Weekend Reading for Financial Planners (Oct 6-7)

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.

Time To Get Inspired By Incredibly Charitable Advisors (Sarah Min & Deborah Nason, Investment News) - The Invest In Others foundation was created in 2006 to support and empower financial advisors who invest in others by giving back to their communities, with an annual awards recognition event to celebrate charitably-minded advisors (that also donates tens of thousands of dollars to the charities those advisors support as well). This year, the Lifetime Achievement award went to Patrick Sullivan of Private Advisor Group, who has devoted 14 years and upwards of 40 hours per month to serving Good Grief, a local non-profit that provides free support groups for parents and their children going through times of grief after the death of a family member. Other notable charitable endeavors of leading advisors included: William Lervaag who co-founded Heart of Illinois Harvest (which collects food that would otherwise go to waste from 90 local donor businesses and individuals and delivers a whopping 7.2 tons of food to 72 food pantries and missions six days a week); Sacha Millstone who is both an advisor with Raymond James and president of Funding the Future (which promotes financial literacy to junior and senior high school kids with school concerts that incorporate music and musicians telling stories about their lives and the financial mistakes they made along the way); Brenda Blisk, who organized a women's-only luncheon and silent auction annual event for her local Red Cross chapter that has now been replicated by other chapters across the US and raised more than $1.2M in 9 years); and Skyoak Wealth which offers its employees 40 hours of volunteer time off every year and has 100% employee participation in the program (in addition to donating 20% of its net profit to charities in its communities).

The "Experiential Advantage" Of Happy Spending Is Not Universal (Juliet Hodges, Research Digest) - Recent research has found that beyond a baseline level of income, having more doesn't necessarily make us any happier; instead, it's how we spend our money that most impacts our happiness, with those who spend on experiences reporting more long-lasting and positive impacts to happiness than those who spend their money on "stuff" (i.e., material objects). However, much of this research has been done on those who already have at least some material level of affluence - most commonly, college students - while those who are less well-off might arguably benefit more from simply buying material goods that actually can be used multiple times, last longer, and can even be resold in the future if necessary. Accordingly, a recent study in Psychological Science tested this and did, in fact, find that those who were at lower levels of socioeconomic status reported greater happiness from purchasing objects, while it was only those in higher socioeconomic classes who were made happier by experiences. And in fact, when the researchers had people imagine themselves in different socioeconomic situations - i.e., imagining themselves to be materially more or less affluent than they currently are - and then envision the spending that would make them happy, they similarly shifted their preferences in a direction of more material-goods happiness at lower income levels and more experiential-spending happiness at higher income levels. On the other hand, it's not entirely clear whether the increased happiness of experiential purchases for higher-income individuals is simply because they're "sated" with material goods purchases already, or simply because they also tend to have more time to engage in and enjoy those experiences in the first place... which in turn raises the question of whether the socioeconomic difference in experiential purchases is really about the value of experiences vs. material goods, or simply about a poverty of time that limits the ability of many to enjoy those experiential purchases in the first place.

A Spendthrift 5-Year-old? Researchers Say Yes! (Lisa Ward, Wall Street Journal) - For some people, spending money feels like a stressful loss of resources, while for others it's fun or even therapeutic... attitudes that over time have been dubbed as either "tightwad" or "spendthrift" personalities (with everyone else falling in the middle of the spectrum). Yet while money and spending habits are typically viewed as being formed in young adulthood when we actually start to earn money and have to make spending decisions, a recent study in the Journal of Behavioral Decision Making finds that even children as young as age 5 exhibit some tightwad or spendthrift tendencies! Specifically, the researchers gave the children a series of slides that asked them to make hypothetical choices about spending/savings habits (e.g., "I like saving money" vs. "I like buying new things"), and then gave them an actual dollar to trade in for a bag of toys and evaluated how likely the children were to keep the dollar or "buy" the toys... observing that the children's measured attitudes about saving/spending did, in fact, predict/match their subsequent saving/spending decisions. The significance of the finding is both the realization that money behaviors, or at least the personality traits that impact money behaviors, are evident at very young ages... and at least implies there may be new/additional opportunities to teach and develop better money habits to children in the very early years (although technically, the research has not yet shown whether or how much children's spending proclivities actually can be changed over time, or not).

