melanie Waddell, ThinkAdvisor) - When a client of an advisory firm has a legal dispute with that firm – which can happen, among other reasons, due to investment losses incurred by the client, or fraudulent activity by the advisor or broker-dealer – the process can generally play out in one of two ways: the dispute can go to court and be heard by a judge, or, if the contract between the client and the firm contains an arbitration clause, the case can be heard by a third-party arbitrator. Either process may end with the client being awarded a financial judgement or settlement payment. From the client’s perspective it could be preferable to have the dispute heard in court (as third-party arbitrators hired to resolve advisors’ legal disputes may be seen as biased towards the financial industry), but because arbitration clauses are often standard parts of advisory contracts, it is possible the client will have little control over the how the dispute is resolved. And even if the judgement is in the client’s favor, it may be possible that the advisory firm lacks the funds (or insurance coverage) to pay the award… meaning that the client, in addition to the initial financial loss which triggered the legal dispute, and the legal and expert witness fees of the arbitration hearing, would be left without restitution even after a judgement in their favor. To address these issues, Michael Edmiston, the president of the Public Investors Advocate Bar Association (PIABA), has proposed including new disclosures on the SEC’s Form CRS (which is provided to current and prospective clients of RIA and brokerage firms) that would inform clients of the existence and details of any arbitration clauses contained in the advisory contract, as well as whether the firm carries insurance (such as Errors & Omissions insurance) that would pay in the event of a legal claim against the advisor. While these changes, if implemented, would not require the advisor to change any of their business practices (or even change any of the dense advisory contract language in which arbitration clauses are often embedded), the presence of the disclosures on Form CRS – where it is more likely that clients may actually see them – may cause advisors to re-evaluate their arbitration procedures, and whether to carry (and how much) E&O insurance coverage to protect their clients from mistakes or negligence (particularly if other competing firms have more client-friendly policies to highlight on their own disclosures).

Top 10 Trends For RIAs From The DeVoe M&A+ Succession Summit (Jeff Berman, ThinkAdvisor) - Last week, the DeVoe M&A+ Succession Summit, an RIA industry event focusing on Mergers & Acquisitions (M&A) and succession planning, was held in San Francisco. Though the summit was focused on topics around dealmaking in the RIA business, sessions also touched on widespread industry concerns like hybrid work, technology, and diversity. Naturally, the state of M&A activity in the industry was a popular topic: with 2021 marking the eighth consecutive record year in M&A activity, some sessions focused on how M&A trends have taken shape during that time. In general, the most significant activity has taken place among the industry’s largest $1B+ firms, which has led to greater-than-anticipated challenges in integrating staff and technology between large and established firms, and the pace of M&A has remained hot, with DeVoe & Co. reporting that the number of deals their firm handled in the first three quarters of 2021 had already surpassed the total number for the entirety of 2020. Discussions also touched on expectations for the future of RIA M&A; namely, when M&A activity may be expected to slow down (as some in the industry speculate that, at the current pace of activity, constraints on buyers’ staff/internal capacity to integrate the addition of new firms could lead to a slowdown in M&A in the near future – though judging by the number of new merger inquiries still being received by RIAs, the industry has yet to pass that threshold). Other topics discussed include the potential benefits and risks of remote work, such as the need for firms to offer hybrid or fully-offsite work options to attract new talent; the effects of virtual meetings on client (and employee) relationships; and the potential that remote work could allow employees (predominantly women) who left the workforce to raise children to re-enter the industry with a more flexible work environment.

How To Talk About Referrals (Stephen Wershing, The Client Driven Practice) - The benefits of client referrals can be significant for financial advisors: The client making the referral acts as a trustworthy megaphone for the advisor’s services, providing a more potent marketing message (for free!) than the advisor could achieve via paid advertisements. But clients don’t always give referrals unprompted; sometimes they may need to be asked to do so. This conversation can feel awkward for advisors: how can the advisor ask for a referral without seeming too pushy? What if the client is annoyed or even angered by the request? New research by consulting firm Maslanksy + Partners measuring the real-time emotional reactions of high-net-worth individuals to various methods of requesting a referral gives some insights into what types of approaches may prove emotionally resonant, and which perhaps ought to be avoided. Notably, the study found that one of the most commonly-used statements – which is along the lines of, “I get paid in two ways: with the fees you pay for my advice, and with the friends and family members you refer to me” – generates a neutral-to-negative reaction, while playing off of the client’s “elite” status and asking them to invite others to “join the club” elicits even stronger negative feelings. The approaches that generated more positive responses were those that showed empathy for the client’s own concerns, such as communicating a potential problem that could impact other people the client knows, or asking how the advisor can help the people the client cares about. Above all, the most positive requests avoided putting clients on the spot and left it up to them to make a referral – or not – as they saw fit. Ultimately, there may be no secret formula to starting a conversation that leads to more client referrals, but the most effective approach is likely to be the one that leaves the client fully in control of the decision, while making it crystal clear to them which people in their network they might be able to help by making a referral for the advisor to solve their friend-or-colleague’s specific problem.

