Weekend Reading for Financial Planners (Nov 9-10)

Author: Michael Kitces

Team Kitces

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

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

Read all of Michael’s articles here.

SEC Issues Plan To Modernize RIA Advertising And Testimonial Rules (Melanie Waddell, ThinkAdvisor) - For the first time in nearly 60 years, the SEC this week issued a (507-page) proposed update to its Advertising Rule that would finally let RIAs begin to use testimonials, endorsements, and third-party ratings to solicit clients. Recognizing that the current rule issued in 1961 was grossly outdated for both the modern world of social media (and even pre-dating fax machines!), and also the nature of advisory services from RIAs (which often go beyond just touting investment returns), the new rule would expand the breadth of what's considered an "advertisement" in the first place to include communication "disseminated by any means", which expands the scope of the Advertising Rule but also implicitly blesses a wider range of advertising channels for advisors, and then also will permit testimonials and endorsements via those channels (albeit still with some limitations to ensure they're not deemed misleading). The new proposal would also expand the solicitation rule to include a broader range of structures than just cash-for-clients arrangements, permitting them but with clearer disclosure requirements across the board. Though it does still contain substantial restrictions on exactly what advisory firms can show when it comes to actually reporting gross and net investment performance results. Once published in the Federal Register, the new Advertising Rule will be open for a 60-day comment period, after which the SEC will either issue a modified rule or release a final rule. Notably, FINRA has also indicated that it is monitoring the SEC's new Advertising Rule disclosures, and may take up action in the coming year to modify its own advertising rules to conform accordingly, and some firms are already gearing up for what may be the need for a new "Chief Advertising Officer" with a likely burst of new ads and testimonials that may be forthcoming from advisory firms if the proposed rule is in fact approved and moves forward.

Schwab Set To Offer 'A Lot More' Banking Capabilities To Advisors [And Retail Investors] (Charles Paikert, Financial Planning) - At its Schwab IMPACT conference this week, CEO Walt Bettinger and head of Schwab Advisor Services Bernie Clark announced that in the coming months, Schwab is looking to significantly expand its banking capabilities for both advisors on the Schwab platform and also retail investors, potentially including mortgage lending, unsecured loans to clients/investors, and even loans to advisory firms. The initiative is part of a broader effort to help advisors on the Schwab platform become more relevant to the clients' liability side of the balance sheet and not just their assets, and in the process making Schwab a bigger part of their advisors' businesses and services to clients - which, notably, represents an "evolution" of Schwab's thinking from years ago when it insisted that it wanted to stay focused on simply scaling the brokerage side of its services to advisors and retail investors. From a broader perspective, though, some suggest that Schwab's move into banking is an effort to expand its revenue opportunities to make up for lost revenue when it recently slashed trading commissions to zero, effectively replicating Envestnet which also announced earlier this year plans to debut a "credit exchange" of banking products for advisors by the end of the year, and trying to further differentiate its breadth and depth of services from Fidelity and TD Ameritrade as the race to zero commissions means pricing itself is no longer a means of RIA custodian platform differentiation.

Introducing The Enhanced Morningstar Analyst Ratings For Funds (Jeffrey Ptak, Morningstar) - Earlier this year, Morningstar announced a series of planned changes to its Morningstar Analyst Rating system, and this month the new scoring rules have taken effect. The biggest changes are that the system is being simplified to just three pillars - People, Process, and Parent - and the new scoring system will give even more weight to fees (based on Morningstar's data that cost continues to be one of the most persistent predictors of out- or under-performance), and effectively sets a higher bar for actively managed funds in various share classes by specifically separating out the ratings on each of the share classes (such that for any particular fund, it might get a Gold rating for its Institutional class shares but only a Bronze or Neutral rating for its A- or C-share classes that have substantially higher costs). In addition, Morningstar is also weighing the cost of funds not just against peers, but also Morningstar's own estimate of how much alpha opportunity is on the table in the first place, such that whole categories of funds whose costs are high relative to the market opportunity may receive lower ratings (even amongst funds that are the lowest-of-the-high-cost within their group). And the new rules will also now consider not just whether an active fund beats its benchmark index, but whether it does so specifically after fees are factored in and being adjusted for risk (again rather than just comparing to a peer group of funds). Notably, though, the new scoring rules only impact Morningstar's Gold/Silver/Bronze/Neutral/Negative Analyst ratings, and not its star ratings, and thus far Morningstar has only rated 123 funds under the new updated approach (with the rest of Morningstar's covered funds being updated over the next 11 months as the analysts do their annual reviews). However, the new ratings systems are already resulting in far more downgrades than upgrades (by a 2:1 ratio), as individual costly funds (or share classes of funds) have ratings adjusted to reflect their fee drag.

