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Weekend Reading for Financial Planners (August 4-5)

August 3, 2018 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 the big news that Fidelity has launched an entirely free index mutual fund, with an outright expense ratio of 0.0%, in what financially is only a modest decrease in cost from the near-zero expense ratios of many index funds already, but represents a major shift in the industry as asset managers officially begin to focus on generating revenue beyond "just" their investment products alone. Also in the news this week was an announcement that the Trump administration is considering a proposal that would index cost basis to inflation over time, effectively applying capital gains on only "real" gains (above inflation), in what would potentially be a game-changer for the relative value of taxable accounts over tax-preferenced retirement accounts (that would have no such basis adjustment).

Also in the news this week were a number of major industry announcements, including that the CFP Board will be launching a series of public forums over the next 18 months to train CFP professionals on the new Standards of Conduct (and gather feedback on where the Standards Resource Commission should issue additional guidance), the Financial Planning Association announces a newly updated "Primary Aim" for the organization with an increased focus on advocacy for the profession, and the latest FA Insight study shows that advisory firms continue to enjoy strong growth in the midst of an ongoing bull market but that profit margins continue to decline (now to an average of just 20%) as pressure rises on firms to reinvest in their value proposition to justify their fees (which are now also beginning to show signs of competition and compression).

From there, we have a number of regulatory articles, including a surprising SEC action against Schwab Advisor Services that may put newfound pressure on RIA custodians to have a more active role policing the RIAs that use their services (particularly with respect to anti-money laundering regulations), some new guidance from the SEC on what constitutes 'inadvertent' custody for which the RIA will not be punished for failing to adhere to the Custody Rule, legal risks to consider for advisors who are publishing content (e.g., blogs or newsletters) and don't want to get in trouble for plagiarism or copyright violations, and a look at just how far the CFP Board's fiduciary regulations have come in the past 11 years (and where they may go from here).

We wrap up with three interesting articles, all around the role and value of financial advisors in the eyes of consumers: the first is a fascinating look at what leads consumers to switch financial advisors, finding that changes in personal or financial circumstances (from divorce or marriage to significant increases in income or net worth) are most likely to cause a consumer to switch advisors (despite the fact those are often the "money in motion" triggers that cause clients to become more profitable for their existing advisor!); the second looks at how financial planning as a profession has evolved over the past 45 years since the first class of CFP certificants in 1973; and the last looks at new research on the value of financial designations themselves, finding that consumers with higher incomes and investable assets really do tend to pay more to advisors who have such professional designations!

Enjoy the "light" reading!

Satisfying The CFP Board Experience Requirement As A Part-Time Career Changer

August 2, 2018 02:03 pm 0 Comments CATEGORY: Personal/Career Development

With the average age of a financial advisor estimated to be 50-something, a looming talent shortage has made it increasingly appealing to become a financial advisor… both as a prospective career for college students, and career-changers looking to switch into a more financially lucrative and psychologically rewarding career. The caveat, however, is that as CFP certification increasingly becomes the requisite pathway to a professional career as a financial planner, the CFP Board’s experience requirement is proving to be especially troublesome and challenging for career-changers who can’t necessary jump in with both feet at once and must make a more gradual transition.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss why the 3-year experience requirement is especially challenging for career-changers pursuing CFP certification, the ways that career-changers can satisfy their experience requirement, and the changes that the CFP Board itself should consider to be more accommodating to the realities of career-changers in the future.

Historically, most financial advisors started their careers as a 20-something that received training to sell their company’s products, and over time moved up into more comprehensive financial advice. The “good” news of this sales-centric pathway was that in the early years that are often lean, advisors were early in their own careers and usually didn’t have many family or income constraints. In other words, it was economically more practical to take the risk. By contrast, though, for those who are mid-career and want to transition into a full-time planning career, it might not be so financially feasible to make an abrupt change. Instead, career-changers more commonly make a gradual shift into the financial services industry, and may only devote a couple days each week to gaining the requisite experience. Yet unfortunately, in that scenario, it can take 5-10 years or more to fulfill the CFP Board’s three-year (6,000-hour) experience requirement, a few hours per week at a time. With the added complication that once a career-changer sits for the CFP exam, the experience doesn’t even count more than five years after passing the exam!

Fortunately, several years ago the CFP Board expanded the ways that the CFP experience requirement can be satisfied, allowing a wide range of “indirect support of financial planning” jobs to count, including working in employee benefits administration or even compliance. And while from the industry perspective, this is concerning – as it means people who have never actually advised anyone nor ever even sat across from a single client can still tick off the experience requirement – from the career-changer perspective, this becomes an especially appealing pathway to finish the CFP experience requirement in lieu of slowly “counting the hours” doing part-time work.

