Nerd's Eye View blog

MailBag: Deducting Investment Management Fees Against Net Investment Income For The 3.8% Medicare Portfolio Surtax

July 25, 2013 11:03 am 0 Comments CATEGORY: MailBag

Many readers of this blog contact me directly with questions and comments. While often the responses are very specific to a particular circumstance, occasionally the subject matter is general enough that it might be of interest to others as well. Accordingly, I will occasionally post a new "MailBag" article, presenting the question or comment (on a strictly anonymous basis!) and my response, in the hopes that the discussion may be useful food for thought.

In this week's MailBag, we look at a question about whether/how to deduct investment expenses - including investment management fees - against net investment income for the purposes of calculating a client's exposure to the new 3.8% Medicare surtax.

Understanding The True Impact Of A Single Premium Immediate Annuity On Retirement Income Sustainability

July 24, 2013 11:01 am 14 Comments CATEGORY: Retirement Planning

In today's low-return environment, retirees have become increasingly stressed about the potential risk of outliving their retirement assets, which in turn has led to an increasing call for strategies that at least partially annuitize a portion of the portfolio. After all, a single premium immediate annuity (SPIA) provides a lifetime stream of income that by definition cannot be outlived, and the potential for long-lived retirees to earn mortality credits creates the potential to earn significantly more cumulative return than what bonds alone can pay. In fact, a great deal of research over the past decade has shown that partial annuitization of a portfolio can improve retirement income sustainability over portfolio-based strategies alone.

Yet in new research produced by yours truly, along with retirement researcher Wade Pfau, it appears that the prior research may not be entirely correct. While it's true that for extreme longevity scenarios, SPIAs provide an unparalleled return and enhance retirement outcomes, the strategy as commonly implemented is also an indirect form of a bucket strategy that disproportionately liquidates fixed-income assets in the early years and lets the rest of the (risky) portfolio run. By reducing withdrawals from risky assets in the early years, the exposure to potentially unfavorable return sequences is diminished, even as the total allocation to equities rises throughout retirement.

In fact, as the results show, the majority of the benefits commonly attributed to partial annuitization are actually just the indirect result of a bucket strategy that produces a rising equity glidepath. While SPIAs do still provide superior results for very long-lived retirees, it truly takes extreme longevity - i.e., married couples living beyond age 100 - before the contribution from mortality credits actually outweighs the benefits of just using a strategy that liquidates more fixed income in the early years and allows equity exposure to rise. Accordingly, the bottom line is that for retirees who truly want to hedge extreme longevity, the benefits of SPIAs remain unmatched, but for most retirees who will not live that long the reality is that SPIAs not only fail to provide benefits, but they can actually produce results inferior to just replicating the rising equity glidepath without annuitizing at all!

Financial Planning Success Means Being A Giver Without Being Taken Advantage Of

July 22, 2013 11:03 am 2 Comments CATEGORY: Personal/Career Development

Helping professions like financial planning often attract "Givers" - people who are naturally inclined to put others before themselves and help those people to succeed. Yet the challenging reality for many helping professions is that often the practitioners go so far out of their way to help others that they undermine their own careers and success in the process. When comparing Givers who tend to focus on others, and Takers who put themselves first, it's no surprise that those at the bottom of the success ladder are often a group of burned out and worn out Givers.

Yet recent research from Wharton Professor Adam Grant made a startling discovery; while the bottom of the success ladder is populated by Givers, the top of the ladder is also dominated by Givers! In other words, the traits that lead some people to be Givers who are taken advantage of lead others who are also Givers to propel themselves to success. Accordingly, in his research Grant digs further to identify what the key traits are that separate the successful Givers from the unsuccessful ones, and how anyone can set themselves on a more successful path.

