Weekend Reading for Financial Planners (Nov 7-8)

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth, which provides an evidence-based approach to private wealth management for near- and current retirees, and Buckingham Strategic Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors through the scaling phase of growth.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

Read all of Michael’s articles here.

Weekend reading for November 7th/8th:

Hitting A Robo Wall, Financial Engines Buys The Mutual Fund Store For $560M (Brooke Southall, RIABiz) - By many accounts, Financial Engines was "the original robo-advisor", employing an increasingly technology-driven automated investment solution in the 401(k) marketplace for almost two decades. At the same time, The Mutual Fund Store is perhaps the opposite extreme, originally a franchisor organization opening retail branches for consumers to invest, now including 345 employees (of whom 200 of advisors) that oversee $9.8B across 84,000 accounts for 39,000 households serving from 125 storefront locations. The driver of the deal appears to have been Financial Engines, in acknowledgement that there are significant limitations to automated computer-driven 'advice' (in the words of the press release announcing the deal, to "drive greater usage and retention of Financial Engines' services and help 401(k) participants with more complex needs", deciding to acquire The Mutual Fund Store in order to bring human-delivered advice (as the acquisition brings both an existing retail location infrastructure, and 200+ advisors to service Financial Engines clients locally in person). The deal was valued at $560M, in a combination of $250M cash and 10 million shares of Financial Engines stock (ticker: FNGN), and once the transaction closes The Mutual Fund Store locations will be renamed to Financial Engines.

12 Predictions About What The Labor Department's Fiduciary Rule Will Look Like When Implemented (Blaine Aikin, Investment News) - While opponents of the Department of Labor's proposed fiduciary rule continue to turn up the heat, most recently by pushing Rep. Ann Wagner (R-Mo) to pass legislation that would prohibit the DOL from finalizing the rule, Aikin points out that in the end these efforts to block the legislation are dead on arrival (the Senate won't pass it, the President would veto it anyway, and the Senate definitely won't be able to generate a veto-proof majority on the issue). So in the end, it looks like the DOL proposal really will survive largely intact. And even potential efforts to stop the legislation after the fact - such as trying to de-fund the DOL to prevent implementation, or challenge the rule in court - are still long shots. That being said, given the volume of comments, and the pressure involved, the DOL is likely to listen to and acquiesce to the fiduciary opponents on at least a few points (if only because compromise helps to ensure the rule cannot be overturned in court as having been too arbitrary). Given this course, Aikin predicts that: the rule will be adopted in Q1 of 2016, with all the originally proposed carve-outs and exemptions, and the controversial fiduciary rule for IRA rollovers; the law will have an effective date no later than January 1st of 2017 (to ensure it is effective and in force before President Obama leaves office), but may include phase-ins for parts of the rule at subsequent dates; the reporting of compensation based on future investment performance will be eliminated, and some of the best-interest contract exemptions will be eased (e.g., regarding the ability to discuss investment recommendations with a client before signing the contract); the carve-out for investor education will be loosened; fiduciary advisors providing advice to the plan on a level-fee basis already will get an exemption to offer rollover advice without being required to sign the best-interests contract (since they are already fiduciaries); and there will be significant disruption of the broker-dealer business model as firms seek to either comply with, or avoid, the requirements to use the best-interests contract.

DoL Proposal Could End Commissions, Morningstar Says (Ann Marsh, Financial Planning) - A recent report from Morningstar's Michael Wong suggests that as the new Department of Labor fiduciary rule comes into place, it could spell the end of commissions for financial advisors. Even though the rules under the best-interests contract exemption explicitly allow advisors to still receive commissions, as long as they are otherwise acting in the best interests of the client, Wong suggests that at least as written, the current exemption will be impossible for most to implement operationally because their entire business model is fundamentally too conflicted, and that as a result (most) commissions will effectively be dead (and/or the recently signaled commission transparency requirements from the DOL would make consumers reject the commission-laden products anyway). In fact, Wong highlights that it's the large companies who tend to distribute their own proprietary products that stand to lose the most in the DOL fiduciary rule, from asset managements and insurance companies to "full-service" wealth management firms, while platforms like Schwab and TD Ameritrade, and low-cost ETF providers like BlackRock and Vanguard (who distribute through advisors), who stand to gain. Wong also notes that firms with a "stronger economic moat" - i.e., highly differentiated services and other ways to generate income - will be better off as well, which includes both full-service independent advisory firms (who provide in-depth financial advice beyond just portfolios), and higher-end wirehouse advisors who add value by giving clients access to unique investments like IPOs and certain hedge funds. Ultimately, the Morningstar report suggests that the DOL fiduciary proposal will accelerate three major trends: the shift from commission-based to fee-based accounts; the emergence of robo-advisors and technology-driven solutions (which will gain as some large firms likely shift away from low-balance accounts); and the increased use of passive investment products over actively managed ones (as many actively-managed funds rely on commission incentives to get sold at all).

