Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the latest in the ongoing saga of the CFP Board's compensation disclosure woes; the latest news is that another CFP certificant was accused of violating the fee-only rules by also owning an insurance company, but has avoided a CFP Board investigation by dropping his CFP marks, "resolving" the issue but raising questions about how this was even possible (as it violates the CFP Board's own Terms of Service to drop the CFP marks with a pending disciplinary issue) and potentially setting a dangerous precedent that encourages other CFP certificants to simply break the rules and then drop their marks if a complaint is ever filed so they can avoid any public discipline.
From there, we have a few practice management articles this week, including one article that looks at tactics firms are taking to attract talent given the shortage of young advisors coming into the business, another that reviews Fidelity's recent "Recruiting Redefined" study that finds the greatest challenge for bringing in talented young advisors may be the product-sales-centric focus of much of the industry and the fact that most college students aren't even aware of a potential career as a comprehensive financial planner, a third article that provides a good reminder of how establishing a succession plan with an existing staff member can avoid communications breakdowns that damage the firm, and a final article that explores how for firms that have focused on holistic advice and not "sales" the challenge now may be on to shift the firm's culture to promote more business development or face declining growth rates as the founders eventually wind down their own efforts.
We also have a few more technical articles this week, including a tale of woe from the tax court about how not do try to invest in real estate using your IRA, an article about the unique situations where it actually does make sense for a married couple to file tax returns separately and not jointly, a discussion of the importance of not just digital asset planning in general but especially for small businesses where digital assets can have significant value, and a nice retrospective look from the Journal of Financial Planning at the so-called "4% rule" as this month is the 20th anniversary of Bengen's seminal research article.
We wrap up with three interesting articles: the first looks at the rise of "prize-linked savings accounts" that pair together small savings accounts or CDs with a "bonus" lottery ticket for a small monthly prize to encourage savings behavior (as even if the person doesn't win, they still saved!); the second looks at the rise of patent trolls in the context of online financial planning and investment advisory tools and whether the "robo-advisors" may face a patent challenge; and the last discusses why a fiduciary standard is crucial to clean up the industry, as when standards are otherwise too low a few "bad actors" can actually drive away the good and legitimate businesses to the long-term detriment of consumers.
And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including the announcement that Schwab may soon be rolling out a "robo-advisor" solution of its own (that would potentially be available to advisors using their platform!), a new digital estate planning assistance tool, and more. Enjoy the reading!
Weekend reading for October 11th/12th:
CFP Board Suspends Probe After Advisor Drops CFP (Ann Marsh, Financial Planning) - High profile CFP activist and "watchdog" Nigel Taylor (a leader in the late 1990s campaign against the CFP Board to stop it from implementing its "CFP Lite" proposal) has dropped his CFP certification, making the move to protest the CFP Board's leadership and an ongoing investigation into his compensation disclosures, after it was alleged that he had violated the rules for "fee-only" by holding out as such under his RIA while he also owns an insurance company that is "separate" from his planning practice (similar to the allegations against Jeff and Kim Camarda, who are currently suing the CFP Board over its decision in their situation). In addition to dropping his CFP certification, Taylor also threatened to sue the CFP Board, suggesting that they do not actually have the authority for the regulatory role they are playing, and that the CFP Board does not have a right to supervise and regulate his advisory firm (and how the firm holds out to the public) just because he individually holds the CFP marks. And notably, now that Taylor has dropped his CFP marks, the CFP Board has informed Taylor that the organization is suspending its investigation into the compensation disclosure complaint against him; in response, Taylor has actually suggested that this is only compounding the issue, and that the CFP Board really should continue its investigation against him, as doing otherwise suggests that the CFP Board really doesn't have confidence in its own rules and investigative processes. (Michael's Note: If the CFP Board allows certificants to avoid investigation by simply dropping their marks, it also sets a troubling precedent for the organization's ability to enforce its marks in the future, when certificants can deliberately flout the rules and simply drop the marks and avoid discipline if/when a complaint ever appears. Notably, the CFP Board's Terms of Service for the CFP certification does reserve the right to not accept a relinquishment of the CFP marks when there is an investigation pending, allowing the organization to complete an investigation and issue a disciplinary ruling first; but given this provision in the Terms of Service, it's all the more unclear why the CFP Board would allow Taylor to avoid investigation, especially if it was confident in its anticipated investigation and subsequent disciplinary ruling.)
