Nerd's Eye View blog

Financial Adviser Vs Advisor – What’s The Difference?

August 18, 2016 07:58 am 18 Comments CATEGORY: Client Trust & Communication

Financial advisor vs financial adviser vs financial planner vs financial consultant vs investment adviser or advisor. The financial services industry uses a remarkably wide range of labels to describe what are substantively similar job titles that are meant to convey the person is in the business of giving financial advice. But does it actually matter which label you use, or is it simply about individual preference?

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at the question of why there's a distinction between financial advisor vs adviser, how the labels have evolved over time, and why it actually can matter which spelling you use, at least some circumstances.

Because the reality is that while most financial advisor labels are just thrown around for marketing purposes, the Investment Advisers Act of 1940 does actually define the terms RIA (registered investment adviser) and IAR (investment adviser representative), and those are spelled adviser with an E-R at the end. Because that's how Congress wrote it into the original law, nearly 75 years ago.

Of course, in the end whether an individual must actually register as an investment adviser or not is dictated by what he/she does, and whether that person is in the business of giving investment advice for compensation. If that's true, becoming an IAR of an RIA is a regulatory requirement, regardless of whether it says financial advisor vs financial planner on your business card.

Nonetheless, in today's environment, where advisor with an O-R seems to be the dominant spelling, arguably the decision to use financial adviser actually does connote some distinction - a sense of greater formality, perhaps, giving the Old English roots of the E-R spelling of the word. So while financial advisor vs adviser have the same dictionary definition, and regulators will ultimately judge you by what you do, you may still want to choose the spelling that fits with the kind of brand you want to communicate. But remember, any time you're actually writing out the definition of the acronyms RIA or IAR, use the adviser with an E-R spelling, because that's the way it's written in the law itself!

Why It’s A Bad Idea To Borrow Based On What The Lender Will Allow

August 17, 2016 07:01 am 6 Comments CATEGORY: Debt & Liabilities

In a world where most major purchases – such as buying a house or a car – cannot be done with cash, the practical constraint to the question “how much can I afford to buy?” is usually based on “what monthly debt payment can I afford to make?” As a result, lender thresholds for the maximum amount to borrow – such as the popular 28/36 debt-to-income-ratios – are typically used to determine affordability.

However, the reality is that what’s good for the lender may not necessarily be good for the borrower. After all, lenders lend money assuming that at least some people will default, and that the rest will do ‘whatever it takes’ to repay the loan, even if that means significantly curtailing lifestyle. In other words, lending guidelines are based not on fiscal prudence, but the maximum amount of pain the borrower is anticipated to tolerate without causing mass defaults!

In turn, this suggests that when evaluating how much a borrower can really “afford”, without potentially making themselves miserable, lender guidelines should not be relied upon. Or at least, it suggests that consumers need a #FinTech tool for themselves, that can evaluate the financial risk of their borrowing, but based on prudent borrowing that minimizes the risk of default, rather than maximizing the level of “acceptable” default loss for the lender!

Of course, ideally the determination of spending levels shouldn’t be based on what you can afford (by borrowing against the future!) in the first place, but what is “enough” to bring about a comfortable lifestyle. Though in a world of trying to “keep up with the Joneses”, that is clearly easier said than done!

Who Watches The CFP Board Watchers?

August 15, 2016 07:01 am 20 Comments CATEGORY: Planning Profession

In the nearly 10 years since Kevin Keller took over as the CEO of the CFP Board, the rolls of CFP certificants have grown by over 35%, even amidst a global financial crisis and an advisor demographics challenge that has contributed to a nearly 15% decline in advisor headcount over that time period.

In Keller’s early days, the CFP Board’s focus was squarely on rebuilding trust with its various stakeholders, from a relationship that had suffered greatly from a string of 6 CEOs in the preceding 6 years before Keller took over. It was a time filled with growing communication from the CFP Board to CFP certificants, where initiatives were extensively vetted for stakeholder opinion and feedback, and more than half a dozen different public comment periods for various rules changes.

Yet since 2012, the first year that CFP Board “lost” an initiative due to negative feedback during the public comment period, the tone of CFP Board’s engagement with stakeholders has shifted. It’s now been a full 4 years since the CFP Board announced a single public comment period at all, despite engaging in numerous – and several unpopular – rules changes in the interim. And the CFP Board’s growing aspirations is leading towards an ever-growing path of mission creep, from being “just” the organization that maintains the CFP marks, into one that offers a Career Center, an academic home for CFP certificants, its own Journal, and even proposed to go into competition with its own CE providers.

