Nerd's Eye View blog

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!

Weekend Reading for Financial Planners (August 30-31)

August 29, 2014 02:22 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with an interesting lawsuit that has been filed by "whistleblower" David Danon against Vanguard, suggesting that it is abusing its unique corporate structure to avoid any Federal and state income taxes that should be paid (to the tune of $1B of foregone Federal taxes in the past decade), in addition to implicitly giving it an unfair competitive advantage as a result.

From there, we have a few investment-related articles this week, including a discussion of whether the era of the stockpicker may be definitively coming to an end as Vanguard approaches $3 trillion of AUM and the expansive march of investment tools and technology makes "everyone" such a capable investor that there's not enough alpha left to go around, the emerging price war between established financial services companies (and financial advisors) and technology companies (e.g., robo-advisors) who are driving down the cost of a pure passive strategic portfolio that is regularly rebalanced, and a fascinating article finding that low-cost active managers really may be providing value (including Vanguard's own active funds) and that the real issue is not about active vs passive but simply high-cost versus low-cost.

We also have several technical financial planning pieces, from a great discussion by David Blanchett and Wade Pfau about how most of the criticisms of Monte Carlo are not actually faults of Monte Carlo but simply flaws in how our typical Monte Carlo tools are designed and used (and could be solved with better software tools and assumptions), to a look at the re-emergence of "jumbo" reverse mortgage loans after "smaller" HECM reverse mortgages have dominated the landscape for 5 years (though the new loans may still be too expensive to be competitive). There's also a good summary of the recent Social Security Trustees' Report, highlighting that Social Security is not as bad off as most suggest!

There are a couple of practice management articles as well, including how advisors can take advantage of the "small data" opportunities in their practices along with the "big data" solutions that are being built for them, some tips about processes/procedures to implement to avoid HR headaches as an advisory firm owner, and a nice guide on how to onboard a new employee in an advisory board.

We wrap up with three interesting articles: the first looks at whether the financial services industry needs to get better about communicating more visually and putting some "glamour" into solutions (without being abusive); the second is written by a so-called "0.01%er" about the problems with income inequality and making an interesting case for why a significant increase in the minimum wage could be good for both the middle class and capitalism; and the last paints a sad but disturbingly accurate picture of just how "strange" the financial services industry really is, in a country where doctors must attend medical school and lawyers must pass the bar - and even becoming a taxi driver in London requires passing a test that can take years of practice - but in financial services, "managing money requires little more than a desire to manage money" (and a very rudimentary licensing test)!

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including big changes for online data storage for users of Dropbox and a look at whether the latest Google Apps are making Microsoft Office less necessary than ever! Enjoy the reading!

Why Social Security Dependent Benefits For A Child Can Make It A Good Deal To Start Early And NOT Delay

August 27, 2014 07:01 am 65 Comments CATEGORY: Retirement Planning

For prospective and current retirees who are concerned that "unexpected" or extreme longevity may lead them to run out of money, there are few strategies more effective than the decision to delay Social Security benefits. The tradeoff - where payments are not received now, in exchange for higher payments in the future - is similar to buying an income annuity, or investing in a bond ladder that will begin liquidating in the future... except that the implicit "pricing" of the decision to delay Social Security is far better than any commercial annuity or bond yields available today.

The caveat to the approach, however, is that Social Security dependent benefits may also be available for those in their 60s who still have young children in the home - an increasingly common situation, between couples who start a family later and the rising divorce rate that has also led to a greater frequency of second marriages with young children. And the availability of dependent's benefits can significant diminish the benefit of delaying Social Security; while delaying does increase the individual's own benefits in the future, along with potential survivor benefits, waiting may also permanently forfeit children's benefits that won't be available down the road (as the children may be too old by the time the retiree reaches age 70).

In light of this situation, planning for Social Security benefits with "young" children in the home (those under age 18) needs to be done more carefully. In some situations, the children may be so close to 18 that it's still worthwhile to delay. In other scenarios, the opportunity to file-and-suspend at age 66 - starting both spousal benefits and activating dependent benefits as well - may be the best way to go. But in many situations, the potential dependent and spouse's benefits are so large - even with the "maximum family benefit" limitations - that the best strategy, even in the long run, is to start benefits as early as possible (especially if the Earnings Test will not apply!).

Why Spend Money On Marketing When You Can Get Paid To Market Your Advisory Firm?

August 25, 2014 07:01 am 4 Comments CATEGORY: Practice Management

Traditional marketing like advertising can be expensive – so expensive, that few advisors ever engage in such tactics, relying instead on less expensive marketing approaches like generating referrals from existing clients and centers of influence, or focusing on a niche where the advisor can build a brand and demonstrate expertise that attracts niche clients to them through an inbound marketing strategy.

Another alternative, though, is to deliberately craft a limited scope solution for clients, valuable enough that clients will pay for it, while giving the advisor the chance to demonstrate their expertise and begin to establish a relationship. For instance, offer clients the opportunity to get a customized, individualized Social Security analysis to help facilitate their Social Security timing decision for a flat $200… and then offer clients who find the meeting valuable the opportunity to work with the advisor on an ongoing, comprehensive basis, at the advisor’s usual “full solution” cost.

The end point of such an approach is that many “clients” will just pay for the lower tier service and stop before becoming top tier clients, only while a few will choose to pay for the advisor’s full comprehensive solution. However, in an environment where advisors already do “approach talks” and “introductory meetings” with prospective clients – for free, and while trying to avoid giving any “real value” for fear of giving away too much of what clients are supposed to pay for – arguably the tactic of simply trying to deliver value and real solutions from the start can be equally or more effective in demonstrating expertise and establishing a relationship… except now, the advisor is actually getting paid to market themselves!