Elizabeth Warren Just Declared War on Another Shady Financial Services Practice (Helaine Olen, Slate) - This week, Senator Warren's office released a new report, entitled "Villas, Castles, and Vacations: How Perks And Giveaways Create Conflicts Of Interest In The Annuity Industry" and as the name implies, it's raising the question of whether there is a coming crackdown on annuity agents and how they are compensated. The report follows on an inquiry that Senator Warren began last April, when she asked 15 of the largest annuity carriers to disclose the commissions and related kickbacks being paid to agents selling their products. Of particular concern appears to be not just the product commissions themselves, but the non-cash compensation, including entertainment and travel bonuses based on sales volume (which can encourage particularly aggressive high-volume sales tactics, including subsidizing the infamous "free dinner sales pitch" for consumers). And while these non-cash compensation details are technically disclosed, they're typically buried - one company puts it on page 55 of the annuity sales prospectus, another puts it on page 70, and a third buried it all the way on page 135. Of course, the potential fiduciary rule from the Department of Labor is theoretically supposed to crack down on some of this activity, but non-IRA annuity sales remain outside the scope of those proposals.

Can MyRA Bring Retirement Planning to the Masses? (Mark Miller, Wealth Management) - This week, the U.S. Treasury formally rolled out the MyRA program, which is essentially a Federally-sponsored Roth IRA account with some special features for funding and a unique investment option. As a Roth IRA, it is subject to the typical Roth income limits ($131,000 AGI for single filers, $193,000 for married filing jointly) and maximum contribution amounts ($5,500 for individuals, plus $1,000 in catch-up contributions for those over age 50), along with the usual requirements for funds to remain in the account until age 59 1/2 for growth to be withdrawn tax-free (in addition to meeting the associated 5-year rule). But the key distinction is that MyRA accounts can be funded directly via payroll deductions (if employers facilitate the process), and/or by opening the account directly at MyRA.gov and then funding it via a bank account or Federal tax refund. In addition, the MyRA accounts will have no fees, no minimum contributions, and the sole investment option will be a principal-guaranteed fund by the Treasury that pays the same variable rate offered by the Government Securities Fund (G Fund) in the Thrift Savings Plan (it returned 2.31% in 2014). While intended to encourage retirement savings, though, critics have noted that the MyRA offers little in the way of incentives to really get non-savers to save, and that ultimately it will take something like an automatic-enrollment IRA (not the MyRA where investors still have to opt in to participate) to really bring about change, either with a national program, or a version adopted at the state level (and notably California and Illinois are already working on a state-level automatic-IRA rollout). Though at a point, when everyone participates in an automatic enrollment MyRA or state-based IRA, it also raises the question of whether 401(k) plans will even remain necessary in the future!

Don't Go For The Exacta (Cliff Asness, AQR) - In the investment world, those who have a certain "view" about the world will invest accordingly: we forecast X, so we're betting on Y. But ultimately, Asness notes that most investors implement such views in a 2-step process because their bet on Y is only indirectly related to X. For instance, an investor who believes certain currencies will do well don't just buy the currencies, but companies that would benefit from the currency, or believing that inflation and interest rates will remain moderate and thus investing in small growth companies that may be most benefitted by the trend in the long run. The fundamental problem is that making such two-step bets requires "the exacta" where the advisor is correct about both the forecasted event, and how it will be expressed indirectly in other investments. And since no belief will ever be 100%, the fact that such strategies requires the investor to be correct twice means it is a fundamentally less likely investment strategy than just investing directly in the single-step idea. For instance, if you're 70% sure the dollar will have a big move, and then 70% sure that if the dollar moves as expected a certain set of companies will benefit, you have now turned what could have been a 70% bet by just investing into the dollar directly into a 49% bet on the dollar and that it will impact the expected companies the expected way (or perhaps a slightly better-than-49% bet, since it's possible that your view of the dollar will be wrong but those companies end out going up anyway). Of course, if your view is about a currency and your lack the investment vehicles to actually implement the investment view, then you might be stuck with the two-step approach, but the point remains that a two-step bet should only be the last resort way to implement a view; the rest of the time, just do it directly (if you think the currency will rise, invest in the currency; if you think rates will rise, just short the bonds or buy interest rate futures; etc.) Especially since while at the track betting and winning the exacta (correctly picking the #1 and #2 horses to win and place) has a larger payout to compensate for the lower odds of winning, with financial markets these two-step bets rarely give a better payout, they just have worse odds!