SEC Cracks Down On Hybrid RIAs' Sweep Money Market Accounts (Tracey Longo, Financial Advisor) - This week, the SEC announced at a conference in London that the regulator was taking an increasingly hard look at how RIAs are selecting what cash sweep or money market programs they use for their clients, particularly in the case of hybrid RIAs who are affiliated with a broker-dealer that may participate directly in the higher-cost cash options that are used. The concern is whether broker-dealers may be inappropriately profiting by steering investors with their hybrid RIAs into the broker-dealer's own money market or cash sweep solutions, without appropriately disclosing the nature of the relationship and the fact that other higher-yielding options may have been available, echoing similar concerns the SEC has had in recent years with hybrid broker-dealers choosing higher-cost mutual fund share classes that pay 12b-1 fees to the RIA's affiliated broker-dealer when lower-cost institutional share classes were otherwise available (which has resulted in broker-dealers returning more than $135M in mutual fund fee overcharges to investors). And the issue is especially acute when it comes to cash options, where yields are so low that in some cases the broker-dealer generates more in profits from the client's cash than the client receives in total interest payments themselves (e.g., taking a 1%+ scrape, or more than 50% of the potential 2% cash yield, just for the broker-dealer alone).

IRS Proposes Lowering Required Minimum Distributions For IRA [And Other Retirement Account] Owners And Beneficiaries (Jeff Levine, Forbes) - Yesterday the IRS released long-awaited Proposed Regulations that will update the life expectancy tables used to calculate required minimum distributions (RMDs) from IRA, 401(k), and other retirement accounts, which would represent the first update since the now-current RMD tables were first issued back in April of 2002. The primary focus of the update is simply to adjust the three primary RMD tables (the Uniform Life Table for RMDs while alive, the Joint-And-Last-Survivor table used for lifetime RMDs with a much-younger spouse, and the Single Life table used for beneficiaries of inherited retirement accounts) given improvements in life expectancy that have occurred since 2002. Notably, though, the change in RMD factors of approximately 1-2 years (i.e., the first RMD factor at age 70 1/2 will increase from 27.4 to 29.1) ultimately only produces a relatively modest reduction in RMD, bringing the first RMD down from 3.65% of the account balance to 'just' 3.44% instead, which even on a $1M IRA amounts to just a $2,100 reduction in the RMD amount and a deferral of just $777 of taxes at the top 37% rate. In addition, IRS data indicates that only about 20% of those in the RMD phase take just the minimum (i.e., the other 80% take even more than their RMD-obligated amount, ostensibly because they simply need those dollars to live on in retirement), which means the scope of the new RMD tables is further limited (albeit more likely to involve the clients of advisors who tend to be more affluent and not need to spend their annual RMDs). Still, though, the cumulative savings of the RMD tables over the span of 25 years (i.e., from age 70 to age 95) would be a cumulative 10.6% reduction in RMDs, which is not trivial (especially on a sizable account). As currently scheduled, the new RMD tables will take effect in 2021.

The 9 Types Of People You'll Meet In Retirement (Advance Capital Management, Financial Living Blog) - One of the unique challenges of working with retirees is that the very label 'retirement' means different things to different people. For some, they live in retirement like a "Tireless Mover", going from one activity to the next (from Bikram yoga class to a 20-mile bike ride, while signing up for skydiving lessons or another Rolling Stones concert) which both keeps them actively engaged and also helps them to stay healthier with the physical activity, while others are more like "Lost" ones who struggle with anxiety, depression, and feelings of loss in the transition into retirement (when they have to lose their career identity), or outright become very "Lonely" ones that struggle to keep personal connections (especially if/when a spouse passes away). In turn, some retirees don't want to lose that sense of work purpose, and instead become "Workhorses" in retirement, even becoming entrepreneurs that start entirely new businesses (in fact, one recent study found that 26% of entrepreneurs are in the 55-64 age bracket!); some focus their energies in volunteer work to become "Superheroes", while others take up extensive travel and become "Globetrotters" instead. For some, it's about figuring out what to do with their financial resources, which again span the spectrum from those who end out being "Reluctant Spenders" and struggle to stop the frugal spending and aggressive savings behaviors that got them to retirement (but then limit their ability to enjoy that wealth in retirement) to the "Overly Generous" who begin to help as many as they can, from children and grandchildren to charitable organizations they're involved with. Of course, for some, they end out being "Never Retired" simply because they haven't been able to save enough to retire and continue to work not out of personal desire but financial need... which, from the financial planning perspective, is what we try to avoid by engaging in retirement planning in the first place!

