Weekend Reading for Financial Planners (Oct 26-27)

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.

Charles Schwab & Co. Brings 'Start-Up'-Style Disruption To The $20 Trillion Mutual Fund Industry By Zeroing Out Free Fractional-Share Trade Ticket Charges (Oisin Breen, RIABiz) - This week, Charles Schwab announced that beyond its elimination of trading commissions on stocks and ETFs earlier this month, it will also now begin to allow (zero-commission) fractional share trading of stocks on its platform as well. The significance of this is not merely that it permits smaller investors to 'fully' allocate their investments even if they don't have the right dollar amount for whole shares (e.g., an investor depositing 'just' $100/month could still buy 0.40 shares of Apple and not need to wait for 3 months to get enough to buy 1 share of Apple at a current price of $245, and an investor depositing $700 could just buy 2.85 shares of Apple instead of getting 2 shares and leaving the last $210 sitting in cash), which has already been popular with stock-trading platforms like Robinhood, but also that by facilitating the purchase of fractional shares, paired with zero-commission trading, it becomes feasible to replace mutual funds (or even index ETFs) altogether with a new wave of Indexing 2.0 strategies that eschew the fund wrapper and instead simply buy all the underyling stocks in the index in their (fractional share) components. Of course, the caveat is that such "direct indexing" strategies will still have costs of their own, from licensing the composition of the index itself, to the technology that will be used to trade and implement such portfolios (especially if/when they are further customized for ESG or factor investing overlays), which may well still add up to a similar cost of a mutual fund (and at least a higher-cost ETF). However, those direct indexing platform costs may be assessed by the technology provider itself, and/or the custodial platform (e.g., Schwab), giving a new set of providers the opportunity to capture all the fees currently going to asset managers for their ETFs and mutual funds... raising the question of whether Schwab is positioning itself to disrupt the mutual fund and ETF industries itself. On the other hand, with Investment News reporting that Schwab has thus far been unclear about whether the new fractional share trading will be available to RIAs directly, the question looms as to whether direct indexing is a new approach Schwab is about to bring to RIAs, or use as a new retail feature to compete against them?

How Advisors Can Help Clients Who Spend Like Mad (Gary Stern, RIA Intel) - One of the fundamental challenges of working with clients who have problematic excessive spending behaviors is that they may not change their behavior without some 'tough love'... except if the advisor gives too much tough love, the client may simply fire the advisor over the uncomfortable pressure (and then not achieve their goals anyway). Which raises the question of where or how to find the right balancing point between the two. The starting point is to recognize that a lot of people simply spend whatever they feel like they have available to spend... which means by automating savings to immediately move out of their checking accounts (or ideally, never allowing the dollars to flow into their checking accounts in the first place), those out-of-sight-out-of-mind dollars are more likely to not be spent in the first place. In other situations, it's important to recognize that clients derive a feeling of joy from their spending - literally, euphoric bursts of dopamine in their brains that are released when a purchase is consummated - which means it's important to try to help them find other ways to direct their energy to get positive feelings... as just telling someone to change their behavior rarely has any impact when they've become physiologically addicted to it (through the dopamine reinforcement cycle). Accordingly, often the best approach is to try to help change the behavior more incrementally - e.g., 'just' switching from credit cards to cash or debit cards that makes the spending more salient, or having clients start to track their spending so they become more self-aware that there is a problem in the first place - and then trying to make subsequent adjustments that are more palatable as 'small wins' are celebrated along the way.

The Sentimental Savings Study (Bradley T. Klontz et al., Journal of Financial Planning) - Part of what makes problematic spending behaviors so sticky and hard to change is that they're not driven purely by logical and rational thinking (where it would be 'evident' that it's not feasible to continue spending more than you earn or more than you can afford); instead, emotions often play a big role in the persistence of spending behaviors. Accordingly, the authors of this study decided to see if they could proactively engage a client's emotionality (using an item that they were sentimentally attached to) in order to improve their savings behavior. Specifically, the researchers have the subjects bring a sentimental item (e.g., something nostalgic or valued from their past) or a photograph of it to a presentation about improving their savings behaviors, where the presentation specifically focused on connecting the feelings and values they had associated with their sentimental object to their desire to change their behavior and become more motivated to save (as contrasted to a control group, that simply received a typical financial literacy educational presentation about the importance of saving for retirement, time value of money, healthy savings goals, and various types of savings vehicles). Immediately after the intervention, the group that had received the financial psychology 'sentimental' presentation reported statistically significant increases in their readiness to save, confidence in their ability to save, financial satisfaction, and financial health, and in a 3-week follow-up reported a 73% increase in their rates of savings from before the session (compared to 'only' a 22% increase in savings rates for the financial education control group), suggesting that rather than trying to help clients become more 'rational' to save more, the best course of action may actually be to engage them more emotionally (but in financially positive terms) instead.