Dollar-Cost Averaging: The Trade-Off Between Risk and Return (David Cho & Emre Kuvvet, Journal of Financial Planning) - Dollar-cost averaging, where an investor allocates money in equal dollar amounts into risky assets over time, is a popular strategy to manage the risk that an investor puts a lump sum into a single investment only to see it fall shortly thereafter. Yet the reality is that dollar-cost-averaging (DCA) is generally an inferior strategy in terms of pure investment returns, for the simple reason that while investors might fear that markets will fall shortly thereafter, ultimately they tend to go up more often than they go down, which means DCA is more likely to just invest incrementally at higher prices over time. However, there is still a danger that markets may decline after a lump sum investment, which means DCA strategies may have an appealing risk-return trade-off, where the expected return is slightly lower in the majority of cases, but the adverse impact of a severe market decline can be greatly ameliorated in the rest - which means the investor gains back more in risk management than is lost in absolute returns. And in fact, that is what the authors find - that a lump-sum versus DCA strategy can be evaluated on a risk/return framework, and varying paces of dollar-cost averaging implementation forms an efficient frontier of possible deployments of capital (from invest it all now, to defer it all until later). Thus, just as with the decision about how much to invest in stocks versus bonds in the first place, deciding how much to invest in lump sum vs DCA is ultimately about choosing how much return to give up (from stocks or lump sum investing) to "save" in reduced risk (by owning bonds or allocating with a DCA strategy).

5 Ways to Make Your Practice More Effective (Katherine Vessenes, Research Magazine) - Many financial advisors treat their advisory firm as a "practice" or as though they are salespeople with helpers, and not as a real "business" instead. The key distinction is that a practice is built around the advisor, while a business is built in a manner to refine the process of the business delivering its services. Accordingly, in building her own business, Vessenes notes several key steps she's taken to make it more efficient, including: a detailed and well-defined "onboarding process" for new clients, so that the team can implement it consistently and effectively, and figure out the opportunities for refinement; implemented a standardized "gap analysis" template (to show clients what the firm will do and how it will change from their current situation) using checklists rather than making every single one customized (which was very time-consuming); created a template for how client notes would be dictated, so there was/is a consistent flow to how details are noted, which makes it much easier for support staff to craft the proper to-do items and follow up appropriately; limit the scope of services to areas where the firm can actually help (e.g., Vessenes stopped doing detailed reviews of employer disability insurance policies, because the reality is that the employee generally won't have the power to change it anyway!); and a refinement of reports (once they're standardized, figure out which ones clients really want/need/like, and eliminate the rest!).

Create a Business Development Process that Works (Brian Stimpfl, Wealth Management) - Growth is essential for most advisory firms, providing hope of a better future for the advisor, and for key staff members to have their own career advancement opportunities. Yet few firms have a standardized process for how they do business development to grow the firm. Stimpfl suggests several tools and techniques to refine the process, including: create a sales pipeline for your business and make reviewing it a weekly ritual, so everyone knows how many prospective clients there are, which are qualified or not, and whether the pipeline is healthy, in addition to what action items must be taken next to keep those prospects moving forward; be certain that you're re-engaging with existing clients periodically, recognizing that they may both have additional assets or other business opportunities, and that they can be potential referral sources (focusing especially on your "A" level clients who drive the most revenue to the firm and can hopefully generate the best referrals of other A-level clients); and create a "roadmap" of the annual services you provide to clients, with a visual chart to demonstrate what you will do for a new client over the first year to create appropriate expectations and convey your value.