Of course, ultimately any organization is accountable to its stakeholders who can “vote with their feet” to take their business elsewhere. Yet the growing dominance of the CFP marks as the financial planning designation of choice means financial planning practitioners have never had fewer real alternatives to choose from. And the CFP Board’s ongoing Public Awareness Campaign, with its “Certified = Qualified” message, implicitly impugns any CFP certificant to their clients if that individual decides to walk away from the CFP marks – which makes the limited complaints to CFP Board’s policy changes look less like tacit stakeholder affirmation, and more like acquiescence under duress.

While some might suggest this is all the more reason to step away from the CFP marks and find an alternative designation, I still believe that the CFP Board and its certification are still the best chance we have to become a recognized and bona fide profession. But it does mean that perhaps it’s time to recognize that the CFP Board’s success in growing the adoption and prominence of the CFP marks is fundamentally changing the stakes and its relationship to CFP certificants as stakeholders.

And so if the organization wants to maintain its legitimacy and authority with CFP stakeholders, it needs to (re-)adopt its use of public comment periods (and actually make the results public as other oversight organizations and regulators do!), not unilaterally force all CFP certificants to waive their right to hold the CFP Board accountable in court under any/all circumstances, and consider whether a governance model that deigns so much authority to its CEO and selects its board successors by purely internal means is really the right approach for its increasing role in the financial planning profession.

Weekend Reading for Financial Planners (Aug 13-14)

August 12, 2016 02:51 pm 6 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the big news that 7 major universities, including Duke, Yale, and MIT, were all sued this week in class action lawsuits over the investment and record-keeper expenses of their 403(b) plans, opening a new chapter in the ongoing ERISA backlash against large employer retirement plans for failing in their fiduciary duty to manage their costs for employees. Also in the news this week was discussion of the ongoing shifts in money market funds, in preparation for new rules rolling out in 2 months that could introduce redemption fees and even floating NAVs for some money market funds.

From there, we have a few practice management articles, including: a review of upstart RIA custodians Equity Advisor Solutions and Folio Institutional; how TD Ameritrade continues to maintain its lead as the RIA custodian with the widest breadth of integrations thanks to its open architecture VEO platform; how the rising tide of ERISA fiduciary lawsuits may be shifting 401(k) plans to prefer 3(38) outsourcing providers over 3(21) plan consultants; and how advisory firms should consider measuring not only the productivity and efficiency of their financial advisors, but also their operations staff.

We also have a several more technical articles, from a look at what questions and issues to consider when selecting a donor-advised fund, to how shifts in the working habits of women and mothers have decreased the relevance of Social Security's "family" benefits (and whether a new caregiver credit should be introduced for working mothers), and whether retirement income strategies that combine portfolio withdrawals and laddered annuity purchases may be more effective than either is alone.

We wrap up with three interesting articles: the first looks at how financial advisors need to burnish their public perception by showcasing the best of what financial advice can provide (to combat the slew of negative perceptions about the broader financial services industry); the second urges financial advisors to be more careful about the language they use to describe themselves, noting that if we can't appropriately distinguish between the profession and the industry, between advisors and salespeople, and between clients and customers, then what chance do consumers and the media have; and the last calls on professional financial advisors to adopt and embrace the DoL fiduciary rule, noting that all true and bona fide professions have a fiduciary duty to clients, and that the implementation of a fiduciary rule for financial advice could mark the starting point for the true emergence of the financial planning profession.

Enjoy the "light" reading!

Should Paraplanners Get Time Off To Study For CFP Certification?

August 11, 2016 08:14 am 14 Comments CATEGORY: Personal/Career Development

It takes a substantial investment to earn the CFP certification. The financial cost can be significant, between signing up for the educational classes, potentially take a live exam review course, and enrolling for the CFP exam itself. And the cost in terms of time is significant, too - for many, the entire process often takes 12-18 months of putting in the hours it takes to learn the material. Fortunately, at least some advisory firms are willing to help share in some of the costs.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at the question of how much should an advisory firm be expected to invest for a paraplanner to get the CFP marks? And in particular, if an advisory firm is willing to help cover the financial cost, is it appropriate to ask for time off to study as well?

The short answer: No. While a growing number of firms will at least support the financial cost of CFP coursework - in part, because it may be outright too expensive for many entry level paraplanners to afford on their own - most firms will still reasonably expect the paraplanner to make an investment, too. Which means if the paraplanner can't put in the dollars, at a minimum he/she can put in the time it takes to study.

Given the commitment, that may well mean that a paraplanner who wants to earn their CFP marks and get promoted will have to carve out from their personal time in the evenings and on the weekends to study. But the reality is simply that sometimes, that's what it takes to get ahead. You always have the choice to not make the investment, and remain in the job you're currently in. But if you want to take your career to the next level, you have to find a way to make the investment in yourself, and not just expect the firm to give you the dollars and the time!

