Nerd's Eye View blog

Weekend Reading for Financial Planners (Dec 12-13)

December 11, 2015 02:37 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the announcement of the CFP Board's new Chair-Elect Blaine Aikin, a long-standing CFP certificant who has spent the past decade not working as a practitioner but in a leadership position with fiduciary training program Fi360, and raising the question of whether it's a problem for the CFP Board to have a "non-practitioner" Chair, or a positive for it to have a fiduciary leader at a time of potentially significant fiduciary regulatory change (with the Department of Labor fiduciary rule anticipated in early 2016). Also in the news this week was the decision of high-yield bond fund Third Avenue Focused Credit to not only shut down, but suspend redemptions to 'ensure it can liquidate in an orderly manner', raising both concerns about how severe the stress in the high-yield bond market really is, and questions of whether more bond funds may soon limit their redemptions given the illiquidity of their underlying bond holdings as well.

From there, we have a few technical financial planning articles this week, from a discussion of whether advisors need to give a fresh look at the uses of reverse mortgages, to year-end planning strategies to optimize FAFSA reporting for those looking to qualify for financial aid, and a review of the rules and requirements for clients to hold investments of gold within an IRA and avoid disqualifying the account (given that IRAs normally cannot invest in "collectibles", which includes some forms of gold).

We also have a couple of practice management articles this week, including: the value of adding a virtual meeting with clients between the data-gathering process and the plan presentation meeting, to review and reaffirm the data and make sure it's accurate before crafting recommendations; how defining a niche for an advisor is about more than just targeting a certain level of wealth; how the real challenge for succession planning is not actually selling the business, but transitioning the founder's role from advisor to business leader; and some tips for young advisors looking to be a successor about how best to prepare themselves for the transition from their end.

We wrap up with three interesting articles: the first is a Reuters investigative report about whether the explosion of share buyback activity is no longer just enhancing returns for investors but may be overdone to the point of threatening American innovation and even exacerbating income inequality; the second is a discussion of upcoming regulatory trends in 2016, including not only a looming DoL fiduciary rule, but also new anti-money laundering rules for RIAs, an expansion to Form ADV, and a new regulatory fight about whether the SEC should use third-party reviewers to increase the pace of RIA exams; and the last is commentary for RIABiz founder Brooke Southall about whether the vendors serving advisors (particular the RIA community) today are still operating too much like the 'traditional' Wall Street firms that advisors are increasingly running away from.

Enjoy the reading!

Capturing An Excess Return Premium For Illiquidity Is A Privilege Not A Right!

December 9, 2015 07:01 am 10 Comments CATEGORY: Investments

Liquidity may be an appealing characteristic for an investment, but a growing base of research is finding that illiquidity may be even more desirable. Because ironically, demand for illiquid investments is so low, that they appear to carry a persistent excess return premium – a view popularized in recent years by those like David Swensen of Yale Endowment, who racked up a whopping 13.9% annual return for the past 20 years in large part by relying heavily on illiquid investments.

Of course, the first caveat to investing in illiquid assets is that it is only appropriate for the portion of investments that the investor can afford to segment into illiquid holdings. Yet the more significant (albeit more nuanced) danger of investing in illiquidity is that the return premium is only a benefit for an otherwise sound investment. For a bad investment, owning one that is also illiquid just compounds the problem by locking the investor in!

And notably, a bad investment is not just one with poor economic fundamentals, but also one where the interests of the investment manager and the investor themselves are not well aligned – leading to situations where even an appealing investment at first turns out to sour later, as has occurred with illiquid investments from various hedge funds, to certain life insurance and annuity products, and more recently with nontraded REITs.

Yet perhaps the greatest misalignment of interests is simply the one that occurs when illiquid investments are sold by salespeople who benefit in the short-term while an investor is locked into the illiquidity for the long run. In other words, illiquid investments may be one situation that is especially appropriate for the involvement of a fiduciary where long-term economic interests are aligned – which goes a long way to explain why illiquidity has served institutional investors like the Yale Endowment so well, even as for the individual investor it so often goes awry!

Is Financial Planning Software Incapable Of Formulating An Actual Financial PLAN?

December 7, 2015 07:01 am 33 Comments CATEGORY: Technology & Advisor FinTech

While crafting a “financial plan” for clients has been a staple of financial planning for decades, virtually no financial plan today actually constitutes a real “plan” for anything. After all, the whole point of planning is to formulate the strategy of how to handle a range of possible future scenarios. If A happens, then we’ll do B. If C happens, we’ll do D instead.

