Weekend Reading For Financial Planners (September 21–September 22)

NASAA Report Outlines Ongoing Sustaining Of State-Registered RIA Headcount, And Their Service Offerings, Fee Models

(Leo Almazora | InvestmentNews)

While the Securities and Exchange Commission (SEC) is often thought of as the primary regulator for RIAs, smaller firms (typically those with less than $100 million of regulatory assets under management) tend to be regulated at the state level. And since many advisory firms begin their lives as state-regulated entities (even if they ultimately grow their client and asset base to the size that they switch to SEC registration), information from the North American Securities Administrators Association (NASAA), an association of state securities regulators, can provide a snapshot of trends within this group of up-and-coming firms.

According to NASAA's latest annual report on investment advisers, there were 16,897 state-registered RIAs at the end of 2023, with total Assets Under Management (AUM) of approximately $360 billion (for an average of $21.3 million per state-registered RIA). Notably, both of these figures declined somewhat from the previous year, with a net decrease of 166 state-registered RIAs and approximately $60 million less in AUM, though this barely 1% decrease in headcount is likely not due to state-registered RIAs "failing" but simply having more and more of them hit the $100 million AUM mark (thanks to organic growth and strong equity markets during the year) and registering with the SEC, or otherwise being acquired, merged, or consolidated into an SEC-registered firm.

Not surprisingly, the most common services offered by state-registered RIAs included portfolio management (offered by 84% of firms), though the ongoing growth of financial planning means that it, too, is now a service offered by the majority (65%) of state RIAs. Other more niche versions of state-registered firms include those that support selecting other types of advisors (26.4%), and those providing pension consulting services (16.8%).

In terms of fees, AUM-based fees were the most commonly used (by 84% of state-registered RIAs), followed by fixed fees and hourly fees (reflecting similar findings from Kitces Research on Advisor Productivity, which surveyed the broader firm population), both of which were used by 51% of firms. Notably, only 1.6% of firms reported using subscription fees, according to the report; however, because some state regulators have scrutinized RIAs' use of retainer or subscription fees, many firms that do use these fee models describe them as a fixed annual fee that is payable monthly, thereby adding themselves to the fixed fee category. Also, and perhaps not surprisingly given their size, state-registered RIAs tend to have few employees, with 83% having 0-2 staff.

Finally, the NASAA report also highlighted the most common enforcement actions involving RIAs during 2023. These included failure to register as an RIA or an Investment Adviser Representative (IAR) in the first place (e.g., people that fail to realize that their 'financial advice' activities require them to become registered, and/or those who may have failed to register in an additional state upon reaching the de minimis client threshold), fraud, failure to maintain adequate compliance policies and procedures, break of fiduciary duty, failure to disclose conflicts of interest, and fee-related violations.

Altogether, the NASAA report paints a picture of a robust landscape of state-regulated RIAs, with new firms being created at nearly the same pace that longer-tenured firms are either acquired or grow and move up to SEC registration. Which many firms want to do, as SEC registration allows them to avoid the sometimes patchwork regulation that can come from being registered in multiple states… though SEC-registered firms' IARs are still subject to certain state-specific requirements, including continuing education mandates, highlighting the importance of still tracking state-specific regulatory trends!

Advisor Coalition Urges Congress To Restore Financial Advice Tax Deduction

(Tracey Longo | Financial Advisor)

One of the many changes made by the Tax Cuts and Jobs Act of 2017 was the repeal of miscellaneous itemized deductions through 2025, which was especially concerning to many financial advisors, as it included the elimination of the deduction for investment advisory fees (though not all taxpayers were eligible to claim a deduction for advisory fees in the first place, as not only did it require the taxpayer to itemize and exceed 2% of the taxpayer's AGI along with other miscellaneous itemized deductions, but even then, could be lost to the alternative minimum tax [AMT]). Notably, though, this repeal is one of the many parts of the TCJA set to 'sunset' at the end of 2025 (along with marginal tax rates and the estate tax exemption, among other measures), making it a potential part of expected Congressional negotiations regarding the expiring provisions.

