Nerd's Eye View blog

Weekend Reading for Financial Planners (Sep 20-21)

September 19, 2014 01:52 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the recent "Fiduciary Leadership Summit" in Washington DC, hosted by TD Ameritrade and the Institute for the Fiduciary Standard, highlighting "war stories" of consumers injured by gaps in the fiduciary duty for brokers and an interesting response by former regulator Robert Plaze that perhaps the best outcome is not a uniform fiduciary standard for all but simply that the brokerage industry needs its own standalone regulatory reforms. Also in the news this week is a new NASAA working group that will look at revising broker-dealer fee disclosures for consumers after acknowledging that today's fee disclosure documents are too long and confusing, and a recent survey by Gallup that finds "creating a financial plan" is one of the few financial issues that consumers consistently do rely on professional advice more than friends and family.

From there, we have several practice management articles this week, including one from United Capital CEO Joe Duran that the golden age for (small independent) RIAs may soon be ending with rising competitive forces putting the big squeeze on profits and margins, a response to Duran's bleak outlook from RIABiz's Brooke Southall who suggests that many of these competitors (from robo-advisors to Vanguard's Personal Advisor Services) are still ultimately just a drop in the bucket compared to the sheer size of the consumer investor marketplace, and a discussion from Mark Tibergien about whether some advisors actually need to get better at having the conversation with clients about raising fees instead.

We also have several more technical articles this week, including: a discussion of what the "true diversifiers" in a portfolio really are, and whether they're even necessary if there's a risk-managed approach to the equities themselves; a review of a recent T. Rowe Price survey suggesting that retirees may actually be more flexible and adaptable in their retirement spending than is commonly believed; and the last looking at the current use of Monte Carlo analysis, suggesting that perhaps one of our greatest problems is not the limitations of the tool itself but that many of today's Monte Carlo software tools do not provide a sufficient range of reporting on the outcomes beyond just the (insufficient) probability of success/failure alone.

We wrap up with three interesting articles: the first looks at how much of the disagreement amongst even the true finance experts may stem from the fact that our experience with investing and the markets can be dramatically impacted by the year in which we happen to be born (and therefore the investment returns and volatility we witness during our early formative years), and that many finance disputes may simply be a representation of two experts whose views are heavily biased and colored by their own (birth-year-sensitive) personal history and experience; the second looks at how the real significance of the robo-advisor trend may not be their actual competitive threat, but simply that they highlight what quality technology and a great client user experience looks like, and how lacking today's tools for advisors really are; and the last is an analysis from Wealthfront about the behavior of investors in active mutual funds versus index funds during market volatility, finding that passive investors are less prone to portfolio turnover during market volatility and suggesting that despite their lack of human advisors to hand-hold clients, many of today's (passively-based) robo-advisors may experience witness less client churn during the next bear market, not more.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including a summary of the first (Orion-Advisor-Services-sponsored) "hackathon" which brought together programmers from numerous advisor tech companies to try and build the best new useful relevant technology tools and integrations for advisors in just 48 hours! Enjoy the reading!

Valuation-Based Tactical Asset Allocation In Retirement And The Impact Of Market Valuation On Declining And Rising Equity Glidepaths

September 17, 2014 07:01 am 11 Comments CATEGORY: Retirement Planning

For retirees who are more concerned about running out of money in retirement than leaving a large inheritance behind, the optimal retirement asset allocation strategies shift from focusing on wealth maximization and owning as much in equities as you can tolerate (to provide the greatest return on average), to approaches that do a better job of preserving wealth in adverse scenarios (even if it costs excess upside when times are good).

This retirement approach of focusing on minimization to spending risks over maximization of wealth accumulation has led to a wide range of retirement asset allocation and product strategies, including the use of annuities with guarantees, bucket strategies with cash reserves, and most recently the “rising equity glidepath” approach where portfolios start out more conservative early in retirement and become progressive more exposed to equities over time as bonds are spent down in the early years.