When Frugality Bottoms Out (Trent Hamm, The Simple Dollar) - While many households could create a potentially significant improvement in their financial situation by becoming more financially frugal, there does come a point of 'diminishing returns' in how much impact it really has to become even more frugal over time. For instance, switching from brand name to store-brand items can be a huge money saver, but comparing every single store-brand option to find the exact lowest-priced item is often a lot of additional time for very little in the way of additional savings. Similarly, finding a cheaper grocery store in town can save a lot, but going grocery store hopping just to save a few more dollars at each store can cross the point of diminishing returns; and switching from eating out for most meals to making healthier lower cost meals at home can generate big savings, but trying to economize the ingredients of the home-made meals further (e.g., general pasta with simple cheap sauce) won't realistically have much additional impact. In other words, the first big chunk of frugal changes can take relatively little time and have a big impact, but a lot of frugal changes often ends out taking a lot of time for very little further impact. The irony, of course, is that the initial spending changes that have the biggest impact often make us feel so good about the improvements that we want to keep doing more... even as the additional incremental changes have less and less positive impact. So what's the best way to handle it? Hamm suggests that after the initial wave of frugal spending changes, the best approach is to literally change what you're optimizing for, from trying to save additional dollars, to now (from a lower spending base) focusing on how to save time (ideally that still doesn't result in much lost savings or only a small increase in spending) instead. Or stated more broadly, being frugal isn't just about spending and financial frugality, but finding the balancing point between being frugal with your dollars, and being frugal with your time as well, and maximizing the coordination between the two (instead of just solely focusing on either at the expense of the other).

Our Moral Obligation To Save Clients From Themselves (Michelle Rand, Advisor Perspectives) - One of the biggest challenge of financial advisors is figuring out what to do to help clients who are on a potentially self-destructive path and seem unwilling to change, especially when it comes to unhealthy spending behaviors on an 'inevitable' track towards depletion. For many advisory firms that manage the client's assets, the decision is simply to stay focused on investment of the portfolio itself, and allow clients to take their own responsibility for their spending, and not raise a difficult spending decision that may well just result in the advisory firm being fired if the client doesn't want to actually deal with the situation. Yet Rand suggests that, in the end, as advisors we have a moral and ethical obligation to discuss problematic spending with clients, and even to deliberately 'scare' them if that's what it takes to help trigger a wake-up call of their potentially self-destructive path. Not to mention that continuing to charge advisory fees on a portfolio that is rapidly depleting, due to unsustainable client spending, risks ending out being a lawsuit for the financial advisor (who may be blamed for not generating more in returns to support the client's spending preferences, even if those returns weren't realistic, which can be especially problematic when clients enjoy good returns in bear markets and come to believe that the advisor can sustain those returns indefinitely). Ultimately, Rand suggests that the starting point is not just to show that clients are on the path to spending depletion, but how sometimes even just modest spending changes can have a significant impact on sustainability, asking for details of client spending (if only to hopefully spot a few big savings opportunities, even if the firm isn't in the business of trying to put clients on a budget), and to potentially force a moment of realization, by simply asking the client "What is your plan for when this money runs out?" Which at least forces the client to really, truly, envision the future they will end out with on their current path.

Are Deals For RIAs Getting Bigger Or Smaller? It Depends On Which Investment Bank You Ask. (Michael Thrasher, RIA Intel) - Firms that monitor mergers and acquisitions in the advisor world all agree that 2019 is on track to be a record year for RIA deal volume (with the 101 announced deals to date already exceeding the total for all of 2018)... but notably disagree about the trend of whether advisor M&A deals are shifting towards bigger firms, or smaller ones. DeVoe & Company finds that the average AUM of RIA sellers this year is down to 'just' $716M of AUM, from an average of $920M in 2018, and over $1B in both 2017 and 2016, driven primarily by 55 deals for firms under $500M this year already (compared to an average of only about 20/year in recent years). On the other hand, ECHELON Partners finds the average advisory firm deal size in 2019 to be $1.34B, up from $1.27B in 2018, and only $1.01B in 2017. The difference, however, appears to be that DeVoe & Company only includes deals up to $5B of AUM (effectively characterizing larger transactions than that as more 'institutional' purchases), while ECHELON counts all M&A deals up to $20B of AUM. Which suggests that ultimately, advisory firm deals may be getting both larger, and smaller, with growing interest in acquiring firms both under $500M of AUM, and firms over $5B, with the 'dangerous middle' between the two generating less interest (ostensibly because aggressive bidding for such firms has already increased their value to the point that there are few 'deals' to be had and limited synergy opportunity for buyers from here?).