Using Virtual Reality To Plan Your Actual Retirement (Elizabeth Harris, The New York Times) - One of the biggest challenges in planning for retirement is that it's difficult for us to actually envision what retirement will really be like, as most people have trouble projecting a future that's any different from the reality we already live in with just a little more gray hair (a phenomenon known as the End-Of-History Illusion). To address the challenge, Fidelity is experimenting with a new kind of Virtual Reality tool that would literally allow people to visualize their retirement experiences - by actually putting on the VR goggles, and then seeing themselves driving through the countryside viewing the landscape, or looking out from a mountain they just 'hiked' themselves. For some financial services firms, these kind of visualize-retirement experiences are being envisioned as the next generation "retirement calculator", moving prospective retirees away from just the math of retirement and what they need to save, and trying to evoke more visceral retirement planning experiences that hopefully will be better at actually helping them to change their behavior and save more. Alternatively, even firms that remain focused on calculator-style tools are shifting their use, creating more 'just-in-time' calculators that provide a place to do a calculation the moment it's relevant (e.g., a retirement savings projection tool right next to the box where the plan participant enters their intended retirement contribution rate), or trying to make retirement tools more visual simply recognizing that most clients only log into financial services firms' websites for 15-30 seconds at a time to check a balance (which means the time is very limited to engage them more meaningfully). Still, though, the potential for virtual reality visualizations to change the way we think and experience retirement planning in the first place now appears to be one of the more promising approaches to actually help prospective retirees really change their behavior for the better.

Healthier Clients Save In Retirement By Avoiding Medical Costs Altogether (Jeff Benjamin, Investment News) - With high health care expenses often ranking as the #1 fear for retirees (even more than 'just' running out of money itself), there is a growing focus on creating more and better estimates of retiree health care expenses in financial planning software, and tools to figure out how to better plan for those expenses (from navigating Medicare and its IRMAA surcharges, to selecting Part D prescription drug plans for early-retiree health coverage, and leveraging HSAs as a supplemental retiree savings plan). But arguably one of the best ways to help clients improve their retirement security is to encourage them to get healthier in order to simply reduce those anticipated future healthcare costs in the first place! In fact, a number of financial advisors - not coincidentally, many of whom are former doctors themselves - are beginning to take up a new focus with their retired clients of trying to encourage healthier lifestyles in retirement, effectively helping clients save for retirement and manage their spending in retirement by reducing the likelihood of costly retiree medical expenses in the first place, along with teaching clients how to be better consumers of medical services (i.e., how to better avoid costly unnecessary procedures by asking why each test is being ordered, getting second opinions, etc.)! One advisor recommends steering clients to GoodRx specifically to help them find less costly ways to fill sometimes-very-expensive drug prescriptions.

Why Don't Rich People Just Stop Working? (Alex Williams, The New York Times) - Income inequality has become an increasingly hot political issue, with some presidential candidates going so far in recent weeks as to say that "billionaires should not exist". While business owners themselves often maintain that their economic wealth is a just reward for the risks that they've taken (and may continue to take) with their wealth, the rise of billionaires also raises interesting questions about the nature of 'work' itself, and why even incredibly wealthy business leaders like Tim Cook of Apple still wakes up at 3:45AM for his work day and why Elon Musk (estimated to be worth $23B) still works 80-90 hours per week (which he celebrates by having dialed back his "bonkers" 120-hour workweeks in the past). Or stated more simply, why don't people stop working once they have more than enough wealth (many times over) to have any financial need to work ever again? On the one hand, it seems that few people even know their "number" anymore - the amount it would take to retire - such that wherever our wealth stands, we rarely compare it to our original goals, and instead stay marching on the treadmill of trying to reach whatever might be achieved next. For others, though, the answer is simply that building a business and engaging as the capitalist is their fulfilling work, and successful business owners in particular often have significant trouble shifting into "lower gears" in a post-work environment (akin to a drag racer who suddenly has to learn to navigate a local neighborhood at just 30 mph and try not to crash). In some cases, it's theorized that an absence of work may force us to face our own personal challenges - ones that we more easily distract ourselves from by engaging in work. And for some, it's not about the wealth itself, but the social status... in a world where business owners are often judged socially by the size/success of their business (driving a never-ending desire to grow more revenue - or in the case of advisory firms, more AUM - to be seen and judged as 'more successful' than others). Though ironically, some research suggests that one of the biggest challenges for the ultra-wealthy is actually that it becomes personally isolating... which in turn may only feed the desire to stay focused on their businesses as their only remaining outlet?