Finding A Young Adviser For Your Team (Liz Skinner, Investment News) - The squeeze is on for finding young talent. Firms are searching through a variety of sources, from building relationships with local college professors, using recruiting services for young planning talent, regularly posting on financial planning job boards (or scanning resumes posted to them), or simply growing talent in-house. In fact, many firms are going the latter route, not even going to financial planning programs (where there is still a dearth of students for the number of job openings, and top candidates are often grabbed up very fast), and instead drawing in people with other business or related degrees into operations positions and then developing them internally towards a track to become a financial planner. Some firms attract students by trying to connect with them earlier as interns, to build the relationship to the point that they can ultimately be hired into the firm, though notably firms that just offer internships doing grunt work are likely to lose students; for the internship to be effective at building a pipeline for talent, it needs to have more meaningful work. Another approach for some firms is to create a "residency"-style program, where students come in for a fixed term of a year or two - allowing the role to be more immersive than just an internship for the potential new advisor, and more productive for the firm (as there's time to train them and then really get some value from them) - and then ultimately deciding whether to follow up with a formal job offer thereafter.
Should Firms Downplay Sales to Attract Young Talent? (Ann Marsh, Financial Planning) - Fidelity has released a new white paper on industry trends in hiring the next generation of advisors, entitled "Recruiting Redefined", which suggests amongst other things that the heavy focus on the sales aspects of jobs in financial services - especially the concept of selling products on commissions - may be a big turn-off that is driving away talent. By contrast, younger advisors are more attracted to job descriptions that take a more holistic view of providing comprehensive financial advice (which in theory may ultimately have holistic-financial-planning business development requirements later?). The study also found that bringing in young professionals for other 'adjacent' fields (e.g., young lawyers or CPAs?) can be very effective, especially if done through networking for recruiting referrals. Overall, though, the Fidelity study found that while Gen Y is far more interested in the "advisory" profession than product-sales-focused roles, the biggest challenge for bringing people into financial planning is simply that they're not aware it exists; only 2-in-10 college students and young professionals were even aware of the field, but most wanted to learn more once they heard about it. In other words, the biggest challenge for bringing in the next generation of financial planners may not be a lack of interest, but simply a lack of awareness!
The Case Of The Resentful Successor (Cam Marston, Investment Advisor) - This article paints the "classic" picture of a frustrated succession plan; an experienced second-in-command advisor is managing the bulk of clients that were developed by a founder who is now adjusting to a better work/life balance after having spent years and decades building the business, and the second-in-command is concerned the founder isn't leaving fast enough to turn over the business, while the founder is concerned the second-in-command is disrespectful of the investments made to build the business and is too impatient to take over. The author suggests that this conflict stems at least in part from the different foundational experiences each advisor has had, and that each advisor's generational perspective is shaping their view, where the veteran advisor views the part-time retirement as an ideal schedule and reward for his hard work, while the second advisor is concerned that there's no career path for what comes next with a founder who seems intent on never fully leaving. The solution? Marston advocates that ultimately, formulating a plan of what the path will be is crucial; it doesn't necessarily have to show an immediate exit and transition from the founder to the subsequent advisor, but it needs to establish a plan of what's eventually intended to come. And as Marston notes, the issue is especially important for hiring going forward, as the next generation Millenials coming into financial planning today dislike career-track-ambiguity even more!
