Nerd's Eye View blog

Weekend Reading for Financial Planners (Nov 9-10)

November 8, 2013 02:02 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with three articles highly critical of the CFP Board. The first is a warning from FPA Board President Michael Branham that the CFP Board's consideration of becoming a CE provider and competing against the 1,200 CE education providers it regulates is an untenable conflict of interest that could cause "irreparable damage" to the credibility of the CFP marks. The second article is a discussion of the latest CFP Board debacle when it granted amnesty to hundreds of wirehouse brokers who had violated CFP Board rules in their compensation disclosure on the CFP Board's own website, even while it publicly and privately disciplined other advisors - including former CFP Board Chair Alan Goldfarb - for similar offenses. The third article is from a CFP certificant who works with clients strictly on a fee-only basis, but because of an unrelated ownership interest is not permitted under CFP Board rules to state that he is "fee only" - and declares that if necessary, he will drop his CFP certification rather than cause client confusion by stating he is "commission and fee" when in reality no clients will ever pay any commissions.

From there, we have several practice management articles this week, including one that provides an overview of the 10 types of online investment startups that may impact financial advisors (some favorable, some complementary, and some competitive), a second that provides some coverage of this week's T3 Enterprise conference for advisor technology, and a third that provides an interesting process about how to craft a client value proposition statement (without all the data, numbers, and target client demographics typical of so many client value propositions).

There are also a few technical articles, including one looking at potential tax law changes that may be coming as a part of the December 13th Congressional budget negotiations (high on the list for planners: potential changes to the favorable payroll tax treatment of S corporation dividends), a second explaining the recent judicial challenge to the premium assistance tax credits that could have a significant "surprise" impact on the Affordable Care Act, and the third providing some excellent advice from 529 guru Joe Hurley about how to properly handle grandparent-owned 529 plans while preserving favorable financial aid treatment for the grandchild/student.

We wrap up with three interesting articles: the first provides a fascinating analogy that compares low- versus high-cost investing to joining gyms that have donut-eating requirements; the second points out that just as planners recognize that financial planning should be about the clients and their goals and not the numbers, financial planners themselves should focus less on numbers-centric business coaches and more on holistic-goal-centric life coaches; and the last provides a humorous look at the so-called "robo advisors" by putting forth a list of 10 questions that consumers can ask to vet their robo-advisor (a riff on the all-too-common "10 questions to ask to vet your financial advisor" articles). Enjoy the reading!

The Impact Of Taxes On The Safe Withdrawal Rate

November 6, 2013 07:07 am 8 Comments CATEGORY: Retirement Planning

While the first safe withdrawal rate research originated nearly 20 years ago, it was simply based on an analysis of the sustainable cash flows that could be drawn from a portfolio over a 30-year time horizon based on various historical scenarios, ignoring the impact of fees and taxes. Of course, in the real world clients must bear the cost and impact of both, which reduce not only the amount of growth that the portfolio enjoys over time, but also the level of sustainable cash flows.

In reality, though, extensive research has been done over the past two decades to model the impact of taxes (and fees) on safe withdrawal rates. The impact is not as severe as some might fear - it's not as though the safe withdrawal rate must be chopped by 25% for a client in the 25% tax bracket - due to the fact that taxes have a natural self-mitigating effect, as they are only due when the portfolio has appreciated (which is when it has the most money available to pay those taxes). Of course, if the account actually is a pre-tax IRA, though, the net spending really does have to be reduced for the entire marginal tax rate!

Although the application of these adjustments can become complex when combining taxable accounts, pre-tax retirement accounts, and tax-free Roth IRAs, the fact remains that a proper application of the safe withdrawal rate research should reduce a client's recommended spending to account for the future drag of taxes, along with investment expenses and advisory fees. On the other hand, the good news is that other factors can help to boost the safe withdrawal rate as well, including a client's greater diversification (i.e., more diversified than the original research assumptions), spending flexibility, and varying time horizon. Ultimately, all of these adjustments can be incorporated to arrive at an appropriate safe withdrawal rate recommendation for a client.

Helping Clients To Switch Behavior By Directing The Rider, Motivating The Elephant, And Shaping The Path

November 4, 2013 07:01 am 5 Comments CATEGORY: Client Trust & Communication

Even though in the end much of the success in a financial planning engagement ultimately comes down to behavior change - helping a client alter whatever he/she was doing towards something that will better allow them to achieve their goals - there is still remarkably little education and training for financial planners focused directly on behavior change. Instead, advisors must turn to resources from other industries and professions to find ideas and best practices about how to help their clients actually make the behavioral changes necessary to achieve their goals.