Although the book is written as a guide for success in any business context, the lessons of Grant's research are certainly relevant for financial planners in particular, from how to help those experiencing burnout, to making slight changes in your Giver behavior to keep from "being a doormat," to how to shift the Takers in your business to act more like Givers for the benefit of the team. Ultimately, changing one's style of interacting with others is difficult - the implications of Grant's research are profound, but certainly not a cure-all. Nonetheless, what emerges is some interesting clarity about why some financial planners seem to build growing, successful businesses, while others stay mired in a practice that can't seem to get ahead.

Weekend Reading for Financial Planners (July 20-21) – Practice Management & Technology Edition!

July 19, 2013 05:01 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's issue is focused on articles about practice management, career development, and technology, and kicks off with a discussion from industry commentator Bob Veres about advisor fee models, particularly the AUM fee model, and how many are looking at changing and evolving beyond an AUM-centric business focus.

From there, we have a number of practice management articles, including a discussion of whether advisors are increasingly "stealing" clients from others in order to grow, how many succession planning deals are actually poorly structured and priced, and the importance of having a career track in your firm to attract and retain talent (and potential future successors!).

There are also a number of technology-related articles, including a review of new digital content marketing services Vestorly and AdvisorDeck, a review of financial planning software eMoney Advisor and how it can also serve as a personal financial management tool for clients, the importance of adopting rebalancing software, the viability of using cloud-based office productivity software like Microsoft Office 365 or Google Apps, and how to balance the benefits of marketing automation with the importance of personalized service.

We wrap up with three final articles: the first is from Angie Herbers and looks at how relinquishing some control to employees is crucial for staff (and ultimately the firm itself) to grow and develop; the second is a case study discussion of the XCelsior study group as an example of the importance and value of being involved with a study group; and the last looks at how clients in the future will have different needs and expectations of their advisor than the baby boomers of the past, and that becoming a "Gen-Savvy Financial Advisor" in order to succeed may require not just an evolution for advisors but an entire revolution from the way things are currently done. Enjoy the reading!

MailBag: Advice For A Career Changer Transitioning Into Financial Planning

July 18, 2013 11:04 am 5 Comments CATEGORY: Personal/Career Development

In this week's MailBag, we look at a question about how best to transition as a career changer into financial planning, the issues to consider, and some best first steps to take.

Why Inferential Statistics Is A Lousy Way To Evaluate Active Managers

July 17, 2013 11:03 am 15 Comments CATEGORY: Investments

Determining whether investment results are due to luck or skill is no small task for even skilled analysts evaluating an active investment manager; given the amount of randomness inherent in markets, it can be very difficult to determine which is which. Fortunately, the field of inferential statistics exists specifically to analyze such situations and help to distinguish the signal from the noise, and determine when results are likely randomness and luck versus when there is at least a high probability that skill or some other factor is at play.

When inferential statistics is applied to evaluating active management, the results are questionable at best - a small subset of managers are clearly inferior, and for virtually all the rest, there are simply no clear indicators of skill at all; even when some modest level of outperformance occurs, the results are rarely ever statistically significant. Of course, just because an actively managed fund has outperformance that is not statistically significant doesn't mean the manager isn't actually generating real outperformance and adding value. It's just that the outperformance isn't large enough relative to overall market volatility to clearly show whether the results are due to luck or skill.

Unfortunately, though, the caveat is that given just how incredibly volatile markets really are, searching for "statistically significant" outperformance may actually be a lousy approach for evaluating managers; even if a manager really does outperform for an extended period of time, the available tests simply are not capable of distinguishing skill from market noise given the tenure of even long-standing managers. In fact, when tested to determine the effectiveness of the approach in the first place, the reality is that even if a manager is adding several hundred basis points of outperformance, annually, for more than a decade, there is still a more-than-90% likelihood that inferential statistics will FAIL to identify the signal that really is there.

In other words, if the goal is actually to determine which active managers really do add value, searching for statistically significant outperformance is an approach with an overwhelming likelihood to fail, even in situations where it should be succeeding! Which means in the end, failing to find statistically significant outperformance amongst active managers may actually be less a failure of active management itself, and more a problem with using an approach that was unlikely to successfully identify good managers in the first place!

