Nerd's Eye View blog

The Problem With Having Client Passwords – Beware The SEC Custody Rule For Advisors

May 11, 2015 07:01 am 15 Comments CATEGORY: Practice Management

The so-called RIA “Custody Rule” under the Investment Advisers Act of 1940 was designed to ensure additional oversight of an RIA that has actual possession of client assets, including both additional reporting to clients, and the requirement of a “surprise” annual audit of the firm. Given the costs involved to comply, most RIAs will go out of their way to avoid having custody so that the rules aren’t triggered.

Yet a recent SEC “Risk Alert”, rule warns that as many as 1/3^rd of RIAs are failing to comply properly with the custody rule, most commonly because the RIA fails to realize it has custody in the first place! As the SEC notes, just using a third-party custodian like Schwab or Fidelity alone is not a safe harbor; there are many ways an RIA can indirectly trigger custody, from being a trustee on a client’s account, to providing bill-pay services, and even “just” having a client’s username and password for their 401(k) can be enough to trigger the rule sometimes!

Accordingly, as RIAs continue to expand their services to differentiate in today’s increasingly competitive environment, it is more crucial than ever for firms to be aware of where the line is when it comes to the custody rule. In some cases, firms may decide that having custody – and handling the additional compliance requirements – is worthwhile for the service that will be provided to clients. But if the goal is to not have custody, firms need to be more cautious than ever about how their services are executed – and some may need to step back from a line they’ve already crossed, when it comes to common situations like having client login details to rebalance their accounts!

Weekend Reading for Financial Planners (May 9-10)

May 8, 2015 03:01 pm 11 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the big industry announcement that Envestnet is building financial planning software company FinanceLogix, as it continues to build towards a "one-stop shop" holistic technology platform for advisors. Also in the news this week was the announcement that the Vanguard Personal Advisor Services solution is now fully open to the public, with a new lower minimum of just $50,000... and notably, has already crossed the threshold of more than $17B of AUM even while it was still in its "beta" phase.

From there, we have a few technical planning articles this week, from a look at the new Section 529 ABLE Accounts for disabled beneficiaries, to a discussion of whether today's potentially low returns in both stocks and bonds may "wreck" retirement, to a recent study from AQR finding that perhaps Active Share is not such a good predictor of fund outperformance after all.

We also have a couple of practice management articles, including: an article by Angie Herbers suggesting that most advisory firm problems aren't actually "business" problems but instead are personal challenges of the owners that they must overcome as the firm grows and evolves; a look at how to properly structure an advisor study group "retreat" to get the most out of your time away from the office; a review of some of the key issues that new advisors should be thinking about (that they aren't always told up front); and a look at how financial advice is not a business where "if you build it, they will come", which is why advisors need to learn to better target a particular type of clientele and really market to them accordingly.

We wrap up with three interesting articles: the first is an article by Shlomo Benartzi in the Harvard Business Review suggesting that employer retirement plans are not paying enough attention to the little issues around how retirement planning choices are presented to today's workers, and that even the smallest differences in how online tools are designed can have significant impacts on retiree savings and investment decisions; the second is a discussion by Bob Veres suggesting that as advisory firms grow, the single most important issue is becoming the firm's ability to cultivate and develop its future leaders, such that the primary role of an advisory firm CEO should actually be focusing on the personal development of its top people; and the last is a look at how 40 years ago, Wall Street predicted doom and gloom with "May Day" and the elimination of fixed commissions, yet instead found that allowing competition and forcing firms to act more in the interests of their customers actually fueled a tremendous investing boom... which raises the question of whether the brokerage industry's current objections to recent proposals for a fiduciary standard represents another moment where the predictions of doom and gloom are off base and that forcing the industry to act more in the interests of their customers could actually lower the cost of and expand the availability of financial advice.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including a review of IBM's recent "World of Watson", the Envestnet acquisition of financial planning software FinanceLogix, and the rollout of Vanguard's Personal Advisor Services to the mainstream public.

Enjoy the reading!

