Nerd's Eye View blog

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!

Weekend Reading for Financial Planners (Aug 16-17)

August 15, 2014 01:25 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition starts out with some new research from the CFP Board about why it is that so many students who go through financial planning programs don't sit for the CFP exam... and find that the sheer cost of both the exam itself (at $595) and the typical exam review class along with it, may be a key impediment, especially given that so many young planners still have limited income and may be digging out from their student loans; students who ended out at firms that paid for the test on their behalf were significantly more likely to follow through on the exam and become CFP certificants.

From there, we have a few practice management articles this week, including: an overview of the latest results from the FA Insight practice management study showing that advisory firms are enjoying record productivity and profit margins but may be too complacent about future growth challenges; a good overview of the challenges to consider for advisors who are thinking about "breaking away" from a broker-dealer (considering everything from needing access to capital, to complying with the Broker Protocol); and a good overview about how to get started in building a social media following once you've set up your initial accounts.

We also have several investment research articles this week, from a look at the value of continuous tax loss harvesting (which may be far less valuable than commonly believed, over just executing loss harvesting transactions once a year when rebalancing), to a discussion from Vanguard about whether indexing is getting "too big", and a look from Morningstar's fund flows finding that actively managed funds are only seeing inflows in a few specialized areas (international funds, allocation and target-date funds, and alternatives) with 2/3rds of all net flows going to index funds.

There's a trio of retirement-related articles too, including the upcoming launch of a big Federal government program to encourage phased retirement (which could become a template for the private sector as well), some tips for advising clients on Medicare decisions, and a good discussion by retirement researcher Wade Pfau about the circumstances in which the "4% rule" may be too high, or too low.

We wrap up with three interesting articles: the first raises the question of what it means to fulfill an investment adviser's fiduciary duty when there is no human advisor relationship and the portfolio is implemented by a "robo-advisor"; the second looks at the various threats that have been a danger to advisors over the decades (including most recently, the robo-advisors) and concludes that the natural outcome of these threats is not the 'death' of advisors but their forced evolution to continue higher up the value chain; and the last is an in-depth article looking at the severe racial diversity problem in the world of financial planning, and some of the efforts that are slowly getting underway to try to tackle the issue.

Enjoy the reading!

Accelerating The Rising Equity Glidepath, With Treasury Bills As Portfolio Ballast?

August 13, 2014 07:01 am 23 Comments CATEGORY: Retirement Planning

Conventional wisdom suggests that retirees should own a “moderate” amount of equity exposure at the time of retirement – to help their portfolio grow and keep up with inflation for a long time horizon – and then slowly decrease their exposure to equities over time as they age and their time horizon shrinks. However, recent research has suggested that the optimal approach might actually be the opposite, to start with less equity exposure early in retirement when the portfolio is largest and most exposed to a significant market decline, and then “glide” the equity exposure slightly higher each year throughout retirement.

As it turns out, though, a better approach may be to accelerate that rising equity glidepath a bit further; after all, the last bit of equity increase in the last year of retirement isn’t really likely to matter. Instead, the better rising equity glidepath approach is to just increase equities in the first half of retirement until it reaches the target threshold, and then level off. For instance, instead of gliding from 30% to 60% in equities over 30 years, glide up to 60% over 15 years and then maintain that 60% equity exposure for the rest of retirement (assuming it’s consistent with client risk tolerance in the first place).

Notably, accelerating the glidepath also reduces the amount of time that the portfolio is “bond-heavy” – a particular concern for many in today’s low-interest-rate environment. In the end, though, it may be even more effective to simply take interest rate risk off the table by owning short-term bonds instead; while such an approach leads to less wealth “on average”, in low-return environments rising equity glidepaths using stocks and Treasury Bills can actually be superior to traditional portfolios using stocks and (longer duration, e.g., 10-year Treasury) bonds, even though Treasury Bills provide lower yields!

Financial Planning and Building An Advisory Firm With An Abundance vs Scarcity Mindset

August 11, 2014 07:01 am 20 Comments CATEGORY: Practice Management

For some clients, the focus of financial planning is just about protecting the limited resources they’ve got. For others, it’s about maximizing the potential of what their financial resources and their lives can become. The mindset of clients as they approach the world can have a significant impact their behavior.

