Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the big announcement that the "robo-advisor" Betterment has launched an Institutional platform that will partner with Fidelity to offer a "robo" solution for advisors to use with their (smaller) clients.
From there, we have a number of practice management articles this week, including a look at new compensation models being explored by advisors who are looking to get away from the AUM model (or serving clients who simply don't have the assets to work on an AUM basis in the first place), examinations from two recent benchmarking studies about what top performing firms do that are different than the rest of the pack (including differentiating themselves with niches and specialization to support their pricing, and using "non-professional" support staff to enhance the productivity of their lead advisors), and an interesting article by Bob Veres looking at the wide range of changes being recommended to advisors and sharing his own take about what is and is not really important for advisors to focus on right now.
We also have a few more technical articles this week, from a review of target-date funds finding that many are becoming increasingly aggressive and equity-centric in the current low bond yield environment (with one fund as high as 94% in equities for someone in their 40s!), to an interesting profile of economic and retirement policy researcher Jeffrey Brown (who may not be familiar to most advisors but probably should be!), to an interview with Nobel price winner Bill Sharpe who has been increasingly focusing his current research time on the complex challenge of retirement planning. There's also an article looking at how, despite all the ongoing fears, health care inflation for seniors appears to be slowing, as the latest announcement of Medicare Part B premiums will be $104.90/month again for the third year in a row.
We wrap up with three interesting articles: the first is a comparison of popular risk tolerance tools FinaMetrica and Riskalyze, finding that one seems to be far better as a sales and prospecting tool for clients but the other may be more defensible in court; the second provides some tips on efficiency and productivity based on the latest research of behavioral finance expert Dan Ariely; and the last is a profile of venture capitalist and technology innovator Marc Andreesen, who created the first popular web browser and backed Twitter, Facebook, and AirBnB, and now sees opportunities for similar disruption in financial services (especially around how big banks charge for facilitating credit card and banking transactions, as "crypocurrencies" like Bitcoin gain momentum).
And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including his take on the recent announcement that Betterment Institutional will partner with Fidelity, and how amidst the SEC's push for better cybersecurity with advisors they lost 200 of their own laptops with potential client data (oops!)! Enjoy the reading!
Weekend reading for October 18th/19th:
Betterment Partners With Fidelity As First Custodian To Offer 'Robo' Platform To Advisors (Joel Bruckenstein, Financial Advisor) - This week, Fidelity Institutional Wealth Services announced a partnership with Betterment Institutional, to provide a "robo-advisor" platform solution for Fidelity advisors who want to use their technology in their own practices. The service for advisors will offer all the features of Betterment for consumers, including its low-cost portfolio of ETFs, automated rebalancing and tax-loss harvesting, and the ability to easily automate ongoing contributions and dividend reinvestments. The Betterment Institutional offering will provide advisors with a central dashboard to view all the relevant data about their Betterment clients, a "co-browsing" feature so advisors can log in as their clients to see what clients see, and will have a paperless onboarding process for new clients to sign up for accounts. The service will also handle the generation of statements and reports for clients, and billing and fee collection on behalf of advisors, but the technology will remain entirely separate from Fidelity's existing custodial platform and technology. The Betterment Institutional platform will cost 25bps for the entire service, including all the Betterment services and an [undisclosed] referral fee to Fidelity, and will have no minimums, upfront costs, or transaction fees for clients; advisors can add their own advisory fee on top of the platform fee. Advisors are expected to look to the solution for simplification and segmentation of small clients/accounts, scalability using Betterment's paperless sign-up process, and to allow for an easy start-up into the space; Betterment indicates that 800-1,000 advisors have already expressed interest in the platform.