Most FLP Valuation Discounts Would End Under Proposed Treasury Regulations

August 10, 2016 07:01 am 17 Comments CATEGORY: Estate Planning

Using a Family Limited Partnership (FLP) or Family LLC to obtain favorable valuation discounts on gifts or bequests has been a staple of high-net-worth estate planning for the past 15 years. While IRC Section 2704, passed in 1990, was intended to limit the aggressive use of valuation discounts, over the decades since a number of Tax Court cases, along with evolving state laws, have undermined the IRS’ ability to enforce those rules.

Accordingly, after years of failed attempts to get Congress to update the rules, the Treasury department has decided to pursue its own crackdown, in the form of newly proposed 25.2704 Treasury Regulations. In fact, the proposed Regulations under Section 2704 are so expansive, that they would severely limit the use of valuation discounts for any type of family limited partnership or other family business transfer, where the family will retain control before and after the gift or bequest occurs.

The new rules would include the imposition of a new 3-year lookback to determine whether a minority valuation discount should apply (limiting deathbed transfers used to create a minority interest), the introduction of new “disregarded restrictions” that go beyond the already-ignored “applicable restrictions” in situations where the family will retain control after the transfer (and effectively create an implied put right for any recipients of a transfer, which significantly curtails most valuation discounts), and a shift away from only looking at restrictions that are “more restrictive” than available state law (given that many states have already shifted their laws to become more restrictive in recent decades).

Fortunately, the proposed Treasury Regulations must go through a 90-day public comment period through November, following by a public hearing in December, and must then be re-evaluated before final issuance (which in turn wouldn’t take effect until 30 days thereafter). And of course, the more restrictive rules are a moot point for the overwhelming majority of families – including family businesses – that still don’t have a value high enough to trigger estate taxes given an exemption of $5.45M for individuals and $10.9M for most couples.

Nonetheless, for those high-net-worth families who are over the estate tax thresholds, just a few months remain to engage in transfer planning to maximize current valuation discounts before the new rules take effect!

Will There Ever Be A #FinTech Advisor Platform Business Like Uber Or Airbnb?

August 8, 2016 07:01 am 20 Comments CATEGORY: Technology & Advisor FinTech

In the span of barely 10 years, companies like Uber, Airbnb, Facebook, and Alibaba have experienced explosive growth, far surpassing the growth rate of their respective industries, and despite the fact they don’t actually produce anything themselves.

Yet in fact, that’s the whole point; they are platform businesses, and their role in facilitating a marketplace between consumers and producers is the primary form of value creation, not the production of goods and services themselves. In the process, these platform businesses have been out-competing or outright disrupting their respective industries, raising the question of whether – or when – the platform model will come to financial services as well.

In point of fact, though, the financial services industry is already filled with platform businesses. Arguably, stock market exchanges are one of the oldest and original types of platforms to connect buyers and sellers. And custodians and broker-dealers constitute a form of platform business as well, connecting advisors and the asset managers who want to reach them. Envestnet is quite possibly an even purer form of platform business, avoiding the hassles of actually being the custodian or doing the clearing, and instead just serving as technology that facilitates the matchmaking process between advisors and asset managers.

Still, this means the door remains open for an actual financial advisor matchmaking platform, that connects consumers directly to financial advisors themselves. Prior attempts at this model have largely failed, likely due to the fact that most advisors are such generalists that it’s not really feasible to match them effectively with consumers in the first place. In turn, this suggests that a successful platform in the future will need to focus not on pairing consumers with advisors, but on helping consumers find an advisor who can answer their particular question – which forces advisors to actually choose a niche specialization by which they can be matched. Which means in the end, the real platform opportunity of the future is not a financial advisor platform, but a financial advice platform instead!

Weekend Reading for Financial Planners (Aug 6-7)

August 5, 2016 02:51 pm 3 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the news that FINRA is beginning an exam sweep of Business Development Companies, raising questions of whether nontraded BDCs may have similar issues to nontraded REITs, which is concerning given how sales plummeted for nontraded REITs after regulators last year applied new rules requiring greater transparency and disclosure. Also in the news this week is a discussion of Andy Millard, a CFP certificant and Democrat from North Carolina who is running for the House of Representatives, who is a long shot running in a district that hasn't voted for a Democrat in the House since 1960, but could become the first CFP professional elected to Congress (which would be very important given the potential for additional regulatory scrutiny of financial advisors in the coming years).

From there, we have a few practice management articles, including: how profession-based niches may be too narrow for some, and whether life-stage-based niches that are a bit broader may be better; how the rise of independent advisor platforms and aggregators may have done much to accelerate the breakaway broker trend, but may be asking too much of a breakaway's revenue or profits to be sustainable; tips for attracting and retaining Millennial financial advisors; and the importance of understanding exactly how "Assets Under Management" is defined for regulatory purposes (and how just giving financial planning advice about a client's whole portfolio doesn't necessarily constitute Regulatory AUM).