To Increase Sales, Change Your Culture (Kelli Cruz, Financial Planning) - As they grow, many advisory firms find a challenge, where the founders are the "rainmakers" that drive sales and business development, and with the next generation advisors that come to work for them, they either have this innate skill themselves, or they don't; and unfortunately, since most people don't (as "sales" can be hard in any industry!), many firms struggle with business development as their needs for growth expand beyond what their founders alone can provide. Yet Cruz suggests that the problems with next generation advisors developing business (or not) lies heavily with the culture of the firm; when the expectation is that most people won't be able to develop business, they don't, but if there is a culture that supports them and creates the expectation that they will, then many actually can learn the skill. So for firms that don't already have the culture, how does it get created? Cruz has several tips: 1) embed business development expectations everywhere within the firm, including (reasonable) business development expectations into job descriptions, and activity-based goals that can be monitored for feedback and measuring results; 2) be more cautious in hiring, and while not everyone will be a naturally-born salesperson you can tilt your hiring towards those who at least show some of the underlying characteristics and traits that would support it; 3) provide coaching support and feedback as your team learns (and/or consider hiring a sales/marketing manager who can coach them); 4) communicate regularly internally about the importance of business development for the firm; 5) reevaluate how the firm is structured, and whether you need to give your lead advisors more support to free up their time in order to do more business development in the first place; and 6) "pay for success", where those who do develop business successfully have the financial rewards and incentives to do so.
Court Nixes Real Estate Move in Schwab IRA (Ed Slott, Financial Planning) - This article tells the story of an unfortunate botched investment of an IRA into real estate, and serves as a good reminder warning that while real estate investing in an IRA can be done, it must be done correctly or there can be significant adverse consequences. In this case, IRA owner Guy Dabney had an IRA with Charles Schwab and wanted to invest in direct real estate, but Schwab told him that they do not allow such alternative investments with IRAs on their platform. Rather than move the funds to a self-directed IRA custodian that could handle real estate, though, Dabney decided to simply have $114,000 from his IRA wired directly to the seller of a piece of real estate, who sold the property "to the IRA" by titling it into the name of Dabney's IRA (or at least was supposed to; separately, the titling was botched, and placed into Dabney's individual name instead, which wasn't discovered until the property was sold 2 years later). When Dabney subsequently sold the property (for $127,000), he wired the sales proceeds back to his Schwab IRA and marked it as a rollover. However, as it turned out, back in 2009, Schwab had issued a 1099-R and marked the original wire transfer out as an early distribution; Dabney claimed he never received the 1099-R, and thus never reported it on his tax return, which was how the IRS eventually caught on to the situation. Dabney challenged the IRS's claim that it was a distribution, and represented himself in Tax Court, but lost; the IRS stated (and the court agreed) that the purchase was a distribution because Schwab's IRAs couldn't possibly hold real estate (given Schwab's policy), and that the purchase couldn't be treated as a rollover because the title company that took the funds to facilitate the purchase wasn't an IRA custodian either. The court did waive the additional 20% accuracy-related penalties, believing that Dabney had acted in good faith, but he still owed taxes on his IRA distribution, an early withdrawal penalty, and now may potentially face an excess contribution penalty tax as well for trying to put $127,000 back into his IRA in what would now be an invalid rollover.
When Does it Make Sense for Married Taxpayers to File Separately? (Michael Piper, Oblivious Investor) - While the tax code does allow for married couples to file separately instead of jointly, there are many other provisions in the tax code that make this approach unappealing for most. A wide range of tax breaks normally available to married couples filing jointly are not available those filing separately, including the American Opportunity and Lifetime Learning college tax credits, the earned income credit, premium assistance tax credits for health insurance, student loan interest deductions, and more. In addition, for couples where there is a significant difference in income, filing separately can result in a higher tax burden for the couple because the lower brackets of the lower income couple remain unused (by contrast, when filing jointly, the higher income spouse's taxable income can fill up the wider lower brackets for joint couples). However, Piper points out that notwithstanding these issues, there are a few reasons couples might want to file separately, including: the couple really is separated (but still married) and filing jointly really wouldn't be feasible (the rule's original purpose); because one spouse has to publicly disclose his/her tax return (e.g., due to holding public office) and the other spouse doesn't want his/her own information to be public as well; where one spouse wants to avoid being jointly liable for any amounts due to the IRS for the other spouse; and in a handful of situations where there can actually be tax savings. While the tax savings scenarios are not common, they are out there, such as where one spouse has significant medical deductions (which are throttled by the 10%-of-AGI deduction threshold) and would be able to get more in deductions for the couple by having the AGI threshold based on one person's income and not both; a similar result could occur with other large itemized deductions subject to AGI thresholds, such as a big casualty loss, or large miscellaneous itemized deductions.