Amidst this backdrop, a coalition of organizations representing the financial advice industry (including CFP Board, the Investment Adviser Association, the Financial Services Institute, the National Association of Personal Financial Advisors [NAPFA], and the Financial Planning Association [FPA]) this week sent a letter to the Chair of the House Ways and Means Committee urging Congress to "restore and expand tax incentives for financial advice, including financial planning", with such incentives including deductions, credits, or a combination of the 2 (and asking that any tax incentives be widely available to American households). The letter argues that the repeal of the limited deduction for investment advisory and financial planning fees led to an "unintended consequence" of raising the cost of financial advice, highlighting the particular value of financial advice during turbulent economic periods, including the volatility resulting from the COVID-19 pandemic (notably, the repeal also had the consequence of giving a tax preference to commissions over fees when it comes to paying for financial advice, as commissions subtracted directly from an investment remained implicitly a pre-tax payment).

In sum, this letter advocates for restoring tax benefits for financial advice in upcoming legislation, with flexibility for what such tax relief would look like (e.g., by restoring miscellaneous itemized deductions that include investment advisory fees, or via some other more direct mechanism to deduct advice fees). In the meantime, there currently remain at least a few ways for some clients to access tax benefits for advisory fees, including taking them from accounts in a tax-efficient manner or deducting them as a business expense when possible. Nonetheless, such domains for advice fee deductibility remain limited, such that if the coalition's proposal is if enacted, could both level the playing field between those providing advice on an asset or fee-for-service basis and those who receive commissions, and simply make paying fees for financial advice a potentially more attractive proposition for clients!

Advisors Winning Clients Through Communication, Referrals: Survey

(Financial Advisor)

While financial advisors tend to enjoy high client retention levels, some attrition is inevitable (e.g., as older clients pass away), meaning that adding new clients is necessary, not only for firms looking to grow, but also for those that are content with the current size of their client base. With this in mind, a recent survey by InspereX of 487 financial advisors explores how advisors are winning (and losing) new clients.

According to the survey, 79% of respondents said they have attracted clients through client referrals without having to solicit them, while 39% won clients after asking for client referrals, 38% from networking, 24% from client appreciation events, and 18% from educational seminars or workshops (digital marketing, such as social media posts and advertising, ranked at the bottom of the list). In addition, 82% of advisors said they had won business from other advisors who didn't communicate with their clients, while 20% said new clients came from advisors who offered bad advice. Also, advisors appear to be increasingly expanding their client footprint outside of their local area, as 50% of advisors said that over the past 3 years their business has expanded to include new clients outside of their area and just 31% said they only have local clients. In terms of client demographics, older clients continue to dominate, with respondents reporting that 59% of their clients are at least in their 60s (and only 18% of clients are under 50). At the same time, 87% of those surveyed do not believe that pursuing younger prospects is a waste of time, suggesting openness to working with this group.

In the end, this survey indicates that client referrals (whether solicited or not) continue to dominate as the primary source of new clients for financial advisors (reflecting similar findings from Kitces Research on Advisor Marketing) and relatively older clients predominate when it comes to advisor client bases. Which suggests that, given advisors' aging client bases and openness to working with younger clients, finding ways to engage this latter group (whether through referrals of adult children from current clients or perhaps digital outreach to attract younger generations who tend to spend more time online) could help a firm build a more robust prospect pipeline and client base over time!

Direct Indexing Extends Reach To Smaller Portfolios

(Lisa Scherzer | Barron's)

Historically, direct indexing (i.e., buying the individual component stocks within an index rather than an index fund) was developed as a means to unlock the tax losses of individual stocks in an index – even if the index itself was up – and was primarily used only by the most affluent investors (who had the highest tax rates and benefitted the most from the available loss harvesting). However, advances in technology have made it easier for advisors to implement this strategy beyond 'just' their highest net worth clientele, and leverage several uses beyond just tax savings, including implementing a more personalized indexing strategy (e.g., based on a client's preferred ESG/SRI criteria), allowing advisors to 'tilt' an index based on their (or their clients') investment preferences or outlook (e.g., by over- or under-weighting certain investment factors), or helping a client invest 'around' a large, highly appreciated, or concentrated position or one whose human capital is tied up in one company or industry.