Yet this mindset of abundance versus scarcity is not unique to clients; in fact, as financial planners our view about the world also shapes our behaviors. For instance, some become active as volunteers in the industry to get involved, give back, and even network for referrals, while others see little purpose in getting involved in a professional association with “the competition” – even though the reality is there are still more than enough clients out there for everyone.

The challenge is that, just as with clients, an excessive fear of scarcity – whether its assets and financial resources, or potential clients for the advisory firm to grow – can actually lead to outcomes that result in scarcity. Extremely conservative investment clients can actually find that inflation undermines their own financial goals, and advisors who are so fearful that there are too few clients can end out wasting time trying to convince mismatched prospects to work with them (even though it won’t be a good fit in the end). So what’s your mindset, and how does it shape your (business) behavior?

Weekend Reading for Financial Planners (August 9-10)

August 8, 2014 02:24 pm 4 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the upcoming "Fiduciary September" events being facilitated by the Institute for the Fiduciary Standard, as both the SEC and the Department of Labor continue their fiduciary rulemaking considerations. Also this week was the CFP Board's Program Directors conference, which highlights the latest successes (registered programs are up 13% in the past 4 years, with bachelor's programs up 40%) and also the ongoing challenges (schools are still struggling with improving student enrollment, retention through the program, and follow-thru to taking the exam); the CFP Board is exploring new initiatives to try to support programs and shore up these shortfalls.

From there, we have a few retirement articles this week, including the latest research from Morningstar's David Blanchett on weighing immediate annuities against the new breed of longevity annuities, a discussion of an emerging trend for states to consider launching automatic-enrollment IRAs after Federal legislation continues to stall, and a deep look at the various enrollment periods that must be considered for clients who are either enrollment in Medicare now or plan to delay but want to enroll in the future without incurring a financial penalty.

We also have several practice management articles, from a look at a new bank that is lending to advisors to facilitate acquisitions and internal succession plans (to the tune of $100M in loans in just the past 18 months!), to some tips for associate advisors who feel like they've hit a wall and can't figure out how to advance themselves to a lead advisor position, to how our psychological tendency to want to reciprocate and repay debts can be used to grow a business. There's also an article on the crucial importance for advisors to have not just a succession plan for the long run, but a continuity plan in the short run, to avoid leaving clients in the lurch if there is an unexpected health event - told from the perspective of Dan Candura, a financial planner who recently found out at age 64 that he has inoperable prostate cancer and had no continuity plan in place.

We wrap up with three interesting articles: the first is a discussion from advisor tech guru Joel Bruckenstein about the challenges in the advisor tech industry that "keep him up at night", including complacent advisors underinvesting in technology and vendors that are still doing a poor job at integration amidst a lack of industry data standards; the second is a look from the Wall Street Journal at an increasing number of advisors who charge "termination fees", raising the question of whether such practices are appropriate, or even legal for fiduciary advisors that may be putting an undue burden on unhappy clients; and the last is from industry commentator Bob Veres, exploring how "unusual" advisory firms really are from most "normal" types of small businesses, and the unique challenges that advisors face in navigating and growing their businesses successfully.

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 offering from yet another robo-platform-for-human-advisors solution! Enjoy the reading!

Shiller CAPE Market Valuation: Terrible For Market Timing, But Valuable For Long-Term Retirement Planning

August 6, 2014 07:01 am 30 Comments CATEGORY: Investments

Despite the recent Nobel Prize given to its originator, the Shiller cyclically-adjusted P/E (or "CAPE") ratio continues to be controversial, driven in no small part by its current "reading" that markets are overvalued, yet they continue to climb higher and higher... a formula that has played out in the recent past as well, in both the mid-2000s and especially the late 1990s. Yet the poor recent predictive performance of Shiller CAPE shouldn't entirely be a surprise; it has never had a particularly high correlation to year-over-year market returns.

Nonetheless, the reality is that while Shiller CAPE has little predictive value in the short term, its correlation to market returns is far stronger over longer time periods; Shiller CAPE shows its strongest correlation to nominal returns over an 8-year time horizon, and is actually most predictive of real returns over an *18* year time horizon... supporting Benjamin Graham's old adage that the markets may be a voting machine in the short run, but they are ultimately a weighing machine in the long run as valuation eventually takes hold. On the other hand, over very long time horizons (e.g., 30 years) Shiller CAPE once again begins to lose its value as other longer-term structural market factors take hold.