A recent new book, however, makes headway in this regard. "Switch" by Chip and Dan Heath, provides one of the most accessible books yet on understanding behavior change and the techniques that can help to bring it about. Using a fantastic series of metaphors, the Heath brothers liken the battle in our brains between the rational and emotional sides as an elephant and its rider - noting that at best, the rational rider can help to steer the direction that the two will go, but that ultimately it's the energy and drive of the elephant that will dictate most outcomes. Accordingly, the authors suggest that the best way to ultimately achieve behavior change is through a combination of efforts, to direct the rider, motivate the elephant, and shape the path that the pair must follow to help guide the outcome.

The book provides a remarkably good framework for financial planners, who arguably spend a great deal of time oriented towards directing the rational rider to long-term goals, but don't spend very much time at all focused on how to motivate the elephant or shape its environment. In fact, many planners are notorious for focusing entirely on the "rational" solutions without engaging "messy" client feelings (a classic "rider-centric" planning approach), and we often spend almost no time at all thinking about how clients can reshape their environment to help themselves succeed (for instance, by encouraging clients to find a social support group for their problematic spending behaviors, or suggesting that they think about relocating to a neighborhood or getting a different group of friends who will be less likely to encourage their bad spending behavior). While the book "Switch" doesn't necessarily provide a lot of new and original research (at least for anyone who's read the works of many of the primary researchers in this space from Daniel Kahneman to James Prochaska), it provides what is easily one of the most accessible treatments of the topic that can help planners to think fresh about how they might incorporate more behavioral change techniques into their own practices!

Weekend Reading for Financial Planners (Nov 2-3)

November 1, 2013 01:31 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with the latest IRS announcement of 2014 inflation adjustments, which will move everything from the top 39.6% tax bracket to the AMT to a new Federal estate tax exemption (up to $5.34M next year), though many key areas will have no change, including IRA contribution limits (still $5,500) and the annual gift tax exclusion amount (still $14,000/year). There was also a second big tax announcement this week - the Treasury is relaxing the "Use It Or Lose It" rules for flex spending accounts (FSA), and instead will now allow up to $500 to be carried over to the following year.

From there, we have several articles related to the new health care exchanges and the shifting landscape for health insurance decisions, including one about how to counsel clients if they're just finding out their individual health coverage is being cancelled (hint: doesn't mean they can't get coverage, just that they have to get new coverage that meets the new requirements), a second providing a workaround for many financial planning clients and advisors who are struggling with the technical glitches on Healthcare.gov (if you don't need a Premium Assistance Tax Credit, just go through a health insurance agent!), and the last looking more broadly at how many financial planners are starting to develop an expertise in health insurance and Medicare as a specialization (especialy for retirees trying to navigate health care through their 50s and 60s).

We also have an array of technical and practice management articles this week, including: new foreign tax reporting requirements for clients who live (or retire) abroad under FBAR and FATCA; a reminder of the importance of having a privacy policy for your advisory firm (and the easy model templates available to craft one safely); a warning from the SEC that it is going to focus in 2014 on examinations of RIAs that have been around at least three years but have never been examined in the past; a list of reasons why it might be a good job to quit your advisory firm as an employee (along with an important reminder to try to work through problems first, and only view quitting as a last resort!); and a look at the industry trends around wirehouses (while there's been much discussion about the breakaway broker trend, it still amounts to little more than a trickle based on the amount of wirehouse advisors and assets).

We wrap up with three interesting articles to give you something to think about: the first is one of the more comprehensive overviews I've seen on all the academic research (good and bad) about the fiduciary standard and how such a standard might impact access to advice for the middle class; the second is a discussion from a former NestWise advisor (the LPL subsidiary that was aiming to bring financial advice to the middle class before it was abruptly shuttered a few months ago) about what was and was not working well as a practicing advisor on the platform; and the last is an interview with financial planning professor and researcher John Grable, who advocates for more "applied" research from academics that advisors can really put into practice with their clients. Enjoy the reading!

Using Social Proof To Help Clients Make Better Financial Planning Decisions

October 30, 2013 07:04 am 1 Comment CATEGORY: Client Trust & Communication

In uncertain situations, we often look for social cues about what to do based on what everyone else is doing. This kind of "social proof" can be highly effective in helping us to navigate what to do in the absence of proper information. In fact, sometimes the effects of social proof can be remarkably powerful, causing the herd to do something dramatic "because everyone else is doing it too," even if no one in the crowd actually knows why they're doing it!