Overcoming The Five Barriers To More And Better Referrals (Michelle Donovan, Advisor Perspectives) - Financial advisors often struggle with generating client referrals, even when their existing clients are highly satisfied with their experience. Even if the advisor asks their clients directly to make referrals, and the client actually follows through and refers the advisor to people they know, that doesn’t guarantee that the people to whom the client refers the advisor will be inspired to pick up the phone and contact the advisor. As while the client’s feelings may be positive, general positive feelings about the advisor may not be enough to elicit a referral. Instead, as with any other marketing message, what matters is that the right message is served to the right individuals… but if the advisor is unclear about the message they want to deliver (or if they don’t convey that message to the clients whom they are asking for referrals), that message is unlikely to reach those for whom it is intended. Instead, to create a referral message the resonates with clients and the people they refer, advisors should first be able to describe their ideal clients and how the advisor can uniquely serve them (in terms that a client would actually know, e.g. instead of asking “Do you have any friends with over $5 million in net worth?, ask “Do you have any friends who are also business owners?” (or whichever niche the advisor actually serves). After all, the best possible referral would be someone who both fits the advisor’s niche, and would be well-suited to the services the advisor offers. Next, adding a personal connection, such as why the advisor serves the clients that they do, can add emotional stakes to the message. Furthermore, it is useful for clients to know who may not be a good potential fit for the firm, as it spares the awkwardness of the client making a referral who does not ultimately become a client. Finally, the advisor should be able to identify some memorable triggers, such as specific phrases or questions that could indicate when someone is in a conversation with a person who could be a good prospect. After the advisor is able to make all of these key points to themselves, the last step to share them with clients so they can go out and spread the well-honed message. Ultimately, the more clear and specific the advisor makes their message about exactly who they serve and what they do for those clients, the more readily the existing client will be able to make the mental connection back to the advisor when talking to someone who could be a good potential client… making the referral both ‘easier’ for the current client and, for the advisor, more likely to result in a good fit for a new client.

You Are Probably Letting Hundred Of Referrals Go Each Year (Tony Vidler) - Though client referrals still only make up a limited portion of overall business development for financial advisors, the number of people who could potentially be referred to any advisor could be in the hundreds (based on the sheer number of people whom clients may live, socialize, and do business with on a day-to-day-basis, and the likelihood that the majority of those clients would be willing to provide a referral if asked). A few clients may never be comfortable providing a referral (even if asked to do so), but for the rest, it is important for the advisor to set a process of positioning and preparation in order to tap into the network of potential referrals that clients can provide. In this case, ‘positioning’ refers to the process of establishing an expectation in the client’s mind that they could (and should) make a referral if they feel it is warranted, and ensuring that the client understands the ‘right’ types of people to refer to the advisor. Notably, positioning is not the same as asking for a referral; it is merely establishing a mindset (preferably early in the client relationship) that, if the advisor provides high-quality service to a particular type of clientele, there could a referral later on if the existing client comes across someone who also needs that service. That way, when the advisor does eventually ask for a referral, it can seem more like a ‘reminder’ of something that was previously communicated, rather than a ‘request’ from out of the blue. Still, the advisor must prepare carefully for the referral request, because of the emotional power of the words used to ask the question. A client who feels in control and empowered is a potential referral source, while one who feels manipulated may recoil from doing so, so the advisor must think about the words they choose and seek out the right moment to seek out a referral… which may come long after the initial positioning conversation, because the advisor must first ‘earn’ the right to even ask for referral by providing referral-worthy services to begin with.