Using Photos To Humanize The Connection Between Clients And Their Financial Planning Firms

July 15, 2013 11:05 am 2 Comments CATEGORY: Marketing

As communication becomes increasingly virtual, from telephone calls to emails, it becomes harder and harder to ensure that interactions between the staff and clients of any firm maintain their personal touch. Yet maintaining that personal connection with the individual client is crucial; in fact, a recent study in medicine found that radiologists are dramatically more effective in their analysis of scans of patients they've never met, simply by attaching a photo of the subject to help make the interaction more personal.

The opportunity to reinforce such connections is equally relevant in a financial planning firm, and equally feasible to implement. Just as the radiologist demonstrates a better connection to their patients with the photo - and report feeling more empathy on behalf of their patients - so too can client photos be attached to client files, or loaded into the main page of a client's CRM record, to ensure staff bear in mind the human being at the other end of the account/phone call/email message.

In addition, the reality is that the need for a visual personal connection in a virtual environment goes both ways. As a result, it's perhaps equally important to include a picture of all your staff members on your website - or even in the signature of their emails - to help clients understand who they're relating to as well. And the issue is relevant for the financial planners themselves, too; while planners will typically meet with their clients in person, at some point before a client is a client, they're a prospect who might visit your website to do their due diligence. When a potential client looks you up on your website, what is their first impression? Do they have a chance to make a visual connection and actually SEE you?

Weekend Reading for Financial Planners (July 13-14)

July 12, 2013 05:02 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's issue starts off with a summary of some of the final comment letters submitted regarding the SEC's request for information for a cost-benefit analysis about a uniform fiduciary standard. Why industry organizations like SIFMA and NAIFA indicated that a fiduciary standard would significantly increase compliance costs and force advisors to stop serving middle market clients, the results of a Financial Planning Coalition study found that fiduciary advisors generate significantly more revenue - suggesting that revenue growth could more than offset any higher costs - and that there are no statistically significant differences between the number of middle-market clients that fiduciary vs non-fiduciary advisors currently serve.

From there, we have a wide array of technical articles, including: a discussion of the ongoing Commission on Long-Term Care established by the American Taxpayer Relief Act to propose structural solutions to the country's long-term care challenges; a great overview of the coming new health insurance rules and how to start planning for them; a discussion of the importance of disability insurance for both clients and advisors themselves; a look from Ed Slott at how the Net Unrealized Appreciation strategy may be a little less appealing at today's long-term capital gains tax rates; and an intriguing analysis by Moshe Milevsky that in some circumstances equity-indexed annuities with guaranteed living benefit riders might actually produce slightly more income than a simple single-premium immediate annuity.

There are also a number of investment-related articles this week, from a review of recent applied research by Harold Evensky in the Journal of Financial Planning, to a discussion by Bob Veres of five new investment approaches being implemented by advisors that appear to have value, to a look at whether it's time to acknowledge that the efficient frontier of mean-variance optimization is more like an efficient "range" because ultimately neither the inputs to the model nor the preferences of investors are really as precise as a strict interpretation of Modern Portfolio Theory implies. There's also a good review of the recent Active Share research and why "hyperactively managed" funds may be best outperformers of all actively managed funds.

We wrap up with an article from industry veteran and luminary Richard Wagner, who suggests that financial planning could become the most important profession of the 21st century, as we human beings collectively become increasingly cognizant of the powerful role that money exerts in our lives, and the unique contribution that financial planners can bring to the table in helping clients to navigate those forces effectively. Enjoy the reading!