Accordingly, for career-changers who are struggling to fulfill their experience requirement, the best option is usually to look for opportunities in the industry to provide “indirect support” (rather than as a financial advisor salesperson out of the gate, which has a high risk of failure), as even if it’s a role in operations or project management, if it’s in an advisory firm (or the industry more broadly) it should still count. Alternatively, for those who do plan to – or need to – transition more slowly, be cognizant of when you’re going to take the CFP exam, given that you only have 5 years after you pass the exam to fulfill the experience requirement. And bear in mind it’s also possible to beef up your CFP experience hours by volunteering to do pro-bono financial planning work (including structured programs like the IRS’ Volunteer Income Tax Assistance (VITA) or Tax Counseling for the Elderly (TCE) programs, or by taking advantage of the FPA residency program to get 3 months of CFP experience in just one week!

In the meantime, hopefully the CFP Board itself will re-think how their policies adversely impact part-time career-changers, with an experience path that isn’t built for the financial realities of career changers who can’t necessarily take a full-time (often entry-level) job out of the gate. Especially since the reality is that even “full-time” financial advisor jobs from the start are often 80%+ prospecting and sales, and less than 20% financial planning anyway… which means part-time career-changers may still be getting just as much real financial planning experience as a new financial advisor trainee anyway!

The bottom line, though, is simply to recognize that there are pathways for career-changers to gain experience, but those who have the most financial flexibility to take potentially-lower-paying-jobs to accelerate their experience progress will have the most options. Which is appealing for those who are able to do so. And hopefully the CFP Board will consider expanding these pathways further over time, so the available career path options aren’t so limited for those who aren’t able to take a step back financially just to make the transition!

How Small Business Owners Overvalue 401(k) Plan Tax Deferral

August 1, 2018 07:46 am 0 Comments CATEGORY: Retirement Planning

Growth of 401k Plan - Gross & Net Value - Vs Contributing To Taxable Account Instead - Save Employee Contributions

The allure of starting a small business employer retirement plan is easy to understand. Not only can business owners provide a benefit to their employees by giving them a means to save for retirement in a tax-deferred account and by making contributions to those accounts, but a 401(k) plan with profit sharing also gives the employer (i.e., founders/owners) a way to save more for their own retirements on a tax-preferenced basis, reducing their tax exposure in the process. In fact, it’s not uncommon to see founders saving more in taxes than it “costs” them in employee contributions!

As compelling as that might seem however, the caveat is that the upfront tax savings of making 401(k) salary deferral and profit-sharing contributions for owners isn’t actually tax savings for them. Instead, it’s merely tax deferral, as those pre-tax contributions will eventually be taxable when distributed. Which is important, because the cash outlays made on behalf of the employees actually are a permanent expense that the owners will never be able to recapture!

The net result is that in the long run, it’s often financially better for business owners to skip the small business retirement plan – even with the tax savings – and simply pay their own taxes and save the net proceeds instead. The business owners may lose out on the upfront tax deduction on the contribution, but by avoiding employee contributions they otherwise didn’t need to make for compensation purposes, the net value is often still higher… especially for taxable accounts that are managed reasonable tax-efficiently to take advantage of the available 15% long-term capital gains and qualified dividend rates.

Of course, the less tax-efficient the investment account will otherwise be, and the higher the percentage of contributions that can be skewed to owners – especially by leveraging the rules permitting some disparity in contributions, such as age-weighted or cross-tested profit-sharing plans – the more compelling the 401(k) plan may become. Still, though, even situations where as much as 90% of all dollars accrue to the owners, who in turn are saving taxes at a 32% marginal tax rate, may still need as much as 20+ years to “recover” the hard cost of employee contributions with the long-term (and very slow) benefits of tax-deferred compounding growth. Which ironically means even salary-deferral-only plans that just require a safe harbor contribution to avoid running afoul of the ACP discrimination tests may still not actually be worthwhile in the long run, compared to just contributing to an IRA (and saving any excess in a normal taxable account).

For small business owners who need to compensate employees more in the form of retirement plan contributions, need to offer an employer retirement plan simply to compete for talent, and/or who may be able to recover most or all of the employee contributions by attaching a vesting schedule (knowing that employees are likely to turn over), the small business retirement plan may still be compelling or an outright necessity. Nonetheless, small business owners should be cautious to recognize that “just” saving on taxes in exchange for making employee contributions is not necessarily as appealing in the long run as it may appear at first… once the fact that 401(k) tax deductions are merely tax deferral, and not real tax savings, in the first place.

#FA Success Ep 083: Switching To The Right Independent Broker-Dealer By Understanding Its Profit Centers With Jon Henschen

July 31, 2018 07:03 am 0 Comments CATEGORY: Financial Advisor Success Podcast

Welcome back to the 83rd episode of the Financial Advisor Success podcast!

This week's guest is Jon Henschen. Jon is the president of Henschen & Associates, a recruiting firm that specializes in helping advisors find and match themselves to the right independent broker-dealer when making a switch to a new platform.

What's unique about Jon, though, is his willingness to be transparent in how broker-dealer recruiting really works in a segment of the industry that historically has thrived by keeping much of its compensation hidden with back-end commissions and markups.

In this episode, we talk in depth about the key factors to consider when evaluating a prospective independent broker-dealer. Why the ownership structure and whether the BD is publicly-owned or privately-owned and whether the private owner is an individual or a bank or an insurance company or a private equity firm is so important, the ways that certain broker-dealers specialize in certain types of reps, how forgivable loans work when advisors are recruited to a new independent broker-dealer, and the ways that broker-dealers have created profit centers above and beyond the payout grid, which is crucial for advisors to know so they don't unwittingly switch to a broker-dealer that may drive higher pass-through costs to their clients.

We also talk about how the independent broker-dealer recruiting model itself works. How recruiters are paid by broker-dealers to find new advisors to switch to them, what broker-dealers really spend upfront in order to attract advisors to make the switch, and how the dynamics differ when being recruited to a larger versus smaller independent broker-dealer.

And be certain to listen to the end, where Jon talks about the trends in independent broker-dealers that advisors should know when considering where to build their businesses in the long run. How the growth of the RIA channel and the fee-based business is impacting the broker-dealer model, and how different broker-dealers are taking very different positions on whether or how to support hybrid RIAs.

So whether you are interested in hearing about the various ways in which broker-dealers make money, how their recruiting process works, the most important things to consider when evaluating a prospective broker-dealer, or what changes may be coming down the pike for the industry in the coming years, then I hope you enjoy this episode of the Financial Advisor Success podcast!

Public Comment Letter on the SEC Advice Rule and Separating Advice from Sales

July 30, 2018 07:03 am 0 Comments CATEGORY: Regulation & Compliance

Earlier this year, the SEC proposed its own long-awaited overhaul of the regulation of broker-dealers and investment advisers. At the time, the Department of Labor’s fiduciary rule was still the law of the land, and the pressure was on the SEC to “harmonize” – both the SEC’s regulation with the DoL’s version, and to close what has long been perceived as a concerning gap in the standards of conduct that apply to the “suitable” advice delivered by brokers versus the “fiduciary” advice of (registered) investment advisers.

And while the DoL fiduciary rule has since been struck down, consideration of the SEC’s advice rule is still, thus far, proceeding as planned, with a controversial overhaul of the standards of conduct for broker-dealers that would require them to act in the “best interests” of their customers when making a recommendation (but not as a fiduciary at all times in their relationship with clients) under the new Regulation Best Interest, along with a new Form CRS (Customer/Client Relationship Summary) to better describe the nature of the broker or investment adviser’s relationship with the consumer, and a potential limitation on the use of the “financial advisor” title by at least the brokers at standalone broker-dealers who have no RIA affiliation.

Yet, while the SEC’s efforts to lift the standards of advice being delivered by brokers is laudable, arguably its effort to do so by applying Regulation Best Interest to the “pay as you go” episodic or transaction advice of brokers inappropriately redefines the Investment Advisers Act of 1940 itself… which knowingly subjected broker-dealers to a lower standard than that of investment advisers specifically because brokers are not supposed to be in the business of advice (ongoing or episodic) in the first place, and were only permitted to provide advice to the extent that advice was/is “solely incidental” to the sale of brokerage products and services. In other words, the problem is not that broker-dealers are giving advice without being subject to a fiduciary standard under FINRA regulation; the problem is that broker-dealers giving such advice are required to register as investment advisers, and if they did, they would already subject them to the fiduciary standard that applies to registered investment advisers, rendering the entire Regulation Best Interest proposal moot anyway!

In this context, it is especially concerning that the SEC’s proposals appear to undermine the clear choice between sales versus advice that Congress intended when establishing the ’40 Act in the first place. After all, it’s hard to imagine that consumers will understand the sales-versus-advice distinction when the proposed Form CRS disclosure states that consumers may receive advice from a broker on a transactional or episodic basis or from an investment adviser on an ongoing basis (when the SEC already requires advisors providing transactional or episodic advice in the form of hourly and project planning fees to become investment advisers anyway), and it is unclear how any consumer could understand their choices given the Form CRS disclosure that broker-dealers “must act in your best interest and not place our interests ahead of yours” while investment advisors “are held to a fiduciary standard” which the SEC defines as the obligation to “act in the best interest of the client” as well!