As this technology has advanced, the fees and account minimums associated with direct indexing have fallen as well. For instance, fees for Charles Schwab's personalized indexing account, which has a $100,000 minimum, start at 0.4%, while Fidelity's Fidfolio product has a minimum $5,000 balance and charges a 0.4% fee. A startup, Frec, has lowered the fee bar further, offering a direct-to-consumer direct-indexing product tracking the S&P 500 with a 0.1% fee and a $20,000 minimum (for its part, Frec ran a simulation based on a $50,000 deposit over 10 years, finding that an investor could boost after-tax returns by more than 2% by using direct indexing, excluding advisory fees and assuming a 42.3% tax rate). Across the spectrum of providers, research and consulting firm Cerulli Associates expects direct indexing to grow to $825 billion in total assets, up from $462 billion in 2021.

Altogether, while consumers have greater access to direct indexing solutions today, advisors can play a valuable role in helping clients make the most of this tool, whether in determining the potential value of tax loss harvesting for a given client, helping to determine the best way to navigate around a concentrated position, or, perhaps, adjusting a direct indexing strategy created by a new client that isn't meeting their financial objectives (given the potential temptation for them to 'tinker' with the index, which could lead to worse-than-expected returns)!

Why Transitioning Clients From ETFs To Direct Indexing Could Be Costly

(Stephanie Lo | Alpha Architect)

One of the factors making a direct indexing strategy attractive is the potential to more efficiently engage in tax loss harvesting (i.e., selling shares of investments whose value has declined since they were purchased, thereby 'harvesting' losses that can be used to offset capital gains or other income in the same year the shares are sold) compared to holding an index mutual fund or ETF, as while the broader index itself might have experienced gains over time, certain individual components within it are likely to have declined in value, which means that by buying each individual index component through direct indexing, an investor can sell those individual stocks with losses.

Nonetheless, unless an investor is initiating a direct indexing strategy with cash (or with investments with embedded losses), there can be transition costs to starting out with direct indexing as assets within their current portfolio (e.g., ETFs or mutual funds) will likely need to be sold to fund the purchase of the individual index components, which could create a large tax bill, particularly if there are significant embedded gains within the investments to be sold. Another factor is the client's income, as realizing gains in a transition to direct indexing could be more costly if they are subject to the 20% long-term capital gains rate (or, further, if they are exposed to even higher ordinary rates because the gains are short-term), the Net Investment Income Tax (NIIT), or Medicare IRMAA surcharges.

Lo ran a simulation considering these variables (and other assumptions), finding that for investors liquidating (a portion) of an existing portfolio to transition to direct indexing, the benefits for an investor facing a 22% marginal income tax rate and a 15% long-term capital gains rate are small to begin with (given the relatively low rates they face) and become negative when embedded capital gains exceed about 10% of the initial investment (as the investor is unable to make up the up-front tax cost of liquidating the initial investment through subsequent tax-loss harvesting, though this will depend on their exact financial situation). For a higher-tax investor (facing a 40.8% marginal income tax rate and a 23.8% rate on long-term capital gains), the threshold of embedded gains where it makes sense to transition to direct indexing is higher at 40%, indicating that while the tax-loss harvesting benefits for these individuals are greater, the decision to transition to tax-loss harvesting is still not necessarily an obvious one.

Ultimately, the key point is that while the potential to more efficiently engage in tax-loss harvesting is a selling point for a direct indexing strategy, it is important for advisors to also consider the up-front tax costs of liquidating assets with gains to fund the new approach (though advisors and their clients might be looking for other benefits from direct indexing as well, such as investing around a concentrated position).

How "Segmented ETF Investing" Could Best Direct Indexing's Tax Benefits

(Victor Haghani and James White | Advisor Perspectives)

Direct indexing is often touted as a way to better access the (potential) benefits of tax-loss harvesting by investing in the individual components of an index rather than a fund representing the index itself. This is due in part to the fact that the individual components of the index (e.g., individual stocks) are more volatile than the index itself, offering more opportunities to harvest losses (even if the index itself is up). Nonetheless, given that the required 30-day wait before repurchasing a substantially identical investment (to avoid triggering a wash sale) can introduce tracking error, engaging in tax-loss harvesting can sometimes deliver returns that don't match the return of the index itself. Further, while index ETFs and mutual funds frequently come with expense ratios below 0.10%, direct indexing platforms frequently charge 0.4% or higher to users, creating further costs to the strategy.