How To Accurately Determine The Value Of Your RIA (Aaron Schaben, Financial Planning) - Determining the proper value of an advisory firm can be difficult, as ultimately it is a highly illiquid asset that may only be sold once ever... and for the advisor who has spent 10, 20, or 30+ years building it, can be even harder to objectively 'value' when they've spent decades of their own blood, sweat, and tears building it along the way. And notably, different types of firms focus their value creation in different ways, as Schaben notes that 'lifestyle' firms are primarily cash flow businesses that are built to generate strong positive cash flows that support the advisor's own lifestyle, 'value achievers' simply focus primarily on delivering solid value to clients and growing along the way (but often become dependent on a few key owners or team members who deliver the bulk of the value), and 'value maximizers' try to build scalable systems with a sustainable and differentiated value proposition (or what, on this blog, we've previously called 'lifestyle', 'small giant', and 'enterprise' firms). The key distinction from the valuation perspective is that these three firms may have similar external metrics (e.g., assets under management, revenue, clients, and growth rates), but will lead to very different valuations because not all of them have the same transferability of value (or the same net cash flow for the buyer to acquire). At a minimum, though, Schaben suggests all advisory firms should focus on a few key areas to maximize value, including tracking and knowing your NNA (Net New Assets, which is much more important than just knowing total AUM to really track the health of the business), and developing the infrastructure necessary to make the business sustainable beyond you (as repeatable processes and systems allow the business to remain valuable even after you sell it, increasing the value to the buyer in the first place). Or at a more personal level, just consider the question "If I suddenly died tomorrow, would I entrust my own family's financial well-being to the firm I've left behind?"

Why Has The Public Market Soured On RIA Consolidators? (Brooks K. Hamner, Mercer Capital) - While virtually all advisory firms are privately owned (by either their founders, other private institutions like privately held banks or larger RIAs, or private equity firms), there are two major advisory firms that are publicly traded: Focus Financial (FOCS, which IPO'ed last year as a consolidator of RIAs), and Affiliated Managers Group (AMG, which has acquired several dozen boutique RIA managers especially in the alternatives space). And in the past year, the market appears to have soured on both types of RIA aggregators, with FOCUS underperforming the broader market by almost 10% in the past year, and AMG underperforming by nearly 50%. To be fair, the woes of the latter appear to be driven in large part by the overall compression of fees and margins amongst asset managers (which threatens AMG far more than FOCS), and the volume of debt that both companies have used to fuel their serial acquisitions as consolidators has further stressed the financials of each (in addition to magnifying their results, good or bad, due to the amount of debt leverage). But rising consolidation even in the more 'traditional' RIA wealth management space - up to and including Goldman Sachs' recent entry into the RIA consolidator world by buying United Capital - suggests that RIA competition is only rising from here, which means more competition for assets, more pressure on pricing, and more buyers that bid up potential firms for sale and reduce the anticipated returns for the (consolidator) buyer. More broadly, though, Hamner suggests that the woes of AMG and FOCS may not be any real threat (or indicator of problems) for the typical RIA, as in practice they are ultimately more 'financial engineering' plays of how to buy and consolidate RIAs themselves (driven by their debt payments and balance sheet leverage), than any kind of bellwether on the health of the RIA market itself.

Ways To Overcome Key Hurdles When Selling Your Practice (Mark Tibergien, ThinkAdvisor) - The rate of mergers and acquisitions for advisory firms continues to break new highs, driven in large part by an ever-rising volume of buyers (fueled in turn by an influx of private-equity-firm capital to fund those acquisitions) looking to acquire absolutely any firm that is at all willing and interested in selling, with some estimating as many as 50 interested buyers for every seller. On the one hand, this means any firm that is considering a sale will have many opportunities to follow through, and likely with a healthy amount of competitive bidding; on the other hand, it also means that the average advisory firm buyer is far more experienced at maximizing the buying process than the seller is in the sales process (which for most will be the one and only deal they ever make in their lifetimes), which means in the negotiating process itself, sellers can still end out with a disadvantage despite the seller's market. And in practice, deals are often complicated by the misperceptions of inexperienced sellers in the marketplace, including: finding it difficult to surrender their emotional attachment to the firm (which can cause the owner to unwittingly self-sabotage the deal, or ask for more than the business is realistically worth); misjudging the financial value of the firm by overestimating its future growth potential relative to what it has actually done historically and is truly capable of sustaining; overcommitting to existing key employees who may have been valuable to the firm up to the point of sale, but who don't necessarily have a good fit in the buyer's future; trying to hang onto the firm by remaining employed by the buyer too long after the sale is completed (when in practice, it's often best to engage in a 'clean break' with just a limited transition period), and/or binding clients too tightly to the founder such that they can't be transferred to the buyer's firm; and getting clear on what the purpose is for selling in the first place (to simply cash out, or to get access to a larger firm's resources, or something else?). In fact, Tibergien ultimately suggests that advisory firm owners should seek out professional counseling (at a personal level) to help with the decision, as the 'psychology of transition' is difficult (in part because an advisor's own personal identity is often so tied up in the business), and because in the end the buyer simply isn't going to be as emotional about the terms and conditions of sale (which means overly emotional founders can again unwittingly harm themselves in the negotiating process).