Financial Incentives Are Weaker Than Social Incentives But Very Important Anyway (Scott Alexander, Slate Star Codex) - A recent article in the New York Times noted a new study by economists who discovered that while we typically believe that a change in financial incentives will materially impact the behavior of others (e.g., almost 50% of people believe that Universal Basic Income would make other people stop working, and over 60% believe that a Medicaid program with no work requirement would discourage those eligible from finding work), when asked about their own behaviors, far fewer report any such tendency in themselves (e.g., barely 15% believe that Universal Basic Income would change their own motivations, and only a similar amount believe expanded Medicaid would discourage themselves from working). Which not only raises the question of why financial incentives don't have more actual power over us, but also what does actually incentivize us instead. The answer appears to be our social status and connections, from chief executives and top athletes who continue to push themselves out of a desire to win and 'be the best', to poor people who may walk away from social benefits if they come with a social stigma. In the logical extreme, this suggests that raising taxes on the wealthy, and removing requirements from welfare programs, may not actually be as problematic as many predict it would be, though Alexander notes several important caveats, including: it's not necessarily about what the average person will do in response to incentives, but what the marginal person will do (after all, if removing the alarm system from your house means 99.99% of the people who visit your house don't rob you, it still means you got robbed); in the long run, our economic incentives can actually change our social incentives (e.g., stealing CDs from a music store was deemed bad, but pirating digital music when it couldn't be well enforced actually became more widespread over time as the behavior was socially normalized, and in Alabama there are counties where the number of people who are on disability has increased by 50% in just 15 years, which may be because the stigma associated with taking disability for lesser and lesser afflictions became normalized); and sometimes, financial incentives are important precisely because social norms may condone societal behaviors that we're trying to change and improve, such that sometimes financial incentives can be an important and healthy counter-balance to social incentives. Nonetheless, the fundamental point remains: while we typically express a lot of concern about how others will respond to financial incentives (from taxes to welfare to worker productivity), in practice most of us claim that we would not be so greatly incentivized... raising the question of whether we're actually just fooling ourselves, or if we really do grossly overestimate the relative impact of financial to other more social incentives (and whether that provides a better opportunity to ultimately drive behavior change for the better)?

Stop Working And Go Home (Noah Smith, Bloomberg) - Last summer, Microsoft conducted a business experiment in Japan (long-noted as a country where workers put in long hours) where employees got five consecutive three-day weekends (and only worked 4-day workweeks)... which after just 5 weeks, was associated with a monstrous 40% increase in sales per employee from the prior year, while also saving the company costs on everything from electricity bills to paper-copying costs. Of course, it's possible that the success was just a fluke, and has yet to be replicated in other branches, but Smith notes that a recent experiment at a New Zealand company in 2018 produced similar results, and research on British munitions plants going back to World War I has found that past a certain point, working more hours just decreases hourly output, both because fatigue sets in (and excessive work fatigue just carries forward from one day to the next) and sometimes simply because there's no current work to do (e.g., a task is waiting on someone else to respond, who may not do so until later in the day anyway). Not to mention that some employees simply try to signal they're hard-working by staying long hours at the office, even if they're not necessarily actually very productive over that time period. Accordingly, the idea is that if companies limit the number of hours that employees work in the first place, it compels them to try to be more productive in the time allotted, limits the ability to put on a 'show' of long hours, and can simply outright reduce fatigue. Which is notable as a concept, especially in the US where we already work longer hours than our counterparts in (more productive) north European countries, raising questions of whether a mandate for shorter workweeks (or shorter workdays, or more paid vacation) may soon be coming to the US as well in the hopes of similar productivity gains?

5-Hour Workdays? 4-Day Workweeks? Yes, Please! (Cal Newport, The New York Times) - The Wall Street Journal recently reported on a 16-person tech start-up that is employing a novel approach of using (just) a 5-hour workday, where employees arrive at 8AM and are expected to leave at 1PM and not work again until the next morning. Relative to the 'typical' business that has employees on site for 8-9 hours per day (or more), the approach seems impossibly limiting to productivity (especially in a tech firm), but the company is betting that in the end employees only have a fairly limited number of truly productive hours in the day anyway and that by focusing them, the same key tasks can be accomplished each day in the (reduced) time allotted. Accordingly, the company is 'forcing' employees to be very focused in that 5-hour window, including a requirement to leave phones in their bags at the office, blocking access to social media on the company network, strict rules on reducing time spent in meetings (generally limited to 15 minutes or less), and a rule that employees only check their work email twice each day (eliminating time-consuming back-and-forth exchanges that fragment attention). Yet while these changes may seem 'radical', Newport notes how today's 'knowledge work' is itself a relatively new phenomenon of just the past 60 years (since Peter Drucker's 1959 book "Landmarks of Tomorrow" coined the knowledge worker term), while the modern work day as currently formulated is really largely an artifact of the industrial era that preceded it, and that in point of fact the new tech start-up approach is more akin to the revolution from 'craft' construction than to the focused-assembly-line approach that Ford used to revolutionize business productivity 100 years ago. Or as Newport has noted in his own book "Deep Work", perhaps a new approach is needed to better facilitate knowledge workers actually doing their best and most focused Deep Work.

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.