The caveat of risk minimization strategies, though, remains the simple fact that most of the time, they turn out to be unnecessary, as the risky event never actually manifests. As a result, tools like Shiller CAPE that allow advisors to understand whether clients are more or less exposed to a potential decade of mediocre returns (which brings about the “sequence-of-return risk” in retirement) can be remarkably effective at predicting when it’s necessary to focus on risk minimization in the first place, and when wealth maximization may be the more prudent course.

In fact, as it turns out, market valuation measures like Shiller CAPE can actually be so predictive of the optimal asset allocation glidepath in retirement, that the best approach may not be to implement a rising equity glidepath or a static rebalanced portfolio at all, but instead to adjust equity exposure dynamically based on market valuation from year to year throughout retirement. While this kind of tactical asset allocation approach is not necessarily a very effective short-term market timing indicator, the results suggest nonetheless that it can help to minimize risk when necessary, take advantage of favorable market returns when available, and have some of the best of both worlds – albeit with the caveat that markets can still deviate materially in the short run from what valuation alone may imply regarding long-term returns!

Effective Succession Planning For Financial Advisors And The Problems With Advisor Compensation Based On Revenue Sharing

September 15, 2014 07:01 am 6 Comments CATEGORY: Practice Management

For years, industry commentators have been anticipating an “onslaught” of retiring baby boomer advisors who will begin to engage in succession planning en masse and sell their firms over the next decade. Yet year after year, the baby boomers get older, and the sellers don’t materialize; with an astonishing paucity of sellers to external buyers and an abundance of buyers, it remains a seller’s market for financial advisory firms.

Yet in a new book, David Grau (founder of FP Transitions, a firm that has potentially already been involved with more advisory firm sales than any other consultant or service provider in the industry today) makes the compelling case that for advisors to be focused on big headline external sales to third parties misses the real opportunity – an internal succession plan executed over a period of years or even a full decade, that ultimately delivers radically more to the founder than a third-party external sale ever could.

In order to harvest the greater long-term value from an effective succession plan, though, Grau points out that advisory firms are still too attached to the wirehouse-style “eat what you kill” revenue-based compensation, that simultaneously destroys value for the business owner and disincentivizes the next generation of owners from wanting to be successors in the first place. Instead, Grau suggests that firms need to shift from compensation based on top-line revenue to a greater focus on compensation built around bottom-line profits, that can ultimately help to both focus the business on maximizing its value, and truly incentivize the next generation of advisor owners to want to step up, buy in, and contribute towards – and be rewarded for – enhancing that long-term value.

Weekend Reading for Financial Planners (Sep 13-14)

September 12, 2014 02:57 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with a call for better regulation of financial planning as a distinct calling unto itself, recognizing that in Massachusetts it's harder to get a license to be a cosmetologist than it is to become a financial planner! There's also an article discussing the recent rumored-to-be-on-a-fast-track NASAA regulatory proposal (now in comment period) that may require state-registered RIAs to adopt more substantive business continuity and succession plans for the protection of their clients.

From there, we have a few interesting new studies and articles on the so-called "robo-advisor" trend, including a Gallup poll that finds investors still prefer dedicated human advisors to financial website solutions by a 2:1 margin (and more affluent individuals favor the human solutions even more), a Spectrem Group study that finds for consumers who do plan to work in an online environment that the robo-advisors may actually be slightly preferable to human advisors engaged virtually (though there may be enough interest for both to succeed), and an interesting discussion from Mark Hurley about how ultimately the technology-will-replace-advisors threat isn't really any more dangerous today than it was in 1999 (when similar comments were made) and that ultimately much of the technology that backs today's robo-advisors will likely end out being used by the rest of the financial services industry (rather than continue to compete with it).