Unfortunately, though, the principles of social proof are often used unintentionally, and in fact can be unwittingly applied to encourage negative behavior. From teenagers making irresponsible decisions because their friends are doing it, to baby boomers not saving for retirement due in part to a perception that no one else is doing it either, it's important to consider the social proof ramifications of any message that is communicated. Otherwise, there's a risk that explaining the commonality of a bad behavior will actually communicate to people that the behavior is socially condoned and that it's ok to do it!

On the plus side, though, financial planners are often in a good position to invoke the positive effects of social proof on behalf of their clients. If the "normal" behavior is bad, we can establish positive role models of what the normal behavior of a "good" outcome would be instead. On the other hand, applying social proof with clients also requires us to let go of the idea that absolutely every client scenario is completely unique, and instead try to identify ways that a client's situation are similar to others, to provide a positive social proof context. But the bottom line is that since our brains are hard-wired to create these kinds of comparisons, just ignoring the phenomenon is not an option!

How to Retain NexGen/Gen Y Advisors – A View From The Trenches

October 29, 2013 07:07 am 4 Comments CATEGORY: Practice Management

As financial advisory firm owners try to grow their practices, at some point the firm owner hits a wall where the only choices are to remain limited in size, or begin to hire. Yet the process of hiring a new junior advisor is difficult, given not only the different expectations that professional staff members (e.g., junior advisors/CFPs) have from administrative staff the firm might already have, but also because of the significant differences between today's "young" Generation Y advisors, and the more veteran advisors who are hiring them.

In this guest post, Gen Y advisor Mary Beth Storjohann, herself a "veteran" of financial advisory firms in many ways - having already worked for 5 firms in 10 years by the tender age of 29 - shares her own view "from the trenches" about what works and what doesn't work in trying to retain "NexGen" advisors. In a world where so much advice on hiring and retaining young advisors is driven by those who do the hiring - not those being hired - Mary Beth's perspective is illuminating in showing what Gen Y advisors themselves are thinking and looking for.

So if you're an advisor who's thinking about hiring a Gen Y advisor, or struggling to bridge the communication gap with your new advisor, this discussion will hopefully give you some ideas about what to do to better attract and retain new advisors in your firm. And if you are a Gen Y advisor, perhaps this discussion will give you a few ideas about what can help you succeed, what to look for in a firm, or even some suggestions that you can (gently!) make to your own firm owner about what the firm can do to help you both succeed.

Will Monthly Retainers Be The Next Big Business Model In Financial Planning?

October 28, 2013 07:05 am 14 Comments CATEGORY: Practice Management

The business of financial planning is in a state of flux, both within the US and around the world. The broad financial services industry has gone increasingly in the direction of a relationship-based assets-under-management approach, a combination of the potential to serve clients with ongoing financial planning, the allure of recurring revenues, and technology's brutal commoditization of many previously-profitable transactional business models - a potentially prescient shift, as the potential for fiduciary regulation in the US could further flatten much of the transactional commission-based model as is occurring with the regulatory reforms of other countries around the world.

Yet at the same time, financial planning faces a new challenge - the increasing focus on the AUM model has left it a profitable way to serve the asset-centric baby boomer generation, but is an ineffective model to reach the even-larger Generation Y that simply does not have the assets to support the model (along with a large segment of Gen X that, similarly, simply does not have the liquid net worth to work with advisors on an AUM basis). The end result is that as financial planning goes increasingly fee- and fiduciary-centric, it is struggling to find a way to serve "the rest" of the market beyond affluent baby boomers.

While the hourly financial planning model has shown some promise, its ability to gain traction has been limited, arguably due in part to the fact that it is a very transactional model for what is ultimately a relationship business, and because the pricing model makes the costs so salient for consumers that many balk at the immediate cost-benefit trade-off. Yet an alternative, through a combination of business refinements and the efficiencies of technology is beginning to emerge: a monthly retainer model, structured like a "financial planning subscription" that may finally open up financial planning to the middle class with a sustainable, profitable business model.

Weekend Reading for Financial Planners (Oct 26-27)

October 25, 2013 12:04 pm 4 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with three interesting industry articles: the first looks at some recent strong statements from the FPA at its recent FPA Experience conference against the CFP Board, even while the organization renews its commitment to CFP professionals; the second is an interview with Sheryl Garrett of the Garrett Planning Network and how the network and its advisor members continue to evolve; and the third is a prospective look at how the financial services industry is changing in the coming two decades, heavily influenced by its currently low position on the trust/reputation scale after a decade of financial services scandals and debacles.

From there, we have several practice management articles this week, including: the benefits some advisors are finding in expanding their practices to lower net worth clientele; advice from practice management consultant Angie Herbers about how female advisors need to get comfortable being more "selfish" and acting on their own behalf; and how running a financial planning business is like poker, in that if you're sitting at a difficult table, you can always get up and change tables (and change your business model/target clientele).