Where Clients Go Wrong In Predicting Life Expectancy (David Blanchett, ThinkAdvisor) - One of the facts of life (and financial planning!) is that nobody knows exactly when they will die. Of course, many individuals might not even want to know when they will die… but this information would be very helpful for financial planning projections! Yet as it turns out, individuals are not particularly good at estimating their life expectancy anyway. Blanchett's analysis of government survey data showed thatindividuals who thought they had a 0% probability of surviving to age 75 actually had about a 50% chance of doing so, while those who thought they had a 100% probability actually had an 80% chance. While individuals did a good job of incorporating their health status in their life expectancy projections, they did not do as well incorporating other factors like smoking, income, or wealth. The latter two categories are positively correlated with life expectancy, so financial planners working with high-income and wealthy clients can consider adjusting their life expectancies accordingly. And notably, while underestimating life expectancy could obviously lead to sharp spending reductions for clients who outlive the estimate (and run out of money by living ‘too long’), overestimating life expectancy can cause problems as well. As while advisors might be tempted to err on the side of conservatism and use extended life expectancies (such as using a standard 30-year retirement horizon for all clients), doing so can lead to overly conservative Monte Carlo projections that suggest clients can afford to spend less than they really could if more tailored (and accurate) life expectancies were used. Luckily, there are many tools advisors can use with clients to get a more accurate picture of client life expectancy, including a calculator based on Social Security period life tables, and a simplified actuarial calculators that incorporates client health and smoking status. So while nobody knows exactly when they will die, getting a more objective estimate of life expectancy can lead to more accurate financial projections and peace of mind for clients.

The Next Evolution Of Monte Carlo Analysis (Matt Rogers, InvestmentNews) - Monte Carlo analysis is a useful tool for financial advisors because it can project a client’s financial situation across a wide range of potential outcomes. However, the results of this analysis are often confusing for clients, making the presentation of these results an important (but often tricky!) issue. A particularly thorny problem is how different clients approach Monte Carlo probabilities of success, as one client might be fine with a 50% success rate, while another is nervous about a 99% chance of success! With this concern in mind, one potential improvement to Monte Carlo analyses would be to show the client’s probability of success at every age across a client’s lifetime. For example, a client might be reassured if the first year they might not be able to cover their spending (i.e., where the Monte Carlo results initially dip well below 100%) were far into the distant future, rather than in the next few years. Another improvement would be to show the magnitude of “failed” Monte Carlo trials. For example, a trial that fails by only $1 of annual spending would be much less concerning for a client than one that fails by $50,000/year. Advisors have many options to tailor how they use and report Monte Carlo analyses, from finding the right level of abstraction to report the results of Monte Carlo analysis to a given client, to using Monte Carlo analysis to construct spending guardrails rather than focusing on the chances of a plan’s failure, and making adjustments based on the idea that Monte Carlo analysis itself is inherently conservative. The key point is that just as no two clients’ Monte Carlo analyses will be alike, the optimal use for and communication of the analyses are likely to differ for each client as well (and Monte Carlo software can and should evolve to facilitate these more nuanced client-specific conversations)!

The Risk Of Buffer And Floor Strategies (David Blanchett, Advisor Perspectives) - While the risk-return tradeoff is familiar for financial advisors, many investors seek investments that offers significant upside potential without the commensurate downside risk. Recognizing this appetite, investment companies have created products that offer investors “buffers” and “floors” to reduce the downside risk the investor faces. A buffer strategy invests in a risk asset but provides a loss “buffer” to those who purchase the product, where the investor only experiences losses that occur beyond the buffer. For example, if an investor purchases a 10% buffer product and the underlying index falls 5%, the individual does not face any loss (because it didn’t exceed the 10% buffer). However, if the index declines by 30%, the investor would face a loss of 20% (as the 30% loss is 20% beyond the 10% buffer). On the other hand, floor products cap the potential downside an investor will face. For example, if an investor purchases a 20% floor product and the underlying index declines by 10%, the investor will have a 10% loss. However, if the index declines by 40%, the investor cannot experience anything greater than the 20% maximum (floor) loss. Of course, this protection comes at a price, with a smaller potential loss from a buffer or floor strategy being associated with reduced potential upside from the investment. Given the complex nature of these products, calculating the risks of these strategies relative to the risk of an underlying equity index can be challenging. Using four different risk metrics, Blanchett’s analysis found that the equity-like risk for a buffer strategy can be determined by multiplying the buffer level by 4 and subtracting that from 100, so that a 10% buffer product would have 60% equity-like risk. For floors, multiplying the floor level by 4 gives you the equity-like risk, so that a 10% floor product would have 40% equity-like risk. These calculations can help advisors determine how the risk levels of these structured products compare with a client’s other investments and whether more (or less) risk can be taken with the remaining portion of the portfolio.