Envestnet Acquires FinanceLogix As The Integrated Financial Planning And PFM Buying Frenzy Continues

May 6, 2015 08:41 pm 15 Comments CATEGORY: Industry News

As the Envestnet Advisor Summit gets underway today, CEO Jud Bergman kicked off the event with the big news that financial planning software and PFM provider FinanceLogix is being acquired in a deal reported at $32.5M of cash and stock, plus significant additional options to the upside. The news comes on the heels of Envestnet's acquisition of robo-advisor-for-advisors Upside Advisor just a few months ago.

Relative to other recent deals like Fidelity's acquisition of eMoney Advisor and the Northwestern Mutual purchase of LearnVest - both rumored to be bought for more than $250M each - the FinanceLogix deal is noticeably smaller, but given that the company may have only had 1/5th the market share of eMoney Advisor, seems reasonably in line and suggests that the acquisition interest in integrated financial planning and PFM software solutions remains strong. In fact, with the FinanceLogix purchase, there are virtually no remaining fully integrated planning-plus-PFM solutions available today... so expect to see the major players begin to acquire standalone PFM solutions and 'manually' integrate them instead as the buying frenzy continues.

From the perspective of FinanceLogix, the Envestnet acquisition will give them significant resources to continue to build and iterate the software - which will remain available to existing and new standalone users, even as it is more fully integrated into the Envestnet Advisor Suite. And from the Envestnet perspective, the acquisition suggests that Envestnet is aiming to build the "Holy Grail" of advisor technology platforms, a fully integrated technology stack including CRM, portfolio accounting, and now financial planning software, integrated with a "robo"-style client-facing portal that includes PFM capabilities... and revealing that perhaps Envestnet is not positioning to someday become a competing custodian, but instead simply wants to take the high ground of advisor value-add and deliver the ultimate integrated technology platform of the future for advisors - one that can be used regardless of their underlying (and increasingly commoditized) custodian or broker-dealer relationship.

Does Tax Loss Harvesting “Almost” Substantially Identical Mutual Funds And ETFs Trigger A Wash Sale Problem?

May 6, 2015 07:01 am 23 Comments CATEGORY: Taxes

Harvesting capital losses to generate a current tax savings is popular. So popular, in fact, that not long after the US income tax was first created a century ago, the strategy was rapidly adopted as a tax savings technique and became a perceived tax abuse. In turn, this lead to the establishment of one of the first pieces of legislation to close an “abusive” tax loophole, and we now know Congress’ solution as the “wash sale” rules.

Yet the challenge of the wash sale rules is that the requirement not to own a “substantially identical” stock or bond within the 61-day wash sale period was rather straightforward to apply in its day, but has become outdated given the rise of pooled investment vehicles like mutual funds, and especially with the explosion of index ETFs. Now, taxpayers face oddly disparate treatment, where it’s not permitted to harvest the loss on a stock that’s down and replace with the same stock, but it’s “fine” to harvest the loss on a mutual fund that’s down and replace it with another mutual fund that owns overlapping securities.

Ultimately, the spirit of the wash sale rules was that investors should be required to endure some “tracking error” risk with the replacement security owned during the wash sale period… which means swapping ETFs with a 0.99+ correlation to harvest a loss without any risk of a performance difference almost certainly violates Congressional intent. And while it remains to be seen whether the IRS will become more aggressive in pursuing the issue, and/or whether Congress will attack this abusive “tax loophole” once again, the fact that there has been no action to limit the abuses yet does not protect taxpayers who are in clear violation of the spirit and intent of the rules in the first place. So investors should at least be cautious to consider how far they push the limits with tax loss harvesting (TLH) of mutual funds and ETFs.

Economies Of Scale In Financial Advice – Are Larger Advisory Firms Really More Productive And Profitable?

May 4, 2015 07:01 am 18 Comments CATEGORY: Practice Management

With markets up and clients (generally) happy, advisory firms are enjoying record productivity, with the average advisor now responsible for nearly $500,000 of revenue by one benchmarking study’s measure. And the larger the advisory firm – and the more it scales its advice offering – the greater the advisor productivity seems to be.

Yet a deeper look at the numbers reveals that in reality, the largest advisory firms actually have the least productive advisors, at least when measured by the number of clients they serve. Similarly, while profit margins for advisory firms overall are healthy, they are remarkably similar regardless of whether a firm has $1M, $5M, or $10M of revenue. In other words, financial advice does not actually appear to be scaling across the landscape of advisory firms!