We also have several investment articles this week, including: a look at how some advisors are starting to adopt small allocations of Bitcoin into client portfolios; how Bitcoin does not really function (yet?) as a true currency but as a non-liquid investment asset may still improve risk-adjusted returns for portfolios (at least based on the historical track record for the virtual currency, which may or may not persist in the future); a fascinating look from Howard Marks of Oaktree at how true risk is more about the possibility of permanent loss of capital than about volatility, but that the truer measure of risk is also surprisingly difficult to quantify and apply effectively; and a discussion from Jason Zweig of the Wall Street Journal at the behavioral finance phenomenon of "shared attention" and the fact that who you choose to listen to and follow and get your information from can have a surprisingly powerful effect (good or bad) on your (investment) results.

We wrap up with three interesting articles: the first looks at how the only real way to stay competitive in today's environment is to be a continual learner, or else face stagnation and boredom that can undermine yourself and your company; the second discusses the five essential skills that planners must learn (as distinguished from the technical knowledge we must have to be competent) if we truly want clients to implement our financial advice (hint: it's all about the key skills that create true rapport and trust); and the last is a piece by industry commentator Bob Veres that takes an interesting look at the current regulatory environment and suggests that the real problem is not that we need to apply a new fiduciary standard to brokers but simply that the SEC has allowed the brokerage industry to drift too far from where it once was and should just do a better job enforcing the rules that were originally written which require a clear(er) separation of brokerage firms and investment/financial advice in the first place. Enjoy the reading!

Why Individuals Should File And Suspend Their Social Security Benefits – Reinstatement Of Voluntary Suspension Versus Retroactive Benefits

September 10, 2014 07:01 am 22 Comments CATEGORY: Retirement Planning

The Social Security file-and-suspend strategy has been used primarily for couples to coordinate the delay of individual retirement benefits (earning delayed retirement credits) while making a spouse eligible to begin his/her spousal benefits. It can also be used as a partial form of "undo" for a retiree who started benefits early, and later wishes to suspend them (at full retirement age) to earn delayed retirement credits (a benefits increase that can partially or fully offset the decrease triggered by electing benefits early in the first place).

However, the strategy to file and suspend can also be used as a proactive planning strategy for individuals, because it creates an opportunity for the retiree to subsequently "undo" the decision to delay and "retroactively" claim benefits back to the date they chose to file and suspend (e.g., full retirement age). Thus, for someone who is approaching age 66 and isn't certain about whether it's a good idea to delay or not, choosing to file and suspend allows them to wait until age 70 to make the final decision, enjoying the benefits of the delay if it still makes sense to do so, but having the opportunity to go back and claim benefits at 66 if there's a change in health or circumstances.

The key distinction is that while the standard Social Security rules only allow an individual to file for up to 6 months' worth of retroactive benefits, the file-and-suspend rules allow for a "reinstatement of voluntarily suspended benefits" that can undo the suspension going back anytime during the suspension period. Thus, choosing to file and suspend can effectively replace the normal 6-month retroactive benefits rules with a more favorable set of reinstatement rules, that at worst will simply leave the individual delaying until age 70 as was planned in the first place, but with the flexibility to change their mind for a few years along the way!

Financial Advisor’s Guide To New SEC Money Market Fund (MMF) Rules And Their Fiduciary Implications

September 9, 2014 07:01 am 1 Comment CATEGORY: Investments

This summer the SEC finally issued its long-awaited new Money Market Fund (MMF) rules, with the hopes of avoiding a future run on money markets similar to what happened during the 2008 financial crisis when the Reserve Primary (money market) fund "broke the buck" due to its holdings in short-term Lehman bonds and the Treasury and Federal Reserve had to intervene in the MMF marketplace to stem the panic by providing a series of temporary guarantee programs to protect shareholders.