Solving The Annuity Puzzle – Inflexibility For Handling Potential Health Care Shocks In Retirement

July 10, 2013 11:06 am 20 Comments CATEGORY: Annuities

From the perspective of economics and life cycle finance, the immediate annuity is often viewed as the perfect retirement vehicle; in research dating back to Yaari (1965), it has been shown that for someone whose primary concern is outliving his/her money (as opposed to leaving a bequest to future generations), investment dollars should be annuitized to generate a superior return over bonds (due to mortality credits) while protecting against mortality risk.

Yet economists have long struggled to explain the so-called "annuity puzzle" - the fact that while the research suggests annuitization should be optimal, in practice remarkably few people ever choose to do so. Does that mean they're all just being driven by an irrational decision-making process and just need to be better educated to understand the true benefits of immediate annuities, or is there some other factor at play?

In new research, researchers Felix Reichling of the Congressional Budget Office and Kent Smetters of the Wharton School of Business think they have found a new way to explain the puzzle: the fact that the value of an immediate annuity changes over time due to incremental (and sometimes shocking) changes in health and mortality. In fact, it can be the worst of both worlds - severe health events can simultaneously reduce life expectancy (decreasing the remaining value of the annuity) and increase cash flow needs (to pay for the necessary care). And when viewed in this dynamic context, the value of annuitization can be quite risky indeed; so much, in fact, that Reichling and Smetters find that for those who are relatively risk averse and/or have limited retirement assets, that the most rational annuity allocation might be to avoid them altogether, and the ideal might even be for many to have negative exposure and "short" annuities instead!

Fee ONLY, Compensation Disclosure For CFP Certificants, And The Strange Case Of Alan Goldfarb

July 8, 2013 11:02 am 5 Comments CATEGORY: Planning Profession

After a sudden resignation last fall, Alan Goldfarb, the former Chair of the Board of Directors of the CFP Board, has been found to have violated the CFP Board's Rules of Conduct for failing to properly disclose his compensation, after he claimed on FPA's PlannerSearch that he was "fee-only" and later "salaried" when in reality a "related party" was eligible to receive commissions from Goldfarb's clients. As a result, the CFP Board's Ad Hoc Disciplinary and Ethics Commission that investigated the matter has issued a public Letter of Admonition for Goldfarb's conduct.

Yet the details of the case suggest that the matter was not as clear as the initially reported findings suggested; Goldfarb's ties to the "related" broker-dealer were through a parent accounting firm that owned both his RIA and the broker-dealer, and Goldfarb himself held only a small 1% equity interest in the firm and was otherwise not compensated. By contrast, even NAPFA guidelines dictate that less-than-2% interests are de minimis, yet the CFP Board declare that because of these related interests Goldfarb should not have labeled himself as "fee only" even though all of his clients in reality only ever did in fact pay him fees through his own RIA.

At a higher level, though, the real issue in the Goldfarb case is that such a strict interpretation of what does and doesn't constitute "fee only" could cause even many large and well-known RIAs to "fail" the test, and renders the definition of "salary" almost moot, and is a problematic reminder of how opaque the CFP Board's adjudication process can sometimes be due to its privacy obligations as a private entity. In addition, taking such an extreme position regarding "fee only" will arguably result in so many financial planners being classified as receiving both commissions and fees - regardless of whether the commissions constitute 0.1% or 99.9% of total compensation - as to render the disclosure relatively useless as a consumer protection. Furthermore, the Goldfarb result also leaves us unclear about where to draw the lines on what constitutes "trivial" or immaterial compensation conflicts, related parties, overlapping ownership of holding company subsidiaries, and complex real-world arrangements that could unwittingly render advisors on the wrong side of the line.

In the end, a strict interpretation of the Goldfarb conclusions about what constitutes "salary" and "fee only" could mean that thousands of current CFP certificants are not complying properly with the rules, and that many need to update their information immediately! But perhaps ultimately, the best outcome for this whole situation is to hope that it can serve as a catalyst for better clarification on the rules for compensation, and an improvement in the transparency of CFP Board's enforcement process to allow clearer *(and better?) precedents to be set for the future.