Experimenting With New Compensation Models (Ellen Uzelac, Research Magazine) - Advisors are increasingly adopting a wider range of compensation models, both to serve younger clientele (where AUM-style models are limited due to the lack of assets) and also older and more affluent clientele (where a 'complexity-based' retainer fee may better align client needs, the services provided, and the associated cost to deliver for the firm). Some firms are exploring ancillary additional services as well (often for an additional and separate cost), from in-house tax planning to helping small business owner clients set up their social media pages. New fee structures include exploring monthly retainer fees for advice (especially for younger clientele), or managing portfolios for a flat fee, or even segmenting clients and offering different fee structures for different types of clients and needs (e.g., AUM for retirees paid from the investment account, and monthly retainers for younger clients paid directly from their credit card). For firms that are looking to adjust their fees and structure, though, be certain to think through how it's communicated, it clients may be upset; some firms create a one-page summary of client services to be certain clients understand what they're paying for (or will be after a change), and it's often best to bring fee changes first to clients you know best who can give constructive feedback and are more likely to adopt what you offer. Be cognizant of the client psychology as well; one advisor felt pushback when his clients saw their fees as a line item on their account instead of being 'invisibly' extracted from their mutual fund and were upset even though the cost were actually cheaper. Notably, while some advisors are moving away from AUM fees simply because they feel it's not well aligned to their comprehensive planning services, many younger advisors appear to be moving away from AUM and towards other fee structures like monthly retainers simply because they don't want to be involved in the investment process at all and prefer to focus on other parts of the financial planning spectrum instead.
Advisors, Show Your Value With Calculated Aggression (Mark Tibergien, Investment Advisor) - A recent joint study by FA Insight and Pershing, entitled "Mission Possible IV", studied some of the most successful leading firms over the 2008-2012 period, attempting to discern what it was that allowed them to grow so effectively (at twice the rate of their peers). The first key differentiator the study found was that the leading firms were more effective at managing their expenses; they kept their overhead costs to 36% of revenue, while the average across all firms for overhead expense ratio had risen to 45% by the end of 2012, and this difference led the leading firms to a 29% profit margin when the rest of the industry averaged only 13%. Notably, this expense control doesn't mean the leading firms lacked headcount; in fact, the difference was that the leading firms added two heads for every half a head added by the typical firm, and used those investments in human capital to fuel the growth in the firm (such that revenue could rise even faster than staff expenses). Another key difference was the types of staff added; leading firms were more likely to add so-called "non-professional" staff with superior administrative skills, and leverage that staff to make their lead advisors more productive (spending 75% of their time with clients, versus only 52% for lead advisors in the average firm) and able to handle more clients per advisor. Perhaps most notable, though, was that leading firms were more likely to engage in disciplined pricing strategies, and not discount their fees or waive minimums in the 2008-2009 crisis; instead, the leading firms sought to compete on value, actually layering on additional services and focusing on premium pricing instead. As a result, leading firms actually raised fees on a $5M portfolio by an average of 10bps over the time period, while other firms reduced their fees by 10bps. The bottom line: for leading firms, their growth coming out of the 2008-2009 crisis was driven by their reinvestments back into the firm, in an admittedly difficult time, that helped them to excel as the rebound came and they found themselves ahead of the curve.
Three Ways Top-Performing Firms Stand Out (Matt Sirinides, Investment News) - Investment News is also digging into the research on top performing firms in their latest Financial Performance of Advisory Firms benchmarking study. For these purposes, "top performers" were based on the average revenue per professional at the firm (a measurement of advisor-client productivity), earnings before owner compensation as a percentage of revenue (essentially the firm's operating profit margins before owners are paid), pretax income per owner, and three-year revenue growth. When comparing the firms in the top quartile on these metrics to the rest, the research found the following key differences with the top firms: they have maintained a stronger focus on revenue growth and quality; they focus on making their advisors more productive with support staff, but not necessarily specifically focusing on operations productivity itself; they were more likely to acquire talent through inorganic means (i.e., mergers & acquisitions); they spent more energy hiring staff, formalizing referral relationships, and integrating technology; they are more structured about taking on clients (more likely to have minimums and evaluate client profitability annually); they are more likely to have owners who are also productive advisors, though they focus on hiring talent to support capacity as well; and they were more likely to specialize their practice and hone in on a client niche.