Similarly, while the SEC’s advice rule proposes to reduce consumer confusion by limiting the use of the “financial advisor” term by standalone broker-dealers and their registered representatives, it continues to allow hybrid advisors to use the label, knowing full well that at least a portion of the advisor’s services will not be in his/her capacity as an advisor but as a salesperson. In other words, advisors are explicitly being granted permission to market their services as “advice” and implement that advice without being subject to the appropriate standard for advice, without any requirement to explain to the consumer when the advice relationship ended. For which the SEC suggests consumers might be “confused” by a requirement that the advisor clearly disclosure and use proper labels for the “hat” being worn… instead of recognizing that the confusion stems from the nature of the dual-hatted advice-and-also-sales relationship in the first place, for which clear use of titles at all times alleviates the confusion!

The bottom line, though, is simply to recognize that the real problem in the marketplace for financial advice today isn’t that broker-dealers are giving advice without being subject to the fiduciary duty that has always been applied to advice relationships of trust and confidence, or that the application of a fiduciary duty to the broker-dealer model could limit choice (and thus why a lower Regulation Best Interest standard is needed instead). The real problem is that Congress articulated in the Investment Advisers Act of 1940 that consumers should have a choice – between brokerage sales and investment advice – which the SEC’s Regulation Best Interest proposal not only fails to honor, but risks undermining to the detriment of advisor competition in the marketplace and the elimination of clear choices for consumers.

In any event, though, whether you agree or disagree, the time to do so is now, as the 90-day Public Comment period on the SEC’s proposals ends on August 7^th. So, if you haven’t submitted your own comments to the SEC about why Regulation Best Interest and Form CRS should, or shouldn’t, move forward… now is the time to make your voice heard!

Weekend Reading for Financial Planners (July 28-29)

July 27, 2018 02:54 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with a look at the recent Focus Financial IPO, which did in fact go off as planned this week, at a lower price than the rumored peak, but far higher than first anticipated when the IPO was announced, with trading that began at $33/share and closed at $37.55 after the company's first day... which at a multiple of nearly 18X EBITDA, is both a tremendous validation of what markets in the aggregate still see as the promise of the independent RIA model, and will likely fuel a fresh wave of advisory firm roll-up aggregation and M&A.

Also in the news this week is a discussion of how CFP Board is beginning to gear up its compliance enforcement capabilities more than a year in advance of its new fiduciary Standards of Conduct that will take effect in October of 2019, and the questions that still linger after the FPA not only terminated its affiliation agreement with a challenged New York chapter but chose not to replace the chapter with a new independent nonprofit entity (as exists for its more-than-80 other chapters) and instead decided to roll the FPA of Metro New York into the national FPA organization, and raising questions about whether the approach may be a template for national attempting to centralize more of its chapter system in the coming years.

From there, we have several articles on investment themes, from a paper in the Financial Analysts Journal suggesting that Bill Sharpe's famous "Arithmetic of Active Management" (suggesting that the average active manager return will and must underperform the market in the aggregate, net of fees) may not be valid in practice due to the existence of IPOs and share repurchases along with additions and deletions from public market indices (which creates opportunities for active managers to still add net value at the margins), to a look from Research Affiliates at when and whether investment manager selection is really worth the effort (at least compared to simply trying to help clients better manage their own behavior), and a candid look from Morningstar at how its own new Morningstar Analyst Ratings have performed after their first 5 years (finding that Gold ratings do predict risk-adjusted outperformance, and Negative-rated funds underperform, but Silver, Bronze, and Neutral funds are ending up in a murky middle).

We also have a series of articles on client communication, including some good icebreaker questions on how to get clients or prospects to start talking about themselves, 10 "tactless" things that advisors often have to tell clients to help them face reality, and what to consider in the unfortunate situation you actually need to communicate to a client that it's time to end the relationship (i.e., to "fire" the client).

We wrap up with three interesting articles, all around the theme of how increased longevity, paired with increased connectivity, are changing the ways we work and the ways we take breaks from work: the first explores the rising interest, especially amongst Millennials, in taking sabbaticals (and even 1-2 year stints off from work) as an alternative to just working continuously for 40-50+ years (given increased longevity) and then taking the vacations all at the end; the second looks at how the conventional view is that you have flexibility to "goof off" and pursue your passions while you're young, but in reality, we often don't really know what we enjoy and want to pursue when we're young, and that perhaps a better formula is to just focus on working hard in the early years and aim to pursue your passions in your 40s and 50s instead (when your life is more stable and you better know what you actually would want to do); and the last makes an interesting case that, in a 24/7 ever-connected world, perhaps it's a good idea to deliberately live a "24/6" lifestyle, where we take one "digital sabbath" per week to completely unplug and focus on ourselves, our health, and our relationships... both because doing so seems to improve our happiness, and because the alternative has a greater risk of leading to burnout, anyway!

Enjoy the "light" reading!