The fact that Shiller CAPE is a strong predictor of market performance in the long run (but not the "ultra" long run, nor the short run) suggests that the valuation measure does have use, but only if applied in the correct contexts. For instance, while all this suggests that Shiller CAPE may be a poor market-timing investment indicator, clients who are retiring and exposed to "sequence-of-returns" risk over the first half of their retirement may benefit greatly by adjusting their initial spending levels in light of market valuation at the start of retirement. Similarly, those considering the benefits of delaying Social Security - or choosing to annuitize or claim pension payments over an equivalent lump sum - would do well to evaluate their decision in light of whether there is a market-valuation-based headwind or tailwind underway. Thus, even if Shiller CAPE is a poor market-timing indicator, that doesn't mean it's useless at all when it comes to retirement planning!

Building A Niche Advisory Business: It Takes 3 Years For People To Know, Like, And Trust

August 4, 2014 07:01 am 14 Comments CATEGORY: Practice Management

Starting a niche business can be very difficult. It’s hard to be a specialist for a particular type of clientele or need that they face from day 1; it takes time to learn the issues and the pain points, and acquire the knowledge and expertise. And even once you have the knowledge and expertise to provide the solutions, there’s still the simple challenge of actually finding clients to whom you can deliver those solutions! After all, it’s not enough to just know how to solve the problems of your target clientele; ultimately, people do business with people they know, like, and trust… which means even after getting the expertise, you still have to become known, liked, and trusted.

As a result, it takes time to build a niche business. In fact, having witnessed the process repeatedly, it appears that with remarkable consistency, the time it takes to become known, liked, and trusted is about 3 years. The bad news of this path is that it can feel painfully slow and even demotivating in the early years. Yet as reputation and trust builds, the end result is a business that builds not just linearly year by year, but expotentially as the years pass and the niche develops. Because while it takes time to become known, liked, and trusted within a niche, once you are the "go-to" person for your target clientele, the pace of incoming referrals can be tremendous!

Accordingly, perhaps the most important "tip" for building a successful niche practice is simply to recognize that it takes time to build one, and have a plan for how to navigate that slow building process (from supplementing income to preparing yourself mentally for the time it will take before the real business rewards may come). Similarly, it's crucial to measure "the right things" in the early years - business activity, not business results - because of the time it takes to build trust. Nonetheless, for those who stay focused in a niche, and refine and evolve it over time, the long-run potential remains a business where growth eventually gets much easier over time!

Weekend Reading for Financial Planners (Aug 2-3)

August 1, 2014 02:31 pm 8 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition starts out with reports emerging that Scottrade Advisor Services appears to be strategically shifting away from its position as one of the more startup-friendly custodians, imposing a new asset minimum of $7M, or a potential $12,000 custodial fee for advisors who don't meet the minimum; dozens of advisors who don't meet the minimum are now shifting away to the leading startup-friendly alternatives, SSG and TradePMR instead. In a related story, the latest data on RIAs suggests that notwithstanding industry consolidation and the push towards larger advisory firms, there is still a lot of growth with new RIAs being formed every year (though a significant number of other firms appear to be closing their doors at the same time, leading to a smaller level of net growth in RIAs).

From there, we have several articles on practice management and advisor technology this week, including: how advisory firms need to shift away from revenue-sharing-based compensation to build enduring businesses; a look at some less expensive rebalancing software tools for advisors including RedBlack, Trade Warrior, and TRX; the re-emergence of consumer-targeted BloombergBlack as an advisor-targeted account aggregation and analysis/reporting platform called CircleBlack; and a look at the ongoing aggravation many advisors still face with account aggregation tools, and a new entrant (Quovo) that's attempting to solve the issues.

We also have a few more technical financial planning articles, from an analysis via Morningstar that finds tactically-based target-date funds are outperforming purely strategic TDFs, to a discussion of the various options for long-term care insurance (and alternatives to "traditional" coverage), and a look at how the line-of-credit borrowing limits are determined for clients who want to obtain a standby reverse mortgage to support their retirement income needs.