Should How Much You Plan For Kids To Inherit Impact How Hard You Work? (Khe Hy, Rad Reads) - There's a famous saying by Warren Buffett about what the "right" inheritance is to leave to your children: "Enough money so that they would feel they could do anything, but not so much that they could do nothing." In Buffett's world, that amounts to a whopping $2 billion each, while for others, that healthy balance might be found at a somewhat lower threshold. Nonetheless, the fundamental point remains that most people believe it's best to leave "only so much" to children, beyond which an inheritance is no longer productive. Yet as Hy points out, remarkably few people who create significant wealth ever actually seem to consider this, or moderate their work and business habits (or adapt their portfolio) to this dynamic. Of course, virtually anyone who is a parent has felt the pressure to provide for children, ideally including both raising them, paying for college and/or graduate school, providing some post-college support if necessary, contributing to a wedding, and maybe even helping out with a first down payment on a home. Yet business owners and executives tend to then get caught in a cycle of working hard (with the sacrifices that may entail) to provide for their families, which may so compound wealth that even though what's "best" for kids is often just a modest inheritance they quickly blow past without slowing down! Of course, the reality is that a strong work ethic is often driven by more than just the need to accumulate wealth to provide for current and future family needs. Yet at the same time, if the real motivators are elsewhere... then perhaps for those who are succeeding at creating significant wealth, it's time to stop saying that you "need to work to provide for the family" (when that's really no longer the case), and instead focus on figuring out why you actually are still working so hard (and whether that's still really what you want to do).

Undervalued Financial Advice (Ben Carlson, Wealth Of Common Sense) - A lot of financial advice today focuses on the small habits that can add up over time, from the cumulative cost of buying Starbucks lattes to making your own toothpaste or hopping from one savings account or credit card to another to rack up a slightly higher yield or a few more bonus points. Yet as Carlson points out, those bits of financial advice are often "overvalued" in the grand scheme of things, while it's getting the big things right that often have far more impact, yet are sometimes grossly undervalued financial advice. For instance, the real challenge of spending isn't indulging in the occasional (or even frequent) Starbucks, but getting trapped on the "hedonic treadmill" of always wanting a little more than you currently have, where it's the cumulative impact of lifestyle creep that really has an adverse long-term impact. Similarly, a recent survey found that just 6% of people in the U.S. say that things in the world are getting better (the rest saying they're getting worse or neither getting better nor worse), even though the hard data clearly shows that no generation in the history of the world has had higher living standards - in terms of education, health, literacy, and freedom - than we do today, ostensibly because we spend too much time on "envy" and seeing that others around us have more instead of having "gratitude" in recognizing how much more we already have than others elsewhere or in the past. Though ultimately, the financial advice that most people "forget" is simply that time and health matter more than wealth... even though we tend to spend more time focused on accumulating money (it's easier to measure?) than accumulating more free time and improving our health.

The Wobble Theory Of How Advice Firms Grow (Jim Stackpool, Certainty Advice Group) - Growth of an advisory firm does not occur in a straight line, because over time, the firm moves through (fairly predictable) stages, and each has their own unique challenges. In fact, Stackpool suggests that within each of these phases, it's actually relatively easy to succeed in the advisory firm and that the biggest determinant of either growth or stagnation of a firm is how it handles the "wobbles" that crop up when it's time to transition between each stage. For instance, the starting point for any advisory firm is the "Activity Stage," where the most important ingredient for success is just repeating the necessary activities to get some clients, deliver some value, and survive the perilous startup phase. However, if/when/as the firm succeeds in the Activity Stage, eventually it hits a wobble point - there are enough clients that the number of administrative demands of the business begin to accelerate... and at that point, firms either succeed or stagnate based on their ability to transition into the second "Administration Stage" where it's necessary to start hiring staff and building out systems and process. With continued success, though, eventually, the Administration Stage hits a wall, where there are so many administrative staff that it becomes time to transition to the Management Stage, hiring and developing more managers and leaders in the firm to keep it moving forward. In turn, firms that succeed through the Management Stage can then get stuck in the "Dependency Stage," where the firm is excelling on the foundation that the founder/owner built, but will wobble unless it figures out how to grow beyond its founder. And even once a firm is successful there, it may still find another wobble in sustaining its organic growth without transitioning into the "Mergers and Acquisitions" stage as well. The key point, though, is simply that finding success within each stage, at least for a period of time, actually isn't that difficult. What really defines the trajectory of an advisory business is its ability to grow beyond the wobble points and not stagnate in the face of them.