The Group Trip For People Who Hate Group Trips (Andrea Petersen, The Wall Street Journal) - One of the primary benefits of traveling with a tour group is that the tour guide is responsible for making all the plans and handling all the logistics, allowing the traveler to simply enjoy the trip itself... unless, of course, the group itself becomes unwieldy (long lines to get on the van or check into the hotel), overly limiting (with a narrow pre-set itinerary), or just outright unpleasant to be with (if there's a real jerk in the group). To address the concern, travel companies are increasingly organizing group trips that are "less group-like", sometimes limiting participants to 20 or fewer, offering more choices on activities, and finding ways to cut down on the wait times (e.g., using their home office staff to remotely check guests into their hotels in advance, so when the travelers arrive they can get their room keys immediately). Thus far, it appears that the prime target market for such high-end group trips are older Gen Xers and younger Baby Boomers - those aged 50 to 70, who have the money and desire for someone else to take care of the details (even down to having someone pick a reasonable bottle of wine for the table, so there's no fighting about who picks the wine and whether it was too expensive for everyone else at the table). And with social media increasingly propagating "what's popular" at travel destinations, travel firms like Abercrombie & Kent are organizing "Design Your Day" features (or "Choose Your Own Adventure" in the case of Classic Journeys, for $500 - $750 per day). Tour group guides also receive training in how to diminish tensions within a group (e.g., if someone is persistently tardy and keeps holding the group up). Although ultimately, for many group travelers, such vacations are in the end an opportunity to meet and connect with other like-minded people who have similar interests, with friendships that sustain thereafter.

How Do Boomers And Millennials Really Stack Up? (Kevin Drum, Mother Jones) - There has been a substantial amount of debate in recent years about whether Millennials really have it harder than prior generations given the current costs of maintaining a lifestyle, so Drum pulled data from the Consumer Expenditure Survey of the spending habits of Millennials, Gen X, and Baby Boomers, when each was in their mid-20s to mid-30s. The data shows that, overall, Millennials actually do average slightly higher incomes (adjusted for inflation) than prior generations did at a similar age, and spend less in total taxes. In addition, home ownership is similar across all three generations, and the automobile ownership rate is actually higher for Millennials than it was for Boomers at the same age (though slightly lower than Gen X'ers). Housing costs for Millennials are up (about $4,000/year) compared to Boomers, but clothing costs are significantly lower, along with food and entertainment. Although, Millennials do spend significantly more on education loans, averaging $2,707/year on a $30,461 balance (compared to an inflation-adjusted average of just $495/year on $2,475 of student loan debts for Boomers). Overall, though, the data suggests that Millennial spending isn't dramatically different than prior generations, with inflation-adjusted income a bit higher, and arguably getting more bang-for-the-buck in a lot of spending categories (given the current availability of cell phones, computers, internet access, better cars, etc.)... but with a significantly higher student loan debt overhang looming as well.

Young People Are Going To Save Us All From Office Life (Claire Cain Miller & Sanam Yar, The New York Times) - In recent years, there has been a growing interest from workers in better work-life balance, with the caveat that businesses still ultimately 'need' a certain amount of productivity from their employees to get the job done... which in recent years, is beginning to shift the concept of work-life balance away from "working fewer hours and having more time at home" to simply "having more flexible hours to fit work and home life together more effectively". For instance, it's the employee who willingly takes a phone call from a client at 8PM at night, but isn't hassled about leaving work to take the dog to the vet at 10AM the next day. In fact, it appears that Millennials, and especially the subsequent Gen Z generation now entering the workplace, are increasingly showing a preference for such work environments, where the issue isn't about whether they are going to get the work done, but simply having more flexibility about when they're going to get it done. Which in turn raises the question of whether the younger generations have been mislabeled as 'lazy and entitled' for not wanting to slave away in an office, when in reality they're simply trying to remake the way we balance work and life instead. As one recent survey from PwC found that for Millennials, work is not a 'place' they go, but simply a 'thing' they do, such that they simply want to be able to do their work on their own terms. Which also has the potential to reduce the 'flexibility stigma' in the workplace, that some suggest has limited young mothers in particular from being able to advance in the workplace (as they're passed over for promotions or new opportunities for others who 'work all the time' and don't ask for such flexibility). Though ultimately, some studies now are finding that when employees have more flexibility, they may actually end out being more productive... in addition to having greater job satisfaction (and reducing turnover) in the process.

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.