Given these potential limitations, Haghani and White suggest an alternate approach, which they call "segmented ETF investing". Instead of buying every component of an index (e.g., each stock in the S&P 500, with the appropriate weighting), an investor could instead invest in a broad, segmented range of low-cost ETFs that together represent the baseline index (e.g., the authors find that the broad U.S. stock market can be segmented into 11 relatively low-cost sector ETFs). Given that the underlying sectors are more volatile than the broader index, this approach will create more tax-loss harvesting opportunities than investing in the broader index while avoiding the platform fees that come with direct indexing. Further, the authors suggest that there tend to be close (but not identical) fund equivalents for various sector funds (that can serve as a substitute after a similar fund with losses is sold for tax-loss harvesting purposes), this approach is less prone to tracking error than using individual stocks (and while individual stocks might be more volatile than sector funds, thereby presenting more potential opportunities to harvest losses, the desire to avoid tracking error could lead portfolio managers to increase the threshold whereby they harvest losses, perhaps leading to a similar number of opportunities as a "segmented ETF" strategy).

In sum, while direct indexing has become increasingly accessible to advisors and their clients, it is not the only way to generate more tax-loss harvesting opportunities than investing in a single broad index fund. Though given that the "segmented ETF" approach comes with additional costs compared to 'just' investing in a broad index itself (including the time needed to identify loss harvesting opportunities and suitable replacements in the portfolio and the potential for sector funds to come with higher expense ratios than a fund representing the broad index), investors and advisors will have to consider whether these costs are outweighed by the potential tax-loss harvesting benefits of implementing such a strategy!

5 "To-Dos" To More Effectively Attract Next-Gen Clients

(Ben Mattlin | Financial Advisor)

Client referrals are the lifeblood of organic growth for many advisory firms, as this tactic not only comes at a relatively low cost compared to other marketing methods, but also can lead to a stream of prospective clients who fit an advisor's ideal client persona (given that many clients will likely know [and refer] others with similar backgrounds). In fact, a recent survey of 1,107 consumers by marketing and PR firm Ficomm Partners found that 60% of respondents over the age of 60 said they would only hire an advisor based off of a referral.

Nevertheless, the same survey identified an impending "referral cliff", as younger individuals were significantly less likely to see a referral as a necessary step to choosing an advisor. For instance, among those planning to retire within the next 5 years, 45% hired their advisor based on digital marketing, while only 29% of this group said they require a referral to hire an advisor. Looking at those under age 44, 57% said they hired their advisor based on digital marketing, while only 17% said they would require a referral (though it's possible referrals will become more important to these generations as they get older?). Which suggests that a multi-channel, hybrid approach (e.g., where a prospective client receives a referral, looks at Google reviews online, and visits the firm's website) could be increasingly effective in the years ahead.

With these factors in mind, the Ficomm study suggests 5 steps advisors can take to boost their marketing efforts for the years ahead. To start, leveraging online reviews and testimonials (enabled and regulated under the SEC's marketing rule) can help a firm build its "social proof" with prospective clients. Next, crafting a compelling and consistent message can help a firm ensure its brand is communicated clearly. Relatedly, identifying the digital marketing channels a firm's target clients are most likely to use (e.g., certain social media networks) can improve the chances of connecting with prospects without having to manage dozens of potential channels and accounts. Further, a firm can leverage its advisors as "brand ambassadors" online, spreading the firm's identity and message further. Finally, tracking metrics to determine which marketing tactics are producing the most prospect leads and clients can help ensure that a firm is targeting its marketing spend (both in terms of time and money) at the most effective tactics.

Ultimately, the key point is that while client referrals have represented a strong source of prospect leads for advisory firms for many years, younger, more digital-savvy generations might seek out other sources of "social proof" when looking for a financial advisor. However, such digital marketing efforts need not be particularly costly, as tactics such as leveraging online reviews and building a brand through social media do not necessarily require significant outlays in terms hard dollars (though given the time involved in executing these tactics, firms will still want to track whether they are effective at bringing in prospects and clients!).