Why Individuals Should Look Beyond Fame And Fortune (Darius Foroux) - 'Keeping up with the Joneses', or engaging in conspicuous consumption to demonstrate one’s relative status, has been alive and well in the United States for several decades. But while the 'Joneses' were generally one’s neighbors or acquaintances, the rise of reality television and social media has greatly expanded the number of people a person can compare themselves to. And even if the wealth and status displayed in these shows and videos is not as real as it seems, the temptation to pursue that kind of fame and riches remains strong for many. This comparison with others can extend into one’s career as well, whether it be a writer who wonders why they have not produced a bestseller, or a musician that has not received a recording contract (while another much less talented artist did!?). This kind of comparison can strike financial advisors as well, with plenty of metrics – Assets Under Management (AUM), total revenue, and client households to name a few – available to compare oneself with other advisors or firms. But just like an Instagram account does not show how happy its owner truly is, Kitces Research shows that advisor wellbeing does not increase with more AUM or clients. In fact, the research shows that more revenue does not necessarily lead to more advisor wellbeing at all, but rather that advisors should decide based on their own values and interests what kind of career they want to have or type of firm they want to own (if they even want to own one in the first place!). And so ultimately, introspection and self-awareness to determine what is ‘Enough’ for themselves, rather than external validation of the Joneses, are more likely to set individuals on the path to greater wellbeing.

How To Stop Comparing Yourself To Others (Michelle Schroeder-Gardner, Making Sense of Cents) - For anyone who uses social media, it is challenging to see the successes of others and not make a comparison to one’s own situation. Of course, the ‘reality’ that is depicted on social media might not truly reflect what is going on in that person’s life, but the only available information is what is posted. For those who want to overcome the urge to make comparisons with others and to have a more positive self-image, Schroeder-Gardner offers several suggestions, including practicing gratitude, celebrating others’ accomplishments, and taking the first step to realizing one’s own goals (in addition to reducing time spent on social media in the first place!). By taking action to move forward in one’s career, finances, or other areas, and showing gratitude to those who support them along the way, an individual’s mindset can shift from what others are doing to what they are doing themselves. And while financial advisors can find themselves comparing their firm or career with others in the industry, financial advisory clients can also fall into this trap as well. Whether it is seeing teenagers get rich from buying cryptocurrencies, or hearing about the ‘hot’ investment ideas their coworkers are discussing, clients might wonder why their portfolio is not reaching new heights. And so, helping clients focus on their personal goals and how they can be reached (what clients say is the most important part of working with an advisor!), rather than comparing themselves to others, can be a significant source of advisor value (and an opportunity for financial advisors to help their clients re-adjust their focus back to their own goals)!

The Game-Changing Difference Intention Makes In Financial Planning (Tim Maurer, Forbes) - The hectic nature of work and family life in the 21^st century can make it easy for individuals to go on cruise control with their finances without thinking about where they are heading. And many financial advisors have probably worked with clients whose financial goal appears to be to inexorably maximize their wealth – where it’s never ‘enough’ and there’s always a hunger for more – rather than actually enjoying it. Maurer suggests that the key issue is that these clients are not acting with intention, the use of which can drive financial plans that are more successful and meaningful. To help ameliorate this issue, Maurer suggests using the ‘Who, What, How’ method to help clients determine who they are (their values and vision), what they are pursuing (and is it their personal goal or someone else’s?), and how to get there (how financial planning can support their personal intentions). Further, it is also important for advisors to be aware of the temptation to jump right into the ‘how’, before considering a client’s ‘who’ and ‘what’, or risk trying to solve problems without first getting to the true underlying intentions that actually motivate clients to action. To help clients discover who they are and what they are pursuing, there are a range of techniques and tools advisors can use, such as George Kinder’s life planning process (including the three questions that can help clients prioritize what is most important to them), and Carol Anderson’s Money Quotient program that allows advisors to approach life planning in a systematized way. Whichever approach an advisor takes, the key is that helping clients act with intention can create better financial plans and more fulfilling lives for the clients!

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.