The Importance of Digital Asset Succession Planning for Small Businesses (Jamie Hopkins, Ilya Lipin, John Whitham, Journal of Financial Planning) - While there has been a growing focus on the importance of digital estate planning, for those who pass away but don't want to lose access to personal files stored online or years' worth of family pictures on Facebook or Instagram, the issue can be even more important for small business owners, where digital assets can have significant economic value. This could include everything from online business/banking accounts, to a business website (or even a valuable domain name), to client information stored in a cloud-based CRM; the problem could even be as "simple" as a business owner who is the only one that knows how to log into the company's software systems for managing customer orders, which means digital asset management for businesses include an aspect of both classic estate planning (who inherits the "asset", as complicated by inconsistent rules about the legal transferrability of digital assets in the first place) and also simply continuity (who manages/accesses the digital information to continue the business in the event of a sudden death of the owner). The article suggests that initial technique to deal with these challenges can be software that is responsible for "Digital Asset Management" (DAM), for instance by having a central online or server-based repository for key digital assets that can be accessed by multiple members of the business. From the estate planning perspective, Wills should specifically grant consent for the executor to access the deceased's digital assets, and ideally should include an inventory of digital assets that are periodically updated (as it's otherwise hard to even find!); some may prefer to use trusts to handle digital assets, for the privacy enhancements of avoiding a public probate process, and reducing the risk that the rights of the account-holder die when the account-holder dies (because it's in the account-holder's trust instead). Ultimately, digital asset estate planning may become easier soon, as the Uniform Law Commission finalizes proposed "Fiduciary Access to Digital Assets Act" legislation for states to adopt, that will improve accessibility of digital assets for estate executors and trustees.
The 4% Rule: It Was 20 Years Ago Today (Jon Guyton, Journal of Financial Planning) - This October cover story for the Journal of Financial Planning is a retrospective on the now-famous "4% rule" for safe withdrawal rates, first established by Bill Bengen in an article entitled "Determining Withdrawal Rates Using Historical Data" for the Journal exactly 20 years ago, in October of 1994. Bengen had just earned his CFP certification 4 years earlier, as a career changer into financial planning who had originally graduated from MIT with a bachelor's in aeronautics and astronautics. At the time, personal savings were still broadly viewed as a supplemental portion of retirement income, something to add beyond a pension and Social Security (as 401(k) plans and IRAs were still in their early years!), Monte Carlo analysis hadn't been introduced yet, and retirement analysis were done with homemade spreadsheets as often as any actual substantive financial planning software. And in that environment, the ongoing bull market was so strong that stock-picking guru Peter Lynch was suggesting that a 7% withdrawal rate from an all-stock portfolio was appropriate, given that the long-term real return on stocks was about 7% at that time! In this context, Bengen's relevation that by looking at rolling 30-year periods, a safe withdrawal rate might only be 4% when based on the worst 30-year period in history, was a significant deviation from the conventional wisdom of the time. Notably, Bengen himself published several subsequent articles on the topic extending his research, and ultimately a book entitled "Conserving Client Portfolios During Retirement" in 2006, and Guyton notes that Bengen's legacy is not only the 4% rule itself, but the ongoing extensions of that line of research he started that are still happening today.