Weekend Reading for Financial Planners (August 23-24)

August 22, 2014 02:55 pm 3 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the interesting announcement that TD Ameritrade has launched a program that will refund advisory fees for clients in their Amerivest managed account if their portfolio is down for two consecutive quarters, following on a similar "accountability guarantee" program launched by Schwab late last year, and raising the question of whether such fee rebates may be an emerging trend and/or competitive threat against advisors or just a lightweight marketing promise that few clients will actually ever exercise.

From there, we have several practice management articles this week, including: tips and techniques for better growing referrals from Centers of Influence (hint: make it about just serving current clients better first, and referrals second); why the industry needs to back off its urgent pleas to advisors about succession planning and recognize that it's simply not what most want to do; a look at the consequences of "dithering" about engaging in continuity planning as an advisor; and a review of two new designation programs recently launched to help advisors bone up on their Social Security planning techniques.

We also have several investment articles, from a Rob Arnott discussion about what "smart beta" should mean (and how to better distinguish the legitimate smart beta strategies), to a discussion from Robert Shiller about the sustained elevation of cyclically-adjusted P/E ratios over the past 20 years and whether it's a permanent or temporary phenomenon, to the recent announcement that Vanguard is now closing in on a whopping $3 trillion of AUM (and its Total Stock Market Index recently become the world's largest mutual fund as well). There's also an article about how "expensive" it actually is to pay insurance premiums on a monthly or quarterly basis rather than annually, with markups equivalent to APRs in the (sometimes high) double digits!

We wrap up with three interesting articles: the first looks at how many financial planners fail to engage prospective clients by appealing too much to their rational side alone and not recognizing that many buying decisions - including the selection of a financial advisor - has a significant emotional component; the second explores how a simple "client service calendar" can become a tool to help communicate an advisor's ongoing value to current (and even prospective) clients; and the last provides a nice reminder about all the ways that financial planners can add "alpha" to a client's life beyond just adding to portfolio returns.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including the explosive growth of Laser App which now has 115,000 advisors using 32,000 "paperless" online forms! Enjoy the reading!

Why A Roth Conversion May Be A Bad Idea Even If Taxes Are Higher In The Future

August 20, 2014 07:01 am 30 Comments CATEGORY: Taxes

With years of ongoing Federal budget deficits and a large and growing national debt, there is a common perception that "at some point" tax burdens must rise to address the issue. While the timing is not certain, the belief that higher tax rates may be inevitable has become a strong driver for many advisors and clients to do whatever they can to manage that future tax exposure. And one of the most popular strategies: take the tax exposure off the table altogether, by contributing to Roth accounts and doing Roth conversions, with the goal of paying taxes now when rates are lower and not in the future when they may be higher.

A closer look at paths to tax reform that can address Federal deficits though, reveal that while tax burdens in the aggregate may be higher in the future, marginal tax rates will not necessarily be higher. In fact, most tax reform proposals, from the bipartisan Simpson-Bowles to the recent proposals from Representative Camp, actually pair together a widening of the tax base and an elimination of many deductions with a lowering of the tax brackets! In addition, proposals to shore up Social Security and Medicare often involve simply raising the associated payroll taxes that currently fund them... tax increases that would result in a higher tax burden on workers, but no increase in the taxation of future IRA withdrawals. And the US remains one of the only countries that does not have a Value-Added Tax (VAT), which could also increase the national tax burden without raising marginal tax rates.

In the end, the simple reality is that there are many paths to higher tax burdens in the future that don't necessarily involve higher marginal tax rates on IRA withdrawals. Which means ultimately, advisors should be very cautious about doing Roth conversions - especially conversions at rates that are 33% or higher - and the best possible thing to do with a pre-tax IRA may simply be to continue to hold it, and wait for tax burdens to increase... because when paired with a compression of tax brackets that leads to lower marginal tax rates, not converting to a Roth could actually be one of the best long-run tax savings strategies around!

Is GIPS Compliant Performance Reporting Becoming A New RIA Differentiator?

August 18, 2014 07:01 am 8 Comments CATEGORY: Practice Management

Historically, financial advisors that help clients with their investment decisions have attempted to differentiate themselves by everything from the merits of the products they offer and the companies they represent, to their expertise and experience, to the personal financial advice they can deliver outside of the portfolio. Yet despite how standard it is in the institutional world, surprisingly few RIAs that work with consumers actually aim to differentiate with their actual performance results and track record... due in no small part to the difficulties in standardizing the process of reporting results on a wide range of clients with different needs, different goals, and different timing of when they became a client.

To create some consistency in performance reporting, the CFA Institute has helped to establish Global Investment Performance Standards (GIPS). While the process has primarily been adopted by institutional advisors so far, it appears some RIAs are deciding that in an era of increasing competition, actually being willing to stand by a performance track record and be accountable for it can be an effective differentiator - especially in a world where standardization of investment process and technology to implement model portfolios consistently for clients really does make it feasible to do so.

Ultimately, it remains to be seen how widespread the trend of RIAs adopting GIPS compliant reporting will become, especially since the costs are not trivial - in terms of both staff time, necessary technology infrastructure, along with consulting and even third-party verification. But arguably it doesn't take a lot of advisors choosing to do so before the pressure is on everyone else to go through with it as well; few advisors will want to be in a competitive position for a client as "the only one" who isn't willing to share their performance track record, where a lack of transparency and unwillingness to be accountable for results can easily be interpreted as hiding poor performance. On the other hand, the reality is that some advisors may find that once a consistent performance reporting standard is applied by following the GIPS compliance rules, their results really aren't competitive... which itself may be an interesting force that impacts the industry in the coming years as well!