Instead, the key differentiator for the largest firms appears to be their ability to attract the biggest, wealthiest clients, and accelerate their growth rates despite spending the smallest percentage of revenues on marketing. Which means ultimately, while the productivity of financial advisors themselves doesn’t appear to scale much as a firm grows larger, the ability of the largest firms to attract the most affluent clients and scale their marketing may be the biggest advantage of that large firms have over their smaller competitors!

Weekend Reading for Financial Planners (May 2-3)

May 1, 2015 03:15 pm 13 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with a recent Guidance Update from the SEC about cybersecurity, suggesting that the regulator is increasingly concerned about whether RIAs are properly stepping up to their obligations to protect client data and whether they are really prepared to deal with a potential data breach.

From there, we have several technical planning articles this week, from a look at how clients might need to update the gifting provisions in their Power of Attorney documents in light of current Federal gift/estate tax exemptions, to the growing trend of "Impact Investing" for especially higher-net-worth clients, tips for how to utilize family resources when a child or grandchild is going to college while minimizing any adverse impact on financial aid, and a roundtable interview on the current issues advisors should be thinking about when it comes to health insurance and the new health insurance exchanges.

We also have a couple of practice management articles, including: the differences in how top RIAs do marketing compared to their peers; the challenges that advisory firm owners/founders face as the business continues to grow; a look at how mega-accounting firm Deloitte is revamping its system of managing employee performance and reviews (with lessons for us all about how to better manage employees); and a look at technology tools that may be helpful for advisors trying to revamp their online presence from website to social media and more.

We wrap up with three interesting articles: the first is commentary from FPA NexGen President-Elect Rianka Dorsinvail about how advisory firms should think about hiring and retaining young talent; the second is a profile of Apex Clearing, the platform that has powered most "robo-advisor" start-ups in the past several years and is now looking to offer its tools more directly to traditional RIAs as well; and the last is a sad reminder that as clients age, financial decision-making capacity is often one of the first things to go, which makes it especially important for advisors to be watchful as the first line of defense... and have a plan in place about how to contact other family members for support, should it become necessary to do so.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including the latest from the Shareholders Service Group (SSG) conference, a partnership between Orion Advisor Services and Jemstep Advisor Pro, and the latest from the SEC on cybersecurity issues for advisors.

Enjoy the reading!

How To Raise Children To Be The Opposite Of Spoiled – Using Money To Teach Values

April 29, 2015 07:01 am 40 Comments CATEGORY: General Planning

No parent wants to knowingly raise a spoiled child. Yet in a world where money is a taboo subject, there is remarkably little guidance available about how to turn a child into the opposite. Certainly making children financially literate is a good start – so at least they understand the mechanics of money and how it works – but that still doesn’t necessarily mean they’ll make good responsible decisions. But what else can be done?

To answer this question, New York Times personal finance columnist Ron Lieber has written a new book, aptly titled “The Opposite Of Spoiled”, exploring the parenting techniques that can not only avoid spoiling a child, but can raise one to be the opposite – a child that grows up to be thrifty, modest, patient, and generous. In fact, given that being not-spoiled is basically about having “good” values, Lieber makes the case that raising fiscally responsible children is all about using money as a vehicle to teach those values.

Accordingly, Lieber’s book navigates issues from “how much should children receive as an allowance” to “should children have to do chores to get their allowance”, as well as how to guide children towards the three fundamental pillars of financial decision-making – whether to spend, to save, or to give. Ultimately, “The Opposite of Spoiled” is something of a manifesto for parents about how to introduce money conversations to children as a means to teach good values, which means it is a book that could easily become a great gift for every client who is a parent likely struggling with these issues, and is equally relevant for advisors who are parents with children of their own as well!

NASAA Adopts New Model Rule 203(a)-1A Requiring RIA Business Continuity And Succession Planning

April 27, 2015 07:01 am 8 Comments CATEGORY: Practice Management

After completing the public comment period, NASAA has just implemented a new “Model Rule” that will require investment advisers to adopt a “Business Continuity and Succession Plan” for the RIA practice. Notably, the rule would apply only for state-registered investment advisers, although the SEC has recently announced it is considering a parallel rule for SEC-based RIA firms as well.