One Simple Idea to Vastly Improve Client Reviews (Julie Littlechild) - For most financial advisors, there is a constant desire to try to reach out to and meet with clients more often, despite the fact that Littlechild's research of 100,000+ clients of advisors reveals that it's not about the frequency of contact but its quality and relevance (less than half of clients say the meetings they hold with their financial advisor are "very valuable"). Which means the real key to driving better retention and more referrals is not to meet with clients more often, but to better engage them in meaningful ways in the meetings that already occur. And Littlechild suggests the best way to ensure that meetings are meaningful is to invite clients to participate in the process of crafting the agenda for each meeting. A starting point is to at least have an agenda in each meeting, and ask the client at the beginning if they have anything to add. Even better, though, is to circulate a prospective agenda of each meeting to the client beforehand, and ask them if they have anything to add with enough time to think about it before they respond (a surprisingly rare practice already, as according to last year's FPA study on client communication, only 9% of advisors saying they always send clients an agenda in advance!). Ideally, though, Littlechild suggests sending in advance to clients some questions or issues to consider, and let them rank the priority of each and decide what they want to delve into further (since most clients are so used to the 'standard' review meeting format, they can't think of what they should be asking to add to the agenda!). Ultimately, though, the key point is that it's not really just about the agenda, but finding a way to ensure that what's discussed in the meetings has the most relevance for clients, keeping them better engaged with the advisor, and more likely to refer.

In Bed With Giants, T3 Software Entrepreneurs Swear They Are Still Independent (Tim Welsh, RIABiz) - The world of advisor FinTech has been so hot this year, with big acquisitions from Blackrock buying FutureAdvisor to Envestnet buying FinanceLogix and also Yodlee and Fidelity buying eMoney, that now one of the hottest topics is figuring out which company will be bought next, and how independent these newly-acquired companies will remain. Accordingly, at the recent T3 Enterprise conference in Florida, numerous companies took pains to maintain their independence, from MoneyGuidePro CEO Bob Curtis insisting that the company isn't for sale at all, to eMoney Advisor's Drew DiMarino insisting that the Fidelity acquisition wouldn't change eMoney's autonomy or its independent and entrepreneurial culture (and in fact Fidelity resources are allowing eMoney to accelerate its five-year roadmap to be delivered in just two years!). Beyond this hot topic, the T3 conference included its usual array of both long-form presentations from tech vendors sharing their perspective on where the industry is heading, and also shorter "flash sessions" of emerging new firms who want to introduce themselves and debut their products. Popular topic areas included the increasingly central role of advisor CRM in operating an advisory business, client portals and engagement tools, the ongoing transition to completely paperless offices, and the ongoing pressure for advisory firms to manage cybersecurity risks.

Big Banks Lock Horns With Personal-Finance Web Portals (Robin Sidel, Wall Street Journal) - For the past week, JP Morgan Chase and Wells Fargo have been limiting the flow of data to third-party personal financial management tools like Mint.com, claiming that the platforms may be putting client data at risk by keeping it all in a single place, and that the volume of data requests from the account aggregation solutions are 'flooding' the bank servers. However, the reality is that while PFM solutions once were "just" a place for consumers to see their household data in one place, the companies that create them are increasingly competing with the banks that provide them data, either by offering wealth management services or soliciting consumers for alternative products from competitors who advertise on the PFM platform. Accordingly, it's not entirely clear whether the banks "temporarily" limiting access to the data was really a privacy or technology issue, or more of a warning shot across the bow in the increasingly competitive environment. And notably, while the fighting so far has been focused primarily between the banks and direct-to-consumer solutions like Mint.com, the issue raises the question of whether banks cracking down on account aggregation may soon start to adversely impact advisor PFM and account aggregation solutions (e.g., eMoney Advisor and platforms that use Yodlee) as well.

Education Shakeup for Future Planners (Miriam Rozen, Financial Planning) - A long-standing criticism of the students emerging from college-level financial planning programs is that while they have strong technical skills, they lack the communication and client interaction skills necessary to succeed as financial advisors (and at the least will have to spend additional years training to develop them). To bridge the gap, the leading financial planning registered programs are forming new partnerships with advisory firms to try to incorporate some education and training on these "softer" skills, as well as even some business development and marketing skills necessary to actually get clients. For instance, 18 months ago Kansas State began requiring financial planning students to take a marketing course, California State University is exposing students to real-world experiences through the campus' Volunteer Income Tax Assistance Program (where students give advice and assistance on tax preparation to low-income families), and Texas Tech was one of the first to create a capstone course where students have to take their classroom knowledge to develop an actual comprehensive financial plan (the capstone course was later incorporated as a CFP educational requirement for all). While not all schools have adopted such programs, the shift appears to be on for financial planning college programs to train students in an increasingly comprehensive manner than "just" the core technical knowledge of the CFP curriculum.

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!