We also have a several more technical articles, from a look at how traditional long-term care insurance sales continue to decline (now down a whopping 85% in policies sold since the year 2000) even as hybrid life/LTC policies are on the rise (though they have problems of their own), to an analysis of whether those claiming Social Security at age 62 are making a mistake (or if in reality early claimants are primarily those who have to claim early due to an unexpected employment or health shock), and a good primer on the various types of student loan forgiveness programs (for Millennials with student loan debts who are willing to work in the teaching, government, or non-profit sectors).

We wrap up with three interesting articles: the first looks at how willingness to delay financial gratification, even amongst seniors, is a good predictor of how effective they were at being savers and accumulating wealth (though it remains unclear whether such 'financial patience' is learned or genetic); the second provides a great reminder about how finding a job you love not only can make you happier and more satisfied, even if it pays less, but may be so motivating that it helps you to reinvest in your training and education and become an expert, which can lead to higher income as well; and the last looks at the research on why it's important to set not just goals that guide how you must incrementally change to improve, but to set Big Goals that force you to recognize the substantive changes you may need to make to achieve sustained and large improvements in your business (or personal life) over time.

Enjoy the "light" reading!

Why Reverse Churning Is About To Become A Big Advisor Problem

August 4, 2016 07:54 am 14 Comments CATEGORY: Investments

Historically, churning - where a broker encourages excessive trading in a client's account in order to generate a large volume of trading commissions - has been a significant regulatory concern. In fact, the rise of fee-based brokerage and wrap accounts, and the ongoing shift to advisory accounts, has been driven heavily by regulators encouraging the switch, specifically because brokers who aren't paid based on the number and frequency of transactions don't have any incentive to churn accounts. However, it now appears that the efforts to stamp out churning may have been "too successful" - giving rise to an emerging new problem: reverse churning.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at the concept of "reverse churning", where an advisor charges an ongoing investment management fee, and how it is likely to be a growing regulatory concern in the coming years, as the DoL fiduciary rule spurs a massive shift towards various forms of fee-based brokerage and advisory accounts.

Arguably, the regulatory concern about reverse churning - where advisors charge an ongoing investment fee but fail to provide any substantive ongoing investment services - is appropriate. However, the scrutiny on reverse churning raises troubling concerns when paired with the growing popularity of using index funds, ETFs, and passive investment approaches. How is an advisor supposed to justify an ongoing advisory fee when the right thing for the client to do might really be to do nothing? And what if the bulk of the advisor's AUM fee is actually for other non-investment (i.e., financial planning) services, paired together with an otherwise passive investment portfolio?

Ultimately, the regulators may be pressured in the coming years to more clearly delineate the difference between true reverse churning, and a prudent passive investment approach. But in the meantime, advisors that charge AUM fees - especially those who espouse a passive investment philosophy - would be well served to clearly and rigorously document exactly what they do for clients on an ongoing basis, to avoid the risk of a reverse churning allegation in the coming years!

The Tax Risk Of Too-Tax-Efficient Investment Strategies

August 3, 2016 07:01 am 13 Comments CATEGORY: Investments

Judge Learned Hand once famously stated that “Any one may so arrange his affairs that his taxes shall be as low as possible” and that there’s no duty to pay any more in taxes than is absolutely necessary. And the corollary when it comes to an investment portfolio might be “Any one may so manage a portfolio to defer taxes as long as possible,” given that if the investor ever intends to use the money, eventually the tax bill must still come due, but it still pays to minimize tax drag along the way.

Yet while it’s appealing to manage investments in a tax-efficient manner – or buy “tax-managed” mutual funds to do it for you – in today’s tax environment, there actually is such thing as being too tax efficient and deferring too much in taxes for too long.

The reason is that since the beginning of 2013, investors effectively face four different capital gains tax brackets (including the 3.8% Medicare surtax on net investment income), with higher rates applying to higher levels of income and larger capital gains. Which introduces the possibility that an investor is so tax efficient, and defers their tax liability for so long, that when the taxable event finally occurs, the sheer size of the gains propel the investor into higher tax brackets, who then ends out finishing with less wealth!

Which means ultimately, while “tax drag” is bad, and strategies to minimize it – such as tax loss harvesting – are valuable, doing too much tax minimization now can just cause even more harm later. Instead, for some investors, the best approach is to recognize that in low tax rate years it’s better to harvest the gains instead of the losses. And in other situations, the best way to minimize tax drag is not to buy a tax-managed mutual fund at all, and instead leverage the asset location opportunity of sheltering growth investments that generate capital gains inside of an IRA (or ideally a Roth IRA) instead.