The ultimate requirement of the Model Rule is that advisors would be required to establish a written plan about how they will handle the transition of everything from books and records of the firm, to ongoing servicing of clients (or at least, an orderly wind down), along with an alternate means of communicating with clients, in the event of either a natural disaster, or the unexpected death or disability of the advisor. In other words, how will the RIA fulfill its fiduciary duty and ensure continuity of service for clients, in light of recent natural disaster events like Hurricanes Katrina and Sandy, or the simple fact that with a sole proprietor advisor the clients might not even know the advisor had passed away and that no one was looking after their assets anymore!

Ultimately, the Rule will not actually have the force of law until it is adopted by individual states in the coming months, but nonetheless the pressure is on now for advisors to begin to prepare their written plan, which state examiners will likely want to see the next time the RIA is audited.

Fortunately, many of the continuity provisions can realistically be achieved by adopting cloud-based services that have a robust backup and disaster recovery process of their own. However, the requirement for “[unexpected] succession planning” in particular may be a challenge for many advisory firms, who must ensure continuity for clients (or at least an orderly wind-down) but may not want to sell the practice now. Will NASAA’s new Model Rule spawn an increase in the number of providers who offer an “exit planning” arrangement for advisors who do want to remain in their practice, but need a continuity solution in the event of death or disability?

Weekend Reading for Financial Planners (Apr 25-26)

April 24, 2015 02:31 pm 26 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the announcement that NASAA has finalized its model rule that, as states adopt the rule, will require state-registered investment advisers to create a written "succession" plan for their business.

From there, we have a number of practice management articles this week, including: strategies to effectively delegate tasks to staff; why it's best to build out the staff infrastructure supporting your advisory firm by building roles around people, rather than trying to fit people into roles; a profile of several advisory firms that have been successful in creating a strong culture that supports the firm; a guide of what to do if you find out you're being terminated by your broker-dealer; and a look at where advisors get their best ideas (from peers and conferences) and how they create the accountability to follow through on them (using coaches and study groups).

We also have a few marketing-related articles, from a look at how being less available to prospective clients can actually help to close them, to strategies to invoke an emotional connection with prospective clients to get them interested in doing business with you, and a discussion of how the world of wealth management is changing as the (younger) emerging affluent have different expectations of what they'd like to see in a "good" wealth management service in the first place.

We wrap up with three interesting articles: the first looks at some of the ways that investment advisers misreport investment performance (from skewed benchmarks that create an illusion of alpha to buying premium bonds that make yield appear higher than it will be over time); the second is a message from a Millennial working in financial services about how mismatched most of today's providers are to the true needs and desires of younger investors; and the last looks at the CFP Board's public awareness program after nearly five years, and the progress the CFP Board is really making in advancing awareness of the CFP marks.

Enjoy the reading!

Asset Location For Stocks In A Brokerage Account Versus IRA Depends On Time Horizon

April 22, 2015 07:01 am 22 Comments CATEGORY: Investments

In an environment where generating portfolio alpha is difficult, strategies like managing assets on a household basis to take advantage of asset location opportunities to generate “tax alpha” are becoming more and more popular. The caveat, however, is that making effective asset location decisions is not easy, either.

For instance, while the traditional asset location strategy “rule of thumb” is that tax-inefficient bonds go into an IRA, while equities eligible for preferential tax rates go into a brokerage account, the reality is that for investors with long time horizons the optimal solution may be the opposite. Once stock dividends and portfolio turnover are considered, the ongoing “tax drag” of the portfolio can be so damaging to long-term returns that placing equities into an IRA may be more efficient, even though they are ultimately taxed at higher rates!

In fact, it turns out that almost any level of portfolio turnover will eventually tilt equities towards being held in IRAs given a long enough time horizon (and especially while today’s low interest rates result in almost no benefit for bonds to gain tax-deferred growth inside of retirement accounts). Which means in the end, good asset location decisions depend not only on returns and tax efficiency, but an investor’s time horizon as well!