Why More Marketing Spend Isn't Sufficient To Boost Organic Growth

(Tom Rieman | WealthManagement)

Years with strong stock market performance (such as 2023) can allow advisory firms to grow their AUM (and, for firms charging on an AUM basis, their revenue) without having to add new clients. Nevertheless, given that advisors cannot control market performance, a focus on driving organic growth (i.e., attracting assets from new clients or additional assets from current clients) can allow a firm to grow more sustainably over time and weather potential market downturns.

For some firms looking to boost their client base and assets, the first thought might be to increase marketing spend (as Kitces Research on Advisor Marketing has found that greater marketing spending correlates with more growth). However, Rieman argues that this step by itself isn't sufficient to boost client growth, suggesting that firms first examine their client value proposition to determine whether it is providing an exceptional experience to current clients (which could make them more likely to make referrals to the firm) and a differentiated offering for prospective clients (to help them see, in a world with myriad options for receiving financial advice, why the firm is the right choice for them). One way to assess whether the firm is offering a strong value proposition is to survey its clients and find its Net Promoter Score (typically determined by asking how likely the client is to recommend the firm to others), which not only can show the firm how well clients are responding to the firm's service offering overall, but also identify the "active promoter" clients who are most likely to give referrals (and perhaps target them for referral generation campaigns).

In the end, while marketing spend (in the form of hard dollars and/or time) can boost a firm's visibility, its value proposition is ultimately what will retain current clients and attract new ones. Which suggests that taking time to examine whether the firm continues to deliver value for its ideal target client could be the most effective marketing 'spend' of all?

How To Craft An Effective Client Survey

(Nitrogen)

When an advisory firm experiences high client attention rates, it might be tempted to assume that their clients are happy with the service they are receiving (or else they would otherwise leave). However, merely staying with the firm is not necessarily a signal of satisfaction (or even better, a level of engagement that would lead them to recommend the firm to others). Which suggests that taking a more formal approach through a client experience survey could help firms better understand whether their client experience is delivering the intended results.

A first step to crafting a client survey is to define its objectives, as these will help determine the questions that are asked (e.g., assessing overall client satisfaction or gathering feedback on specific services or products). Next, including a mix of closed- and open-ended questions can reveal a mix of quantitative and qualitative data from clients (though too many open-ended questions could lead to survey fatigue and fewer completed responses). For instance, advisory firm survey questions could ask about a client's overall satisfaction with the firm, how responsive the firm is to the client's needs, how likely the client is to recommend the firm to a friend or colleague (which can help determine the firm's Net Promoter Score), and/or how well the client's advisor understands their risk tolerance and investment preferences (perhaps offering the opportunity for open-ended feedback when clients choose a relatively low score for a question). Once questions are determined, testing the survey out with a small group of clients can help ensure the survey is clear and error free (and give the firm the time to refine it if necessary). And after the survey is published (with the firm encouraging clients to take it across multiple channels) and a sufficient number of responses are received, the data can be analyzed to identify trends, common themes, and areas for improvement.

Altogether, an effective client survey can play a variety of roles, from assessing client willingness to make referrals to others to identify potential trouble spots in client communication or in the planning process. Which suggests that crafting a deliberate, thoughtful client survey could be well worth the time needed for the firm to prepare it (and clients to take it), as it might unearth insights that would allow the firm to offer a better client experience going forward (and perhaps encourage more referrals and client testimonials in the process!).

8 Ways To Read (A Lot) More Books

(Neil Pasricha | Harvard Business Review)

While there are seemingly infinite opportunities for reading in the 21st century, much of this reading is done in small doses (e.g., a social media post or short article), frequently on one's smartphone. Which might take time away from reading longer-form content, including books.