Five Biggest Ways Your Practice Needs To Change (Bob Veres, Advisor Perspectives) - While there has been a great deal of discussion lately about all the 'disruption' that technology is bringing to financial advisors, often the conclusions regarding what to do about it are incomplete or overly broad; in this article, Bob Veres attempts to parse through the major evolutionary changes that are coming, provide some suggestions about how to address them, and help prioritize which ones are most important to address. Topping the list of "high priority" includes the coming commoditization of investment advice, symbolized by the robo-advisor trend, although Veres suggests the outcome may look more like a "cyborg" advisor that blends together the human advisor benefits and the technology to deliver services better; in the near term, Veres urges firms to focus on leveraging their technology (if large enough to do so), or outsourcing to a third party platform to help implement efficiently. On the other hand, Veres notes that while leveraging technology like a robo-advisor is a high priority, actually fearing them as increased competition is not; in fact, Veres suggests that independent advisors themselves have been the disruptive force impacting the financial services establishment, and are well ahead of both traditional brokerage firms and the automated advice platforms. Other high-priority items include: building data integrations across your technology so it interacts (and/or deliberately choosing technology vendors capable of doing so); marketing to the next generation, which is not utterly urgent as most firms can survive with their aging client base for another 7-10 years, but forward-looking firms will be working on this now (often by hiring younger advisors and give them the opportunity to market to and build a client base with their peers, and loosening up the firm's minimums); creating a more interactive planning experience with clients (as Gen X and Y are more inclined towards collaboration than total delegation, and the outcome is more referrable as well); getting a succession planning strategy in place (urgent because it takes so long to execute well, even though many advisors can and likely will work into their 70s or even 80s). Of less priority: migrating your firm entirely to the cloud (necessary eventually, but not immediately); acquiring scale as firms of the future will likely have multiple partners and share resources (but not crucial today, as most firms are doing well enough as is); changing your revenue model (the trend has been from commissions to [AUM] fees, but shifting from AUM fees to retainer may ultimately be necessary but isn't urgent, although in the end it may help many firms run more profitable practices); outsourcing key office tasks (helpful but not urgent); and creating a social media presence (Veres suggests that most advisors should play to their strengths in marketing, and for most advisors that may not be social media).
Big U.S. Firms Boost Equity Weightings In 401(k) Target-Date Funds (Jessica Toonkel, Reuters) - Major fund companies, including Blackrock, Fidelity, and PIMCO, have recently made adjustments to the target-date funds they hold in 401(k) plans, increasing the allocation to equities (especially for those who are younger to middle age); some target date funds are now as high as 94% in equities for those in their 40s. The concern is not merely the magnitude of the equity increases, but also that the companies increasing equity exposure have all had target date funds lagging their competitors in performance, raising the question of whether the greater equity exposure is intended to amplify returns (albeit at greater risk); the companies respond that the changes are simply based on positive forecasts for equities, juxtaposed against lower expectations for bond returns given low yields and the danger of rising interest rates. Critics also point out that the target date funds in question carry higher expense ratios as well, averaging 0.85% per year, which investors could hypothetically replace by simply owning the underlying index ETFs at a fraction of the cost (though investors would then have to manage their own allocations across asset classes over time).
Jeff Brown: Retirement Researcher, Model, & Mentor (Michael Finke, Research Magazine) - Jeff Brown's name may not be very familiar to financial planners, but he's won numerous awards for his retirement research in top-ranked journals, has co-published with a veritable "Who's Who" of economic scholars, and is widely respected as a highly capable "policy wonk" when it comes to economic policy issues around retirement. One of Brown's leading areas of research is into annuities, studying the question of why people don't buy more annuities. Brown has observed than annuities bought in the private sector (e.g., from annuity companies) tend to be more expensive than pensions due to the adverse selection (pensions include 'everyone' covered, while annuities are generally only purchased by healthy people) but it doesn't explain low annuitization rates, not does the tax treatment of annuities. Brown has found that concerns about uneven risks in retirement (e.g., health care shocks) may slow annuity adoption, though technically the more efficient solution would still be to simply purchase insurance coverage against the risk, and then annuitize much of the rest. Ultimately, Brown's research finds that people do value the income stream of annuities, but appear to have trouble mentally converting what was an account balance into a(n illiquid) income stream; to combat this, he suggests that creating a default where retirees will annuitize at least a portion of their wealth at retirement may help (as when the default it to have an income stream, people seem to value it more, as they do with Social Security benefits). More recently, Brown has also been looking at why people don't buy long-term care insurance very much either, and is exploring what can be done to improve consumer interest in that type of product as well.
Bill Sharpe On Retirement Planning (Robert Huebscher, Advisor Perspectives) - Bill Sharpe has a long history of notable research, from being one of the originators of the Capital Asset Pricing Model (for which he won the Nobel prize!), to developing the Sharpe ratio for investment-performance analysis that carries his name, to the binomial method for valuing options and the returns-based style analysis for evaluating funds. Now, Sharpe is spending time analyzing the world of retirement, and this article is an interview with him that shares some of his recent thinking and research. Notable points include: even relative to the other research that he's done, analyzing retirement is spectacularly difficult because there are so many dimensions; annuitizing income can be a very effective strategy, but relatively few people do it, yet that might be understandable given how much annuitized income they already have in the form of Social Security (and possibly a pension as well); the traditional glidepath during accumulation (to decrease your equities as you approach retirement) may be less about portfolio management and more about the fact that as an earner's human capital decreases that bonds need to rise to take its place (but because different clients have different types of careers, traditional target date funds may be mismatched for many people's human capital characteristics); the 4% rule is reliant on mean reversion, but it may be counting on too much to count on mean reversion for retirement strategies; if socially responsible investment (SRI) stocks become too favored as a strategy, they could actually begin to produce lower-than-market returns as investors pile into them. As Sharpe spends more time on retirement research, he has launched a blog of his own to share his thoughts, which you can follow here.
Healthcare Inflation Is On The Mend (Mark Miller, Wealth Management) - Every year, Fidelity Investments publishes an updated report on retiree health care costs, and the most recent report suggests a 65-year-old couple will need to have saved $220,000 to meet their future health care expenses; what's notable, though, is that $220,000 is the same estimate the company made last year, as cost growth in Medicare expenses appear to be slowing. In fact, the Congressional Budget Office has cut its Medicare spending forecasts in each of the last 6 years, and its 2019 spending forecast is now $95B lower than it was four years ago; Medicare Part B premiums will stay at $104.90/month in 2015, for the third consecutive year, and the average Medicare Part D prescription drug plan is projected to drop slightly next year, from $38.95/month to $39.88. Medicare Advantage plans, which bundle together Part B, Part D, and Medigap supplemental coverage, with an annual out-of-pocket spending limit of $3,400, have also become increasingly popular, with an estimated 33% of all Medicare enrollees choosing the plan next year. Drivers of the slower health care inflation include cuts in payments to hospitals and private Medicare plans under the Affordable Care Act, a shift from brand-name to generic medications in prescription drug plans, and possibly some ongoing effects from slower economic growth in recent years.
Risk Tool Smackdown: FinaMetrica vs Riskalyze (Bob Veres, Financial Planning) - In this article, Bob Veres compares what are probably the two most popular standalone risk tolerance tools in the advisor marketplace today (besides the minimalistic questionnaires that many compliance departments require): FinaMetrica (which has been around since 1998) and Riskalyze (the "newer" kid on the block, launched in 2011 as a consumer site and then adapted as a tool for advisors in 2012). In the case of FinaMetrica, the process begins with a series of 25 questions, covering everything from whether you get a "thrill" from investing, to your adaptability when things go wrong, to the importance that investments retain purchasing power, and more; in Veres' own experience, he finds that he may have actually overestimated his tolerance, as while FinaMetrica did score him "above average" he wasn't that far above (if he was a client, this would have been a good opportunity to help him reflect on the fact that he may be underestimating risk and/or overestimating his tolerance for it). By contrast, Riskalyze evaluates risk tolerance in a more 'quantitative' way, based on behavioral finance researcher Daniel Kahneman's prospect theory - the tool asks how much the investor has to invest, how the investor would define a "devastating" loss, and then asks a series of extreme investment trade-off questions (e.g., "would you prefer a certain gain of 10% or a 50/50 chance of either losing 25% or gaining 150%?"); as Veres responds, the trade-offs choices adjust, focusing in further on Veres' tolerance for risk, until ultimately concluding that over the next 6 months he would be comfortable risking a 15% loss for a 23% gain. Notably, Riskalyze also evaluates a client's current portfolio and investment choices, helping them to consider risk tolerance not just in the aggregate, but how it compares to their actual current portfolio, projecting risk/return for their investments based on their results in recent years (pulling performance data on the underlying stocks, funds, ETFs, etc.), and identifying mismatches. Ultimately, Veres notes that the purpose of risk tolerance software is two-fold: to help figure out what kind of investment mix will be consistent with a client's risk tolerance (especially to keep them on board in the event of market volatility), and to have something to substantiate that process in the event that regulators come knocking. From that perspective, Veres suggests that for an advisor who had to stand up in court to defend the process, FinaMetrica may have a more rigorous foundation for its risk tolerance process. However, Veres notes that for advisors who want to use risk tolerance as a prospecting tool, Riskalyze's capabilities of quickly assessing a prospective client's risk tolerance and then showing them how their current portfolio compares (or is mismatched) would be hard to beat for bringing in new clients.