Yet financial plans today, and the financial planning software that supports the process, is incapable of illustrating such scenarios and the appropriate responses! Answering a simple planning question like “how much do the markets have to decline before I need to cut spending in retirement, and how much would I need to adjust my spending to get back on track” cannot be easily answered with any financial planning software available today!

Ultimately, as financial planners, we cannot eliminate the uncertainty of what the future may unfold, but we can eliminate the uncertainty of what to do and how to respond to those possible future scenarios. And by crafting a real plan about how to deal with that future, we can make it far less stressful as well, and eliminate the danger of needing to make a potentially regrettable high-stakes decision in the worst possible (and highly emotional) moment!

But ironically, in the end the very software that we rely upon to do financial planning and help clients navigate their uncertain future may actually be the greatest inhibitor to truly formulating a real financial plan for clients to deal with it!

Weekend Reading for Financial Planners (Dec 5-6)

December 4, 2015 02:33 pm 3 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the latest 2015 Financial Advisor Tech Survey from Financial Planning magazine, highlighting the latest in advisor technology trends, from the most popular CRM and financial planning software, to which advisor channels (and age demographics) are adopting new technology the fastest. Also in the news this week is another discussion of the Vanguard whistleblower suit, suggesting that Vanguard really is facing the possibility of being forced to increase its internal pricing by as much as a factor of 4X (and potentially pay billions of dollars of "evaded" taxes as well).

From there, we have a few technical financial planning articles, including: Social Security planning tips from Larry Kotlikoff in the aftermath of the recent Bipartisan Budget Act crackdown on File-and-Suspend and Restricted Application; a summary of the upcoming rules changes next year on money market funds, including which types may face a 2% redemption fee and have a floating (not-fixed-at-$1) NAV; a discussion of looming Medicare changes, from rising healthcare inflation impacting premiums, to new income threshold for the Medicare surtaxes in 2018 and changes to Medigap supplemental policies in 2020; and a look at "swap powers" and their relevance in income and estate tax planning (especially to get a step-up in basis on certain appreciated assets) for various types of irrevocable grantor trusts.

We also have a couple of practice management articles this week, from a review of the latest technology enhancements at broker-dealers like Cambridge, Commonwealth, and LPL, to a look at how advisory firms are adopting virtual part-time paraplanners and interns, and a discussion of the "pricing trap" that many advisory firms are facing as growth rates slow and firms (wrongly?) try to cut prices to compete instead of getting more focused on really crafting a unique value proposition for a clear target clientele (because in the future, it's really going to matter!).

We wrap up with three interesting articles: the first is a look at the recent FINRA initiative to reshape the Series 7 exam and/or to introduce a new "general knowledge" exam, which in turn has kicked off questions about whether the Series exams are even still relevant in today's financial advisor (and not-stockbrokering-centric) world; the second is a discussion of Facebook founder Mark Zuckerberg's announcement to donate 99% of his Facebook stock (about $45B) for philanthropic purposes, but to not use a private foundation and instead contribute to a for-profit LLC instead (possibly a newly emerging philanthropic trend?); and the last is a touching discussion about the "real" value of the home, as told by the Wall Street Journal's Jason Zweig when he had to move his 87-year-old mother out of the family home that they had owned for more than 50 years.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, featuring his own take on Financial Planning magazine's 2015 Advisor Technology Survey results, from what is still poor adoption of advisor CRM (the most common advisor CRM is "none"!?), but rising technology spending budgets as advisors look to step up in the future!

Enjoy the reading!

Using Systematic Partial Roth IRA Conversions And Recharacterizations To Fill The Lower Tax Bracket Buckets

December 2, 2015 07:01 am 34 Comments CATEGORY: Retirement Planning

From the moment the Roth IRA was created in the late 1990s, it has been a popular vehicle to generate future tax-free growth and income, whether by contributing to the account on an ongoing basis, or even doing a Roth conversion of an existing IRA or other pre-tax retirement account.

Yet the caveat is that the decision to contribute or convert to a Roth IRA incurs an immediate tax liability. And in the extreme, a large Roth conversion can generate so much taxable income that it actually drives up the IRA owner’s tax bracket to the point that the transaction becomes wealth destructive!

Fortunately, though, the decision to do a Roth conversion doesn’t have to be “all or none” – and in fact, not only is a “partial” Roth conversion permitted, but in practice it’s often the optimal strategy, allowing retirement account owners to convert just enough to fill the lower tax brackets, without causing “too much” income that would trigger the top tax brackets.