After applying some modest initial reforms in 2010, and considering a wide range of potentially more significant money market reforms going forward - from floating NAVs to allowing for redemption fees and gates during times of crisis - the SEC has ultimately adopted a combination approach. As Duane Thompson explains in this guest post, the new rules from the SEC will provide for floating NAVs for institutional money market funds, redemption fees (up to 2%!) and gates (limiting investor liquidations) for retail and institutional funds that can be imposed by fund boards during times of financial stress, and reduced limitations for money market funds that invest purely in government bond holdings (so-called "government money market funds") due to their reduced riskiness (though governmental MMF boards can still potentially apply redemption fees and gates if necessary). Fortunately, the new rules also require money market funds to hold greater liquidity buffers (reducing the risk of problems in the first place), and dramatically reduce the permitted use of derivatives in many types of MMFs.

Nonetheless, the end result of these reforms may potentially be a significant shift into government money market funds to avoid these potential limitations, and while consumers and institutions may ultimately still prefer what will likely be the slightly higher yields of non-government money market funds, the decision to use them - and face the floating NAVs, or redemption fees and gates that may apply - will have significant implications regarding money market fund due diligence obligations for advisors. In fact, greater money market fund reporting requirements may leave advisors with little excuse for not having done effective money market fund due diligence in the future!

Introducing The Newest Fiduciary Standard For (Most CPA) Financial Planners

September 8, 2014 07:01 am 10 Comments CATEGORY: Planning Profession

After a nearly year-long drafted and public comment period, the Executive Committee of the AICPA’s Personal Financial Planning section adopted its “Statement on Standards in Personal Financial Planning Services” (SSPFPS) on January 1^st of this year, with an effective date of July 1^st.

What’s notable about the new SSPFPS, though, is that it’s not merely intended as a best practices guide from the AICPA’s PFP section about how (CPA) financial planners should try to conduct themselves. Because the PFP section’s Executive Committee has standard-setting authority under the AICPA, and most state boards of accountancy adopt AICPA standards as their own laws (and have in the case of SSPFPS), the effective result of the new rules is (in most if not all states) an enforceable set of professional standards under state law. And for financial planners who want to claim that they're subject to the "highest standards" regarding the services they provide to their clients, the AICPA's new SSPFPS may represent a new highest bar in the profession... at least in terms of enforceable standards.

The bottom line, though, is that while technically CPA financial planners have already been required to adhere to the AICPA’s Code of Professional Conduct - including as it pertains to their financial planning services, which includes a fiduciary-like requirement to avoid conflicts of interest that impair objectivity, disclose potential conflicts of interest that do not impair objectivity, and always act in the best interests of their clients - the new SSPFPS provide significantly more in-depth guidance about how to conduct themselves appropriately, and in a manner that could potentially be enforced in a court of law! Which means that while the rules ultimately apply only to those subject to the SSPFPS in the first place (including both CPAs who work in a state where the state board of accountancy has adopted the standards, and even non-CPAs who are members of the AICPA and deliver personal financial planning), they nonetheless may represent the broadest and most enforceable fiduciary professional standard yet to financial planners - not just regarding investment activities but all financial planning duties - and a powerful potential precedent in the future regulation of financial planners.

Weekend Reading for Financial Planners (Sep 6-7)

September 5, 2014 12:03 pm 2 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the announcement of a series of events by the Institute for the Fiduciary Standard and TD Ameritrade to celebrate (and build awareness for) "Fiduciary September" this month, along with news of the latest in the Camarda vs CFP Board case (including a much-discussed request by the CFP Board for the Camardas' entire client list even though they have not been accused of client mistreatment), and a study from Pershing suggesting that the "fee only" label may not have as much cache as believed and for consumers is analogous to just saying "no commission" instead.

From there, we have a few retirement-related articles this week, including the latest from Wade Pfau and David Blanchett about the use of Monte Carlo analysis and the relevance (or not) of the 4% rule in today's environment, a review of some of the proposals to "fix" Social Security and how it might change in the next 20 years (when the trust fund is scheduled to run out and force at least some change), and a look at how researchers are suggesting that the ideal retirement vehicle of the future really might be a variable annuity (albeit not quite the types available in the marketplace today).