How To Be Efficient: Dan Ariely's 6 New Secrets To Managing Your Time (Eric Barker, Barking Up The Wrong Tree) - Dan Ariely, author of "Predictably Irrational" and several other books about behavioral finance, has released a new web-based app called Timeful that aims to help people better manage their time. This article covers some of Ariely's recent research and analysis into what makes us more efficient, and presents several tips, including: the world is increasingly being built to distract us (think everything from advertising to smartphone notifications) so it's crucial to structure your environment to minimize distractions; you're more likely to follow through on things when you write them down, so use your calendar (or reminders, or post-its, or whatever else) to record what you plan to do and it will help you follow through and do it; recognize that you're more productive at certain times of the day and plan your schedule accordingly (most people hit their peak productivity for a few hours in the morning, starting a few hours after waking up); big productivity time-wasters to avoid (or at least minimize) include meetings (too many unnecessary meetings), multitasking (the research is clear - you're really NOT more efficient trying to multitask, you're far worse off!), and email (taking a break to check your email reduces your productivity, as it's difficult for the brain to switch back and forth, so check email in structured intervals and not constantly as a distraction!
Marc Andreessen on Finance: ‘We Can Reinvent the Entire Thing’ (Anthony Effinger, Bloomberg) - Marc Andreesen, who co-founded the first widely used web browser and a well known venture capital firm that backed Twitter, Facebook, and AirBnB, has begun to focus on how technology can disrupt the financial services sector. Andreesen notes that the regulation around the banking sector creates a lot of opportunities for targeted firms to "unbundle" parts of the industry (e.g., how peer-to-peer consumer lending is disrupting traditional bank lending). He also suggests that in the end a lot of what the financial sector does with humans could be done better with software; for instance, in the end a comprehensive analysis of a borrower is probably a better evaluation of lending risk than a loan officer just sitting across from the person talking to them, especially when "big data" on consumers is tapped to evaluate their creditworthiness with an immense number of data points (e.g., PayPal has found that evaluating someone's eBay purchase history is a better source of creditworthiness behavior than the data used to craft a FICO score!). Another big area where Andreesen sees opportunity is the rise of cryptocurrencies (e.g., Bitcoin) as a means to decentralize the financial systems, undercutting the costs and profits of banking centers and bringing down the cost of doing online transactions. (Michael's note: See here for an interesting rebuttal of why Bitcoin may become a tool for transactions, but will be prevented from replacing "real" money with simple regulations that limit bitcoin banking leverage.)
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!
Michael,
One issue in regards to annuities is they are not in financial advisors best interests. (and for a practical matter annuities are best for those with $250k or more assets.. as those with less do need to keep some capital for unexpected events). Vast majority with $250k or more have “advisors” of some sort.
A SPIA is a commission of between 3-5% usually. So take $500,000k. Between $15k-$25k usually, which is relatively fair in my opinion (probably be best to stagger over a 3 -5 year period and choose multiple companies.. but you get the point).
Most RIA’s get 1% of AUM (between .50% to 1.5%). Lets assume the retiree is 60 with 25 years on average to live. Each year for 25 years they would get at least $5k, or at least $125k. This could be more or less depending how much of the principal that the retiree uses, but never enough to reduce it to under the $15k or so.
I have not seen this analysis before… thoughts? Seems so obvious.. but kinda reminds you of the Upton Sinclair statement something to the effect of “hard to get people to believe / see something when their income depends on them not understanding it”.
I will need 72 hours of CE to reinstate my CFP; where do you suggest to get a bunch of hours done? everything I see is for like 3 to 5 hours.