In fact, the Roth recharacterization rules make it feasible to precisely fill the bottom tax brackets, but not a dollar more, by converting more than enough to fill the lower tax brackets each year, and then doing a partial recharacterization to back into the optimal partial Roth conversion amount after the year is over!

How Tax Treatment Changes The Valuation Of An Advisory Firm Acquisition

December 1, 2015 07:01 am 2 Comments CATEGORY: Practice Management

As the pace of advisory firm acquisitions slowly but steadily increases, more and more attention is being paid to the "going rate" valuations of advisory firms, with some recent mega-deals valued at upwards of 2.0X recurring AUM fee revenue.

Yet the caveat is that not all advisory firm acquisitions are treated the same for tax purposes. Earn-out arrangements result in the purchase price being taxed as ordinary income to the seller, while others deals that purchase the underlying business assets may be treated as a capital transaction eligible for long-term capital gains treatment. As a result, a deal that is reported at 2X revenue could actually be worth another 15% more (or quite a bit less) depending on the tax treatment.

The issue is further complicated by the fact that the treatment most favorable to the seller - taxation at long-term capital gains rates - is least favorable to the buyer, who will be compelled to spread the cost of the purchase for tax purposes over 15 years as "goodwill amortization" even though the cash flows for the purchase occur immediately. As a result, the tax treatment of the deal can be a significant factor in setting the price itself, as buyers may pay more for a deal with more favorable tax treatment for themselves, and sellers may accept less if they can receive more favorable tax treatment on their end.

In this guest post, advisor Daniel Zajac shares his perspective on how the valuation of an advisory firm can swing by 15% or more, based on both the tax treatment to buyers and sellers and the expected growth rate of the practice. Whether you're considering the sale of your own practice, or are a prospective buyer of one (either as a way to start out as a financial advisor, or to make your existing advisory firm bigger), hopefully this information will help you gain a better understanding of the tax issues to consider that may influence the valuation of the firm involved!

NSR Invest Platform Aims To Open Peer-To-Peer Investing Marketplace To Advisors

November 30, 2015 07:01 am 11 Comments CATEGORY: Investments

In today’s low-interest-rate environment, the pressure is on for advisors to add value when it comes to fixed income allocations. Yet unfortunately, some of the most appealing segments of the fixed income markets to generate higher yields – such as peer-to-peer (P2P) investing – have little or no means to fit into the typical financial advisor investment platform.

But that may soon change, as peer-to-peer analytics and management solution NSR Invest prepares to launch the first integration of P2P investment platform Lending Club to ‘traditional’ advisor portfolio analytics solution Orion Advisor Services. The ultimate goal – to make it feasible for financial advisors to manage client investments in P2P loans, including allocating capital into individual loans (in a diversified manner), managing cash flows in and out of P2P investment accounts, and facilitating consolidated performance reporting of P2P investing and the client’s other portfolio investments. All done in a manner that advisors can even bill for their services.

Of course, the caveat is that peer-to-peer investing still has significant risks to accompany the higher yields it offers, from a material risk of default (which can only be partially diversified away) to significant illiquidity if clients unexpectedly need to sell their allocations. Nonetheless, the relatively new sub-asset-class within the fixed income environment remains appealing for yield-starved clients, and NSR Invest’s technology may finally make it feasible for, at least, independent RIAs to begin to allocate client dollars to P2P investment opportunities!

Weekend Reading for Financial Planners (Nov 28-29)

November 27, 2015 02:00 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the big news that now Fidelity is throwing its hat into the "robo" ring, with a new automated investment advice solution called "Fidelity Go" that, like Schwab's own effort, will function as a distribution channel for Fidelity's own proprietary mutual funds for a portion of the investment assets. Also in the news this week was a settlement between Vanguard and the state of Texas driven by a whistleblower allegation that the company may be setting its costs at a below-market rate as a tax avoidance scheme (and raising the question of whether further tax-related lawsuits may eventually force Vanguard to raise its fees).

From there, we have a few technical financial planning articles this week, from a look at the ongoing rise of Deferred Income Annuities (also known as Longevity Annuities) and why advisors should consider them, to a discussion of why factor investing strategies (e.g., a value-tilt or a small-cap tilt) continue to persist despite the fact they are "known" and theoretically should be arbitraged away, a look at the "investment portfolio of the future" as advisors increasingly shift to "core" investing with index funds and "satellite" positions with an ever-widening range of alternative investments, and discussion of a recent EBRI study that found while retirement spending declines by more than 20% for nearly 1/3rd of retirees in the first 6 years of retirement, a material number of retirees increase their spending early in retirement (and not just those who are affluent).