For those looking to increase the number of books they read, Pasricha offers several suggestions. To start, giving books a central place in your home (by having books and bookshelves throughout) can increase the chances that you will be more likely to pick up a book than alternate entertainment options (e.g., watching television or scrolling on their phone). Next, making a public commitment to read more books (e.g., by starting a competition with colleagues or by committing to publish short book reviews on a regular basis for friends and family) can provide accountability for reaching your reading goal. Another way to boost the number of books you read is to be more open to 'quitting' books that aren't interesting or well-written, making it easier to move on to the next book on the shelf (otherwise you might constantly put off reading the 'bad' book and delay starting a new one). Further, for those having a hard time finding good books to read, consulting curated lists from trusted sources can be a way to filter the myriad possibilities out there. Finally, finding a few minutes here and there to read books throughout the day (e.g., while waiting in line) can lead to having more total time read than only reading during longer free periods.

Ultimately, the key point is that while it can sometimes seem like there is little time to read books given work and family commitments, being intentional in making reading a central part of one's life, whether in reducing the temptation to do other activities or making a public commitment to do so, could lead to more time spent reading and, in the end, more books read!

When Is It Okay To Not Finish A Book?

(Sophie Vershbow | The Atlantic)

Everyone has experienced the feeling: you're reading a piece of fiction and you start to doze off as the plot fails to develop, or perhaps you're reading a non-fiction book and the author continues to make the same points repeatedly. On the one hand, you want to book down and move on to another that will be more interesting, but you might also want to see the book through until the end (it has to get better, right?). Which begs the question: how to decide when to finish a book and when to let it go?

A first step when considering this question is to tune into your underlying reaction for wanting to stop the book. For instance, if you're tempted to put the book down because the author writes in a unique style or makes points that conflict with your personal views, continuing the book could be an opportunity for personal growth (whereas if the plot is dragging, it could be time to put it away). Further, if you plan to critique the book (in a book club or on a review site), finishing the book is necessary to provide a complete (and accurate) review.

Another factor is how much time you have to read. For instance, if you only have time on vacation for one novel, you will likely want to make it an enjoyable one. In this case, setting aside a book after reading 30 (uninteresting) pages could be a good choice, whereas you might give the same book more leeway when you have more time to read. Also, books can be a prime target for the "sunk cost fallacy", the tendency to follow through with something you've already invested heavily in (e.g., reading the first 100 pages of a book) even when giving up is a better idea (e.g., because the book is terrible). With this in mind, even if you can't bring yourself to toss the book completely, at least putting it aside (leaving the door open to restart it later) and beginning a new book could be a more productive option.

In the end, while there are no hard-and-fast rules for deciding whether to stop reading a book, it can be helpful to consider both internal (e.g., is the book poorly written or is it challenging you in some way?) as well as external (e.g., how much time you have to read) factors, which can ultimately allow you to read more, and better, books in the long run!

Why Books Don't Work

(Andy Matuschak)

Some books (often works of fiction) are read for purely entertainment purposes, meaning that it's not a big deal if you don't remember every plot point because the act of reading the book itself was enjoyable. On the other hand, certain non-fiction books are read in order to learn something new, making retention of the information important. However, it's common to have the feeling after reading a (300+ page) non-fiction book to perhaps remember the main theme but not the underlying details of the work.

Matuschak suggests that narrative works of non-fiction are not well-designed to promote retention of the material because they don't force the reader to stop and reflect on what they read along the way (with readers often reading straight through instead), which can be particularly important when reading dense, detailed, research-filled books. One alternative to this approach would be to make non-fiction books more like school textbooks, which divide the material into clearly divided chapters with discussion and review questions at the end of each section. However, Matuschak notes that few people buy textbooks independently, rather using them when required to for a class, perhaps because while textbooks might provide answers to review questions, readers still might not know whether they are grasping the full picture (which is where having a classroom lecture combined with a follow-up discussion to supplement it can be helpful). For those out of school and without the time to enroll in a course, Matuschak suggests that new types of media could be created that would better help individuals retain information from informative books. For instance, he and a co-author created an online 'book' on quantum computing that mixes narrative text with brief, interactive review sessions to test comprehension (of the very complicated material) and provide feedback at regular intervals.

In sum, while books have existed for thousands of years and are a common way to convey information, they might not be the most effective tool for learning (at least by themselves and as currently structured). Which suggests that supplementing a book with review questions and further exploration (e.g., holding a discussion with friends or experts on the topic) could provide a greater return on the time invested in reading the book itself!

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We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog.