Nerd's Eye View blog

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!

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!).