We also have a couple of practice management articles this week, including: the latest Cerulli data, which finds that despite prior predictions, the number of financial advisors actually increases last year (albeit by just 1.1%) as large firms increasingly hire junior advisors to deepen their teams and formulate succession plans; a look at the importance of really asking your clients what they truly value, recognizing that what we think clients appreciate may not really be what they value most; and the last looking at how financial planning may change in the coming decade as technology increasingly impacts the way advisors do business and serve clients.

We wrap up with three interesting articles: the first looks at how the coming Department of Labor fiduciary standard could actually become a disruptive threat to RIAs (even as it benefits consumers), as RIAs simultaneously lose their differentiating fiduciary factor and face an onslaught of new competition from sales-oriented fiduciary advisors who may prove more capable at gathering clients and assets; the second is a cautionary note from former SEC Investment Management Division director Norm Champ about the problems that may arise if the SEC proceeds with its anticipated proposal to outsource RIA exams to a third-party examiner; and the last raises the interesting question of whether the entire retirement paradigm of "work now for financial freedom later" is the wrong approach, and whether a series of periods of work followed by periods of "mini-retirement" may ultimately be the more fulfilling "retirement" approach of the future.

Enjoy the reading!

How PEP And Pease Don’t Actually Penalize Deductions, They’re Just 1% Surtaxes On Income

November 25, 2015 07:01 am 3 Comments CATEGORY: Taxes

Back in 1991, Congress first enabled the "Pease limitation" phasing out itemized deductions, and the "Personal Exemption Phaseout" (PEP), which were designed to limit the tax benefits of those deductions for higher-income taxpayers. While the PEP and Pease limitations were themselves phased out in the mid-2000s, the American Taxpayer Relief Act of 2012 re-enacted them beginning in 2013, making them a current tax planning issue.

Yet the irony is that while they are referred to as "phaseouts of itemized deductions" and a "personal exemption phaseout" the reality is that the Pease limitation and PEP are applied primarily based on the extent by which someone’s income is over specified thresholds. As a result, while they're labeled as penalties to deductions and exemptions, the Pease limitation and PEP actually function more like surtaxes on income, amounting to a 1% marginal tax rate increase for the Pease limitation, and another 1% rate increase per family member for the PEP.

The reason why this distinction matters is that ultimately, as surtaxes on income, the PEP and especially the Pease limitation are not actually disincentives against deduction-producing strategies; for instance, with almost all taxpayers, the tax savings of charitable giving is actually identical with or without the Pease limitation! In the end, this means that advisors and their clients should be cautious about trying to avoid deductions when faced with PEP and the Pease limitation; instead, simply recognize their 1% surtax effects, and focus planning on income given the higher marginal tax rates that result!

Celebrating My 5 Year Blogiversary, And A Look At How I Get Paid For “Free” Blogging

November 23, 2015 07:01 am 26 Comments CATEGORY: Nerd's Eye View

With nearly 1,000 cumulative articles, this past month the Nerd’s Eye View blog celebrated the 5-year anniversary (or “blogiversary”?) of its re-birth in the fall of 2010. And over that time span, this blog has gone from a sleepy little side project that had a dozen or two readers for every article, to one that generated a whopping 120,000 unique visitors last month, and has become the center of my business and professional world.

From many of you who are regular readers of the blog, and enjoy the entirely free (and advertising-free) content, I’m often asked how I can ‘afford’ to give away so much of my time and content without charging anything (or selling third-party ads). The key is simply this: no matter how much free information is out there on the internet, there will always be a subset of people who need some help implementing the ideas and strategies they read.

In fact, given the size of this site, it means that ultimately even if only 1% of you (or even 0.1% of you!) have a need to do business with one of the various companies I own, or want me to speak at your event or consult with you, and the other 99.9% of you simply use this information for free to improve your own lives (or your practice, or your work with clients), we all win. And that simple strategy has more-than-quadrupled my personal income in the past 5 years, even as I give away more and more for free!

Accordingly, I am happy to report that even as the Nerd’s Eye View blog grows to new highs, I remain committed to giving you as much helpful information as I can entirely for free - and remain free from any third-party advertising as well. In fact, you’ll notice that we’ve re-launched with an updated visual look and interface to the site to make it even easier to read and navigate, and with a re-design on the back end of the site will be rolling out more new features and services in the coming months as well. All I ask is that you continue to visit the site regularly, read the content, share it with your friends and colleagues, and if you have a need for some further assistance, please don’t hesitate to reach out if one of my businesses can help.