There are also a few technical articles, including one about how risk tolerance measures could be improved, another looking at some examples of the size of premium assistance tax credit subsidies for those buying health insurance on the exchanges (which, because the rules are based on income only, can apply for clients even with a very high net worth), and a look at how advisors are increasingly using HELOCs again as home equity levels rise and banks become more willing to lend.

We wrap up with three interesting articles: the first looks at how dramatically life expectancy has increased over the past 150 years, though despite significant medical advances it turns out the driving force of the improvement has been our ability to better manage (and avoid) the spread of disease; the second looks at how you can inspire more creativity and build a "culture of healthy debate" in your advisory practice to encourage growth; and the last is a "manifesto" from blogger and personal finance writer Ramit Sethi, who makes the case that people would be better served by focusing less on traditional financial advice around budgets and trimming little expenses, and more on the "Big Wins" that can really meaningfully impact their finances and more importantly, establish healthy financial behaviors. Enjoy the reading!

Should Advisors Use Series I Bonds To Hedge Inflation And Rising Rates In Client Portfolios?

October 23, 2013 07:01 am 10 Comments CATEGORY: Investments

Government bonds that pay a rate of return that adjusts with inflation to ensure investors receive a fixed, real return have been around since the late 1990s. The most popular form are Treasury Inflation Protected Securities (TIPS), which can be purchased in brokerage accounts or directly from the Treasury, are actively traded in the secondary market, and are often pooled together into increasingly popular mutual funds and ETFs as investors worry about the risk of future inflation. Yet shortly after the arrival of TIPS, the U.S. Treasury also began to issue "Series I Bonds" directly to investors; these government savings bonds were an alternative to the historical Series E/EE and H/HH bonds, but like TIPS offered a rate of return that would float with inflation and ensure a specific fixed, real rate of return.

As real interest rates declined over the past decade, and the U.S. government experienced a sharp increase in debt issuance, TIPS have become increasingly popular as a way to hedge against the risk and fear of future inflation. Given the nature of their return, arguably I bonds can do so as well, but with one notable feature that makes them quite unique: the U.S. Treasury is always available to redeem Series I bonds at their full value, which eliminates any risk that their prices could decline if/when/as interest rates rise. In addition, unlike TIPS bonds, that have some very unfavorable tax treatment (which is why they're often held within IRAs), the I bond actually accrues and compounds its interest without paying it out, which allows the investor to both avoid reinvestment risk and enjoy automatic tax deferral as long as the savings bond is held!

Given these unique features and benefits of Series I bonds, arguably financial planners and their clients should be looking more closely at I bonds (or "Ibonds"!) as a potential way to hedge inflation and rising interest rates in client portfolios, or simply to use as an alternative to cash or ultra-short-term fixed income at a more appealing yield. Unfortunately, dollar amount limitations on the purchase of I bonds restricts the extent to which they can be used, and the requirement that I bonds be held in a TreasuryDirect account (and not a standard brokerage/investment account) further limits the practicality of their use. Nonetheless, for clients who are looking to manage their exposure to inflation and rising rates, or would simply like a better return on emergency funds or short-term funds they don't plan to use for a few years anyway, perhaps it's time to give Series I bonds a closer look.

Financial Planning For Gen X And Gen Y Clients: Focus On Human Capital First

October 21, 2013 07:03 am 2 Comments CATEGORY: Human Capital

For those who are retiring, their income needs for the remainder of their lives will be funded by their financial capital - the numerous assets that have been accumulated in various types of accounts, that can either generate income directly, or be systematically liquidated to free up necessary cash flows. For younger clients, though, the reality is that their "human capital" - the ability to generate earnings from their labor - is actually the greatest asset on their balance sheet, and financial capital simply represents human capital that was converted to income and saved rather than spent.

From this perspective, the reality is that for younger clients, financial planners can bring significant value to the table by helping clients to enhance and maximize not just their financial capital, but also their human capital. Sometimes, it may even be better to invest in the client's career than a tax-preferenced retirement account, and many clients unwittingly fail to diversify between their financial and human capital.

Accordingly, in the future firms that are aiming to serve younger clientele should consider adding "career asset management" services, and advising clients on their career decisions, and not focus too heavily on "just" the financial products clients need to purchase or the assets they have available to manage. In fact, such services may be especially conducive to an ongoing retainer-style financial planning engagement, and become a way for advisors to bring value to the large number of underserved Gen X and Gen Y clients. And of course, clients who are effective maximizing their human capital in the early years may even become the clients with the most financial assets in the future, too!