The (Un)certain Future For Small Advisory Firms (Bob Veres, Advisor Perspectives) - Industry analysts have long foretold of a coming wave of massive industry consolidation in financial services that would result in a few "Goliath" advisory firms that would make it nearly impossible for the small "Davids" to compete, built on the benefits of major economies of scale, including a combination of lower price, better branding and marketing, and in-house expertise resources... all of which small firms simply cannot afford. Yet the reality is that despite 20 years of these predictions, and the admitted emergence of a few sizable roll-up firms and the emergence of nearly 700 $1B+ AUM firms (up from nearly 0 a decade ago). Yet still, almost half of all RIAs today still have less than $100M of AUM (given 17,688 state-registered investment advisers and "just" 18,225 SEC-registered firms), and it's not entirely clear that the smaller firms are vanishing anytime soon. In fact, if we look to other professionals like law and accounting, which have long since gone through similar professional growth cycles, a very different prediction of the future emerges... while there are 8 law firms with 1,000+ lawyers, and 56 more than have 500 - 1,000 attorneys, there are still a whopping 127,942 law firms with 1-4 professionals, and another 25,042 with 5-9 lawyers. Similarly, in the accounting profession, it is true that nearly 1/3rd of CPAs work at one of the big-4 accounting firms, but 41% of attorneys work at firms with no more than 20 CPAs (and nearly half of those are still solo CPA firms!). In other words, even century-old professions haven't seen a wave of Goliaths that drove the Davids out of business, and instead, both continue to remain. On the other hand, if advisory firms are similarly divvied up today, $1B+ firms still only have barely 4% of the AUM, while those with <$10M still control nearly 1/3rd of AUM in the aggregate... which suggests that, even if the Goliaths won't put the Davids out of business, there is a lot of room for the Goliaths in the advisor industry to grow similar to the Goliaths of law and accounting. And recent industry data suggests that the Goliaths are increasingly outgrowing the Davids. Nonetheless, smaller firms retain many advantages that suggest there's still a golden age for solo advisors, from software flexibility to fewer management headaches and managerial friction, to the sheer adaptability of being leaner in a rapidly changing environment.

Getting To Scale: The Virtual Solution (Todd Thomson, Investment News) - One of the key drivers of advisory industry consolidation is the search for "economies of scale," where larger firms use their size and depth to gain unique efficiencies and pricing power. Yet the reality is that in today's technology era, it's increasingly feasible for small firms to efficiently outsource key tasks, recreating the benefits of large-firm economies of scale without actually being a large firm with economies of scale. To measure this, Dynasty Financial commissioned a study where it compared what it calls "EBAC" (Earnings Before Advisor/owner Compensation, which makes it easier to compare the overhead and other costs of firms regardless of their size) of large multi-billion-dollar firms (that ostensibly have economies of scale) and smaller firms of "just" $200M, and evaluated the relative benefits of insourcing vs. outsourcing by size of firm. And the results showed that firms utilizing outsourced shared services reported an average EBAC of 62%, compared to firms that in-source at only 56% to 58%. The key distinction for most was that hiring for key front- and middle-office functions (e.g., advisors, investment team, etc.) resulted in an insufficient allocation of resources to back-office staffing that eventually reduced profit margins while usually failing to achieve the size necessary to actually gain scale efficiencies. And speaking to the challenges of scaling back-office functions, the study found that firms using outsourced/shared services expanded their EBAC as they grew, essentially scaling their front- and middle-office functions while not failing to scale their back-office functions (by using a scaled outsourced provider instead). Which is important not just for the growth and profitability of firms themselves, but also for enterprise value given that a firm's free cash flow is ultimately the primary determinant of its valuation. Of course, the caveat to all of this is that the study was commissioned by Dynasty itself, which serves as an outsourced back-office service provider and obviously has a dog in the hunt for showing the benefits of outsourcing. Nonetheless, it provides an interesting framework for considering the relative benefits of trying to grow for economies of scale - particularly in the back office areas - versus outsourcing for back-office support and focusing the advisory firm on the front-office client-facing functions it does best, anyway.