We wrap up with three interesting articles: the first gives a credit list of important lessons from the research in social psychology, some of which have significant implications for us as financial planners and how we build a business; the second is a fascinating look at how the pricing of your services dramatically impacts the long-term growth of the business, when you take into account the potential of reinvesting profits back into the business to get new clients in the future and how it compounds over time; and the last reports on a recent research study finding that financial knowledge/acumen is a poor predictor of making good financial decisions, and that the better predictor is whether the individual tends to focus more on the past, present, or future... and notably, the best results are not from those who focus on the future, but those who focus on the past!

Enjoy the reading!

How To Evaluate Your Current And Future Marginal Tax Rate

July 30, 2014 07:01 am 4 Comments CATEGORY: Taxes

Proper tax planning for clients relies on understanding what the tax consequences will be for various tax strategies - in other words, what tax rate, at the margin, will apply to the next dollar of income or deductions. Whether it's taking advantage of charitable deductions, calculating the true after-tax cost of tax-deductible interest, of evaluating the consequences of a Roth conversion, it's crucial to know how the client's tax liability would be impacted, on top of the existing "base" income that already exists, if the planning strategy is implemented.

However, for tax strategies that shift the timing of income - most notably, decisions like to whether to a traditional or Roth retirement account (or whether to convert from traditional to Roth) - it's important to evaluate not only the current marginal tax rate, but also the one that will apply in the future. After all, if the reality is that a Roth conversion accelerates income from future (tax rates) to the present day (tax rates), it's crucial to know whether today's tax rates are actually likely to be lower - or higher - than they would have been down the road!

While the conceptual process for determining a marginal tax rate is fairly straightforward - the tax rate that will apply at the margin after accounting for the underlying base income - the situation is much more complex in light of the various factors that impact marginal tax rates beyond just the client's tax bracket itself. The situation is further complicated by how inflation will change tax brackets in the future, and compounding growth can change the income and wealth picture as well. Nonetheless, it remains crucial to make reasonable estimates of how a client's tax situation will change over time, or it's impossible to make good tax planning decisions!

CFP Board’s Flawed Fee-Only Compensation Definition Creates Another Three Bucket Mess

July 28, 2014 07:01 am 17 Comments CATEGORY: Planning Profession

After almost a year of often-public discussions, the CFP Board recently delivered its decision to financial planner Rick Kahler that, because he owns a (commission-based) real estate brokerage firm to which his financial planning clients are sometimes referred, he will no longer be permitted to label himself as "fee-only" and must describe his compensation as "commission and fee" instead, in light of the commission-based related party. In response, Kahler has declared that he will likely drop his CFP certification (after being the first in South Dakota to earn the CFP certification over 30 years ago), and may even file a lawsuit with the CFP Board over the issue, after failing to find any other remedy to the situation in more than 10 months of talks with CFP Board staffers.

In point of fact, though, the CFP Board's "related party" rules were arguably designed to catch situations precisely like Kahler's - the whole point of the rule is that a planning firm cannot make itself "fee-only" by simply splitting off its commission-based work into a separate business still owned by the CFP certificant. To allow such behavior would render compensation disclosure meaningless, as all advisors could be both "fee-only" AND "commission-only" by just hanging two shingles! As a result, it appears that this time the CFP Board may have really gotten its ruling right in this case.

However, the reality that the CFP Board could not come to an amicable resolution with Kahler about how to unwind the situation highlights what is still the CFP Board's fundamentally flawed interpretation of its own compensation disclosure rules. Kahler offered to cease providing referrals to the real estate firm, or even to outright bar any of his financial planning clients from doing business with the real estate firm, yet the CFP Board still insists that the mere fact that he owns the private-held firm "taints" his fee-only status, and that even if Kahler can prove that 100% of his clients pay only 100% fees from this day forward, forever, Kahler is still required to "disclose" client commissions that wouldn't actually exist or face potential sanction.

Instead, the CFP Board insists that the only solution is for Kahler to divest himself of his non-majority stake in a family firm he has owned for over 40 years, for what would surely be a significant personal financial loss to Kahler in trying to sell an illiquid closely-held business. But should the CFP Board really be allowed to dictate to fee-only CFP certificants what are and are not "permissible" investments to own for personal investment purposes apart from their financial planning clients? Ultimately, Kahler's dilemma about how to come back into compliance with the fee-only rules - and his inability to do so without divesting himself of a family business that he is willing to legitimately run separate from his financial planning clients - emphasizes the continued absurdity of how the CFP Board is interpreting its own three bucket doctrine for determining compensation to disclose.