Using Gambling to Entice Low-Income Families to Save (Patricia Cohen, New York Times) - This article explores the rise of "prize-linked savings accounts", where individuals are encouraged to save by receiving an entry in a small lottery for each deposit they make to a savings account or CD; for instance, one organization launched a program called "Save To Win" where individuals at participating credit unions get a monthly lottery ticket for each $25 deposit, with prizes like $25 or $100. The point is not really to help (or encourage) people to win "big" in lotteries, but simply to provide a modest incentive reward for savings that can encourage people to save, especially those at the lower end of the income spectrum who otherwise struggle to save. Contrasted with "traditional" lottery tickets, these prize-linked savings accounts don't actually take away the deposit to buy lottery tickets, so at worst the saver who "earns" lottery tickets is still saving... but may be more encouraged to do so by also having the chance to win (or saving more, such as trying to save $25/month to reach the lottery ticket threshold rather than saving only $10 or $15 per month). Another version of the accounts is being rolled out for students, to help them build positive savings habits early. The approach is becoming increasingly popular, leading some states to adjust their banking regulations specifically to allow the creation of prize-linked savings accounts; thus far, liberty poverty advocates like the approach because it encourages saving and is not nearly as destructive as purchasing 'traditional' lottery tickets, while conservatives have been supporting it as ultimately being private-market-based and helping to encourage personal responsibility.
Will Robo-Advisers Raise The Ire Of Patent Trolls (Andrew Barber, Institutional Investor) - Last month, GRQ Investment Management filed a lawsuit against Financial Engines, the leading online adviser working in the defined contribution marketplace with $824B of assets under administration and $92B under management. The suit alleges that Financial Engines has infringed upon GRQ's patents on systems used to provide computer-based advisory services. The lawsuit is not the first at the intersection of online software and financial advice; back in 2011, Wealthcare Capital Management (owner of the Financeware Monte-Carlo-based financial planning software) sued UBS for its use of MoneyGuidePro software, claiming patent infringement on Financeware's software-based financial planning methods, and ultimately UBS (and MGP software-maker PIEtech) settled out of court for an undisclosed sum. The challenge is part of a broader trend of "intellectual-property portfolio managers" who purchase patents and then look for opportunities to sue to enforce them; the number of suits filed by such "patent trolls" climbed to 3,134 in 2013, almost 20% higher than 2012 and accounting for more than half of the year's patent infringement lawsuits. Software-based lawsuits appear to be especially sticky, in part because many software-related patents have "overly broad or unclear claims" according to the GAO. The recent Supreme Court decision in Alice Corp. v. CLS Bank in June may have limited the patentability of software (and the enforceability of some existing software patents), but the question remains about whether lawsuits like Financeware, or more recently GRQ about computer-based advisory services in particular, could present a challenge to today's crop of "robo-advisors" or future web-based software solutions that startups might try to innovate in the future.
Gresham's Dynamic: Why Bad Actors Dominate Financial Services (Ron Rhoades, Scholarly Financial Planner) - In a famous 1970 article "The Market for Lemons: Quality Uncertainty and the Market Mechanism", Nobel-Prize-winning-economist George Akerlof wrote how in situations of information asymmetry (where the seller knows more about a product than the buyer), that dishonest sellers cause damage not only due to the losses their lies incur to the purchaser, but also because their dishonest dealing can actually drive honest legitimate businesses out of existence, in what he called "Gresham's Dynamic". While Akerlof's original research was in the content of selling lemons (a "lemon" is a slang term for a car that turns out to be defective after it is bought), Rhoades suggests that financial services suffers in the same manner, where it is too easy for financial "advisors" to sell questionable products, yet their ability to do so is harmful not only to the public but drives away honest advisors who struggle to compete with the lowest common denominator. So how can Gresham's Dynamic be resolved? In the context of lemons, it was to subsequently pass "lemon laws" that give consumers some recourse for defective products; in the case of financial services, Rhoades states that avoiding this dynamic is ultimately why a fiduciary duty is so crucial; lifting up the minimum threshold for advice helps to limit the success of the bad apples who can otherwise come to (and Rhoades claims, have come to) dominate the industry. Unfortunately, though, Rhoades also suggests that the regulators who must impose such a duty (e.g., the SEC) have been so captured by those they regulate, that change has been slow to come; in other words, it's hard to lift up the minimum standards to avoid bad actors dominating financial services when the bad actors already so dominate that they have significant influence and control over the regulators themselves.
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!