Financial Advisors Embrace Virtual Offices (Jeff Benjamin, Investment News) - Financial advisors have long met clients in their offices, both to help convey a sense of professionalism and credibility for the firm itself, and also simply as a means to conduct a client meeting itself (since a "meeting" has to happen somewhere!). Yet in practice, this can be difficult for advisors, either because they're in dense metropolitan areas where traffic makes it hard to meet, because the advisor is still new and in "startup" mode and can't afford office space, or because the advisor has to relocate and will no longer be geographically near clients and able to meet them. And with the rise of more and more technology tools to communicate with clients, it turns out that advisory firms actually are increasingly meeting with clients virtually instead of in-person! The first driver of virtual meetings is the rising ubiquity of video conferencing tools for financial advisors, as the latest Investment News Adviser Technology Study found 64% of firms are already using enterprise video conferencing tools with clients... which clients are increasingly embracing if only to avoid the traffic commute of otherwise driving to an advisor's office (even if the client is otherwise local). For advisors, the appeal of more technology-based virtual practices is also that it becomes possible to operate a "location independent" firm from anywhere (at least, anywhere with a WiFi connection!), making it far more accommodating to building a lifestyle practice (although the tools are increasingly being adopted at larger firms as well), and video conferencing is especially effective because it otherwise puts the visual "face-to-face" back into an otherwise virtual meeting (which is important given how much communication is non-verbal). Though for many advisors, the appeal is simply cost savings, in a world where "rent" is often the second biggest line item expense for an advisory firm next to staff themselves, while video conferencing software is only a minuscule fraction of the cost (even if it must be supplemented with an occasional on-demand office meeting space like Regus).

The Freakishly Strong Base (Morgan Housel, Collaborative Fund) - One of the amazing effects of compounding is that astonishingly large results can occur from a freakishly small-but-strong base; for instance, scientists have now figured out that the earth's ice ages emerge simply because, at some point, with the planet's wobbling, there is eventually an unusually cool summer that fails to fully melt the prior winter's ice, which in turn makes the ground cooler and allows snow to more readily accumulate the next winter, which then makes it harder to melt, and then attracts even more snow the following winter, while the perpetual snow reflects more of the sun's rays and further exacerbates cooling that brings even more snow... until a few thousand years later, the entire earth is covered in miles-thick ice. In the investment context, a good case-in-point is Warren Buffett, whose amazing $81B net worth isn't just a result of his being a good investor, but a good investor with an incredibly long time period to compound; in fact, a whopping $80.7B of Buffet's $81B net worth was accumulated after his 50th birthday, and $78B of the $81B came after he already qualified for Social Security! As a result, if Buffett had simply gotten serious at age 22 just out of college, instead of age 10 when he did, and started his compounding then... he'd "only" be worth $1.9B today, instead of $81B! The key point, again, is that while compounding is powerful in the long run, it's the speed and effectiveness of the base at the beginning that drives outsized results. It's why Amazon started with books (a strong base) and expanded later, and why strong brands are so successful over time (it's hard to topple them once the compounding from a strong base is already underway). And so while there's nothing wrong with sometimes starting fresh with a clean slate... it's important not to underestimate the benefits of relentlessly leaving something alone because it may look small today, but has the chance to compound into something really big!

The Daily (Seth Godin) - Given how the biggest assets are built by compounding over time, Godin asks the simple question: is there something you do every day that builds an asset for you? It might be developing another bit of intellectual property that belongs to you. Or something new that you learn. Or investing into an asset in a way that makes it a little more valuable. In the long run, it may seem easy to skip a day here and there, as any one day missed in the short run doesn't seem like a big deal in the long run. But as Godin notes: in the end, the long run is made up of the short runs. So be certain you're doing something every day that builds an asset for you!

Being Heroic About Consistency (Khe Hy, Rad Reads) - Hy has a successful business of speaking, consulting, and coaching, which has been built around his writing... despite the fact that historically he didn't do much of any writing, and only picked it up in his mid-30s (and still refers to himself as an "accidental creative" and not a "writer"). Nonetheless, by maintaining a consistent practice of writing and sharing his expertise, the cumulative compounding results of racking up "small wins" (one article at a time) have been enormous. In fact, the reality is that while it's often appealing to try to find or take consistently heroic actions that make big leaps forward for a business, it's often being "heroically consistent" at the small wins instead that work better. Especially since heroic efforts can take a big toll (emotionally, physically, and cognitively), and are difficult to sustain, while consistent compounding of small wins can achieve the same or more over time (thanks to the compounding) with far less stress. In fact, engaging in "heroic consistency" has long been a recognized tactic of creatives in particular; author Ray Bradbury was famous for suggesting to other writers that they'd be successful by trying to write one short story every week, since it wasn't "possible to write 52 bad short stories in a row!" Of course, being consistent at creating value in your business is challenging as well - the volume forces you to think more widely over time (or risk running out of ideas), and sometimes forces you to dig deep if you hit a proverbial (or actual) writer's block, even as becoming too obsessed with consistency can cause you to lose sight of the big picture as well. Nonetheless, the fundamental point remains: the pathway to success isn't about consistently trying to take big heroic leaps that (hopefully) bring business breakthroughs, but simply about being heroically consistent and letting the compounding work for you instead!

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.