We also have a few practice management and marketing articles, from a look at how the evolution of Google's search algorithms are favoring specialists over generalists in search results, to ways you can actually try to become a "thought leader" (and not just abuse the increasingly overused term) to enhance your firm's appeal to prospective clients and potential referrers, and some marketing tips for those who are specifically trying to reach a younger Gen Y clientele (for whom many "traditional" marketing methods don't necessarily work).

We wrap up with three interesting articles: the first takes a harsh look at what it really means to be client-centric, suggesting that most advisory firms can't possibly be truly client-centric because they're trying too hard to be everything to everyone (which means they can't really center their focus on any particular type of client); the second suggests that financial services firms and software vendors need to stop focusing on individual client products/accounts and come up with a "household" identifier to make it easier to understand and group a client household's entire balance sheet and cash flow activity; and the last is a look from Bob Veres at the ways that advisors are trying to differentiate themselves in an environment where it seems increasingly difficult for many 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 a look at the changing landscape of technology from the major RIA custodians and tips to stay safe online after this week's "Celebgate" hack of private photos! Enjoy the reading!

Separating Risk Tolerance From Risk Capacity – Just Because You Can Afford To Take Risk Doesn’t Mean You Should

September 3, 2014 07:01 am 19 Comments CATEGORY: General Planning

The traditional approach to evaluating risk tolerance - which has been enshrined into our standard regulatory process for determining the "suitability" of a recommendation - involves gauging a client's attitudes about risk, their financial capabilities to take risk (e.g., time horizon, need for income, and availability of other assets), and mixing them together into a composite score that can be assigned to a portfolio. A strong attitude and financial ability to take risk gets a high score and an aggressive portfolio, a poor attitude for risk and significant portfolio needs result in a conservative portfolio, and a mixture of the result leads to a moderate growth portfolio in the middle.

Yet the fundamental problem with this traditional approach is that it confuses someone's capacity to take risk with their actual need or desire to do so. The end result is that wealthy clients who don't want or need risk end out being given moderate growth portfolios anyway, young clients who have a long time horizon but no desire for risk end out with equity-centric portfolios that may scar them for life, and clients who have unrealistic spending goals end out with impossibly conservative portfolios doomed to fail.

The solution to this challenge is a fundamental change to how we view risk tolerance and financial risk capacity in the first place. The optimal portfolio solution is not a combination of risk tolerance and risk capacity; it's the portfolio that can best achieve the client's goals, constrained by risk tolerance to ensure that neither the portfolio, nor the goal, exceeds the client's tolerance in the first place. In other words, it's absolutely crucial to separate out our evaluation of whether someone needs risk, whether they can afford risk, and whether they want to take risk, so that the ultimate portfolio recommendation can properly align all three.

Filling The Income Gap When Starting A New Financial Planning Firm

September 1, 2014 07:01 am 46 Comments CATEGORY: Practice Management

Launching a financial planning firm is difficult. Not merely because of the cost and complexities of founding the business, and the challenge of getting new clients, but the opportunity cost of foregone income when you’re trying to build a practice and don’t have enough clients to be sustainable yet. In fact, for most advisors the “income gap” from when a practice is launched until it pays a livable wage can be many times the pure startup costs alone!

In the past, financial planners often bridged the gap by selling financial services products and taking the significant upfront commissions to round out their income in the early years. Yet in today’s environment, and especially in an advice-centric business, selling products for large commissions simply isn’t feasible or desirable… yet the lack of commissions and rising focus on fee-only firms ironically makes it even harder to bridge the gap successfully!

Fortunately, there are solutions, from doing hourly planning and offering standalone financial plans, to actually providing a limited amount of commission-based insurance solutions that clients actually need (and would have to pay for anyway), to easing into a practice by getting a job as an associate planner first or even getting a “side gig” to help make ends meet in the meantime. While these income gap fillers won’t necessarily fully resolve the issue – especially since the greatest challenge may simply be finding and getting clients in the first place – they can go a long way to at least partially bridging the gap and making